This article continues our discussion from the last newsletter of important considerations on which companies should focus to create an enforceable array of competitive advantage protections. In this, and in subsequent client communications, we will focus on the most important considerations, not only contractually but also under state and federal common and statutory law.
Employee raiding covenants. Though most state courts will permit reasonable contractual restrictions on not soliciting other company employees, there are some jurisdictions that have refused to enforce such restrictions. Courts are also mixed on the extent to which an employee’s duty of loyalty, as opposed to a company officer’s fiduciary duty, restricts the employee from encouraging a co-worker to join the employee at a competitor, so you should review the state law that will apply to your situation.
Even in states where courts have not enforced postemployment restrictions on soliciting employees, an in-term restriction will generally be enforced, so you should apply such restrictions both during an employee’s employment and after termination. In deciding whether to enforce these restrictions courts look to protectable interests of an employer. They generally review such restrictions to determine whether they are reasonably necessary to protect an employer’s confidential information about its employees or justified by an employer’s interest in maintaining a stable work environment. Courts in some states have refused to enforce such clauses, concluding that an employer does not have a proprietary interest in its at-will employees or in their skills. In other cases, courts have held that there did not exist confidential information in need of protection. To demonstrate the need for such restrictions, it is often important to document the employer’s expenditures on training and maintaining the work force, and the efforts undertaken to keep information about its employees confidential.
The enforceability of post-employment employee non solicitation restrictions will often depend on the scope of the restriction. As with any restriction, they must be reasonable in terms of scope and duration (e.g., if circumstances supporting a protectable interest only justify a limited time period for the restriction, or the employee only works for and has knowledge about employees in one of the company’s facilities, the company should not overreach and prohibit solicitation of employees of affiliates or in facilities where there is no chance the employee has any confidential information about employees in other locations, or for a period of time long beyond what is justifiable).
On the other hand, it cannot be emphasized enough that when circumstances justify a post-employment employee non solicitation covenant, a company should not draft the restriction too narrowly. All too often, such restrictions are limited to “shall not solicit.” The result is usually that the court will then narrowly enforce the “non solicit” restriction and leaves the employee free to encourage other employees to leave. More inclusive drafting of the restriction will close that loophole.
Do I arbitrate?
In some industries, such as securities, arbitration of non compete and non solicitation issues is the norm and is accomplished efficiently. For most employers, however, arbitration is often not the best forum for resolving disputes stemming from the breach of such restrictions. Proponents of arbitration claim that, in seeking damages, arbitration is often swifter and less expensive. But, unless your industry is committed to and has considerable experience in such arbitrations, a company may better meet its needs in a judicial forum. The decision as to what is best for your company will be guided by the applicable state law and the court in which the restriction would likely be heard.
Even if you agree to arbitration, you may have to seek judicial enforcement or vacation of an arbitration award. Further, arbitration discovery is almost always more limited in scope than in court actions, especially as to non parties, and it is often more difficult to enforce. Therefore, the scope of discovery should be expressly set forth in the agreement. Companies should also carveout an exception for injunctive relief to combat the fact that obtaining injunctive relief from an arbitrator can be complicated and near impossible. Even when there are carve-outs, injunctive reliefs complicates the interplay between an arbitrator’s authority and domain over damages, as the court may decide legal questions in the injunction action that could have material consequences for the merits of the damages action before the arbitrator.
If you decide to use an arbitration clause, you should consider limiting the employee’s defenses to enforcement of the restrictive covenants by noting that alleged breaches of the agreement by the company are not defenses to the enforcement of the restrictive covenants. This should be justifiable, since the parties have provided for arbitration to resolve disputes as to the enforcement of the parties’ breaches of the agreement and the employee can seek enforcement of the employee’s rights more economically and swiftly through arbitration. Depending on the state law, the same limitation on employee defenses to alleged company breaches would likely be enforceable without reference to arbitration.
Can I get an agreement while the employee is walking out the door?
Many employers realize they have left themselves vulnerable when employees are being fired or are resigning and the company cannot locate an agreement signed by the employee. The company may or may not have enforceable trade secret protections that will slow down the employee’s competition, but, at that point, employers often will seek to include restrictive covenants in a severance agreement with the employee. Is it enforceable? That depends on the applicable state law and the circumstances. Generally, restrictive covenants are viewed as an exception to state laws protecting competition and, in virtually every state, such restrictive covenants must be ancillary to a valid employment agreement or business sale agreement to be enforceable. However, courts in many states (where restrictive covenants are generally legal) will enforce such severance covenants as being limited to an “employee choice,” e.g., compete without the money or take the money and don’t compete. Courts in many states will enforce it to that extent, and they may permit an employer to seek “claw-back” of payments already made if the employee is found to have breached the agreement. On the other hand, since a severance restrictive covenant is unlikely to be viewed by a court as ancillary to a valid employment agreement, it is possible that the same court would not grant injunctive relief or damages for its breach beyond requiring the employee to give back the money.
There are tactical reasons that such an agreement may be valuable as well. An action to seek a declaration of rights or claw-back of payments under a severance restriction would likely survive a motion to dismiss and provide a solid count as part of an action seeking to enforce rights under other theories, such as trade secrets laws. A prevailing attorneys’ fees provision may also enhance the likelihood of compliance. Even in sates where such severance restrictions are void, an employer might consider use of an ERISA severance plan containing restrictions and claw back terms. Those plans would be enforced under federal rather than state law. Although space is too limited in this newsletter to discuss this further, the use of ERISA plans to provide additional protections will be featured in the next newsletter.