The 2019 legal landscape of employee mobility continues to evolve, at times drastically. Courts and legislatures are giving increased scrutiny to employers’ claims to protect the confidentiality of their trade secrets and attempts to enforce their employees’ restrictive covenants, including non-competition and non-solicitation agreements. It can be hard for employers to prevent their confidential information and client goodwill from following certain departing employees.
With greater knowledge of the latest legal theories, decisions, statutes, and other developments in this area, employers can better protect and defend their interests—even preemptively—including in the ways they draft their employee agreements, design their compensation structures, and consider whether and when to engage in litigation.
This issue of Take 5 aims to provide a few tools for deciphering and navigating this changing employee mobility landscape.
Drafting Employment Agreements to Comply with New State Laws and Pending Legislation Restricting Enforceability of Non-Competes
In the last year, Maryland, Massachusetts, Oregon, and Washington State passed game-changing laws that restrict the enforceability of provisions between an employer and an employee that limit the employee’s post-termination ability to work in competition with the employer. Numerous other state legislatures, including Missouri’s, New Hampshire’s, and New Jersey’s, recently have considered similar legislation.
Employers can get ahead of this trend by implementing the following measures when preparing and presenting non-compete agreements to new and existing employees:
- Do not ask low-wage or junior-level employees who do not have important client relationships or access to company trade secrets to sign non-competes.
- When presenting a non-compete agreement (and it must be in writing), provide the individual with at least 10 days’ notice and an opportunity to review the agreement with counsel.
- Provide compensation to the employee during any non-compete period. For a non-compete presented to an existing employee, offer more consideration than mere continued employment.
- Limit the duration of any non-compete to one year at the most, and preferably less.
- If including a choice of law or forum selection clause, specify the state where the employee works or resides.
- Keep the scope of the non-compete restriction reasonable by limiting it to the specific industry, job duties, and/or geographic area in which the employee worked for the employer.
- Advise departing employees of their ongoing non-compete obligations.
While no guarantee of enforcement, adherence to these measures will increase the likelihood that a non-compete will be upheld if challenged in court or arbitration.
Red Flags When Recruiting a Competitor’s Employee: Spotting Issues Before a Demand Letter
Winning in restrictive covenant litigation is one thing, but most employers would prefer to avoid it if possible, or at least make decisions with “eyes wide open” as to the litigation risks of a potential hire. Below are some “red flags” that may motivate a dispute.
The Former Employer’s Sensitivities, Generally and Specific to the Candidate:
- What are the resources and litigation appetite of the former employer? Non-compete litigation is expensive and comes with significant risk. Does the former employer have a history of filing such litigation? Is the former employer aggressive in enforcing restrictive covenants, and under what circumstances?
- How sensitive is the former employer likely to be about the loss of the candidate? How senior or junior is the candidate? Is he/she a practice leader or individual contributor? Does the candidate hold key client relationships, trade secrets, or other intellectual property (“IP”) knowledge that may motivate litigation?
- Did the candidate take any IP or other property of the former employer? A belief the candidate stole IP casts the candidate as a bad actor and opens up statutory claims for theft of trade secrets. The new employer should expressly remind candidates to take and bring nothing from their former employer.
- How vulnerable are the restrictions in the candidate’s agreement if an enforcement action is filed? The restrictions may be overly broad and out of step with recent case law in the applicable jurisdiction. The greater the vulnerability, the less likely the former employer will bring litigation.
The Former Employer’s Sensitivities to the Candidate’s New Employment:
- Is the new employer a direct or indirect competitor of the former employer? The more direct the competition, the more likely the former employer is to be motivated to take action. It may be possible to avoid a dispute by providing assurances the candidate will not, for the restricted period, solicit the customers or employees of the former employer.
- Is the candidate being hired in substantially the same role as at the former employer? Hiring into a different role, at least for the duration of the restriction, may avoid a dispute. Former employers have limited ability to monitor the candidate’s activities, but a representation may be enough.
- Is the candidate being hired to work/compete in the same geographic area or market space? A candidate moving to a competitor in the same city or market may lead to a dispute. If this can be avoided for the duration of a restriction, there is a greater likelihood of resolution without litigation.
The Parties’ History:
- Is the former employer’s perception likely to be that the new employer is targeting its employees? Is the candidate the first or just the most recent individual hired from the former employer? Did the new employer recruit the candidate, or did the candidate make the first contact about employment? One or two hires may go unchallenged, but additional hires, particularly over a short period, increase the risk of litigation.
- Has the former employer previously hired employees of the new employer, and how did the new employer react? If the new employer’s previous reaction was to file suit to prevent an employee from working for the former employer, one shouldn’t expect the former employer to turn the other cheek when the situation is reversed.
- Are there other indications of bad blood between the parties? Have there been other disputes between the new employer and former employer that led to litigation? Has the candidate or new employer disparaged the former employer in the marketplace? The more bad blood, the greater the risk of litigation.
ERISA Nonqualified Deferred Compensation Plans, Restrictive Covenants, and ERISA Preemption
Although typically the province of state law, Employee Retirement Income Security Act (“ERISA”) preemption may override state law limitations when forfeiture-for-competition covenants come within the purview of an ERISA benefit plan. Valid forfeiture provisions in ERISA plans, therefore, may be enforced even in states where forfeiture-for-competition clauses are not typically enforceable.
The most suitable type of ERISA plan for a forfeiture-for-competition clause is a type of nonqualified deferred compensation plan colloquially known as a “Top Hat Plan.” Top Hat Plans are a category of unfunded ERISA plans maintained “primarily for the purpose of providing compensation to a select group of management or highly compensated employees.” In general, “ERISA preempts state law regarding forfeiture of retirement benefits.” ERISA also has been found to preempt state laws limiting the enforcement of non-competition clauses in Top Hat Plans. This suggests that employers with Top Hat Plans including forfeiture-for-competition clauses could use those forfeiture clauses to enforce restrictive covenants that would otherwise violate state law if provided under an agreement not subject to ERISA.
Top Hat Plans with embedded forfeiture-for-competition clauses also could afford employers advantages in adjudicating whether departing employees violated their non-competition obligations. If Top Hat Plan documents clearly state that the plan administrator maintains discretionary authority to determine benefits eligibility and to construe the terms of the Top Hat Plan, many courts will afford the plan administrator’s determination a deferential standard of review. Employers sponsoring a Top Hat Plan with embedded forfeiture-for-competition clauses should proceed with their eyes open concerning what this provision can and cannot accomplish. A restrictive covenant in a Top Hat Plan does not directly prohibit the behavior; rather, it is only enforceable to the extent compensation is forfeited as a result of the behavior. Further, the purpose of a traditional Top Hat Plan is to provide a stream of retirement income to key executives and not necessarily as a tool to enforce restrictive covenants, so any restrictive covenant provisions should be considered in the context of the purpose of the Top Hat Plan, the plan design, and the overall compensatory policies of the employer.
A Judge’s Tips for Keeping Trade Secrets “Secret”
Just because information is sufficiently sensitive and valuable that it can qualify as a “trade secret” does not mean that it will qualify unless the owner of the information takes adequate steps to protect its secrecy.
In a recent decision, Judge John J. Tharp, Jr., of the U.S. District Court for the Northern District of Illinois explained that “there are two basic elements to the analysis” of whether information qualifies as a “trade secret”: (1) the information “must have been sufficiently secret to impart economic value because of its relative secrecy” and (2) the owner “must have made reasonable efforts to maintain the secrecy of the information” (internal quotation marks omitted).
According to Judge Tharp, some of those “reasonable efforts” that a company can take to maintain the secrecy of its information include:
- using non-disclosure and confidentiality agreements with employees;
- enacting a policy regarding the confidentiality of business information that is more detailed than a mere “vague, generalized admonition about not discussing [company] business outside of work”;
- training “employees as to their obligation to keep certain categories of information confidential”;
- asking departing employees whether they possess any confidential company information, and, if they do, instructing them to return or delete it;
- adequately training IT personnel about data security practices;
- restricting access to sensitive information on a need-to-know basis; and
- as appropriate, labelling documents “proprietary” or “confidential.”
As Judge Tharp made clear, companies that fail to institute reasonable measures to protect sensitive information do so at their own peril.
Can Plaintiffs Use an Antitrust Defense as a Weapon to Challenge Non-Competes?
On March 15, 2019, four radiation oncologists alleged that their employer, 21st Century Oncology LLC, and its related entities have maintained an illegal monopoly over the provision of radiation oncology services in three counties in southwest Florida in violation of federal antitrust laws. Dosoretz v. 21st Century Oncology Holdings, Inc., 2:19-cv-00162-UA-UAM, filed in the U.S. District Court for the Middle District of Florida, alleges that the anti-competitive conduct includes requiring the oncologists—the “only radiation oncologists in these counties”—to sign “onerous” non-compete agreements that stifled competition in the counties and “exclusive long-term contracts with key hospitals,” which allegedly created a monopoly on radiation oncology services for patients at those hospitals. The complaint seeks a declaration that (1) the defendants violated the Sherman Act through their anticompetitive practices and (2) the doctors’ non-compete agreements are unenforceable. Alternatively, the doctors seek to restrict the temporal and geographic scope of the overbroad non-competes. The defendants’ motion to dismiss is pending.
It is not easy to prevail on a monopolization claim premised on non-compete restrictions in employment agreements. As explained in Cole v. Champion Enters., 496 F. Supp. 2d 613, 635 (M.D.N.C. 2007), although “[t]here can be little doubt that the Sherman Act applies to [non-competes],” there is little “precedent”; “[o]ne explanation … may be the difficulty involved in proving that a post-employment noncompetition agreement violates the Sherman Act. Such agreements are not per se violations of the Sherman Act but must be analyzed under the rule of reason. To establish a violation under the rule of reason, one must prove that the agreement has an adverse effect on competition in the relevant market.”
The Dosoretz case is worth watching. If it progresses, it may provide valuable insight for non-competition litigants, whether they are asserting or fighting an antitrust claim premised on non-compete agreements.