Covenants not to compete, or “noncompetes,” provide a unique tool for protecting intellectual property that can migrate with employees. In most states, such covenants are enforceable, at least to some extent, to prevent an employee’s mere association with competitors without proof that the employee has misused any of the former employer’s intellectual property. While some courts may likewise enjoin an employee’s actual employment with a competitor on the basis of “inevitable disclosure” of trade secrets even if the employee has done nothing wrong (yet), the inevitable disclosure doctrine supporting such a strong measure on the basis of trade secrets alone is far from universally accepted. Thus, the most proactive measure for the protection of intellectual property is often to have noncompete agreements.
What employers do not always realize is that, for two reasons, their interests may not be sufficiently protected by simply rolling out a covenant not to compete that complies with the legal requirements in the employer’s home state or the employee’s principal state of employment. First, in this day and age, most businesses can be subject to competition from a former employee resident in another state. If business can be conducted via the Internet, then a business needs to consider the possible effect of other states’ laws on its noncompetes.
Second, as a long-anticipated decision from the Texas Supreme Court reminds us, different states have very different rules about the enforcement of noncompetes. California, for example, will enforce noncompetes, by statute, only in extremely narrow circumstances. In the great majority of states where the agreements are enforced, the laws vary substantially and, as discussed below, companies and employees cannot simply overcome those variations by agreeing to the law of a particular state.
Perhaps the most important variation from state to state is on the subject of what constitutes sufficient contractual consideration to support a noncompete. While the Texas Supreme Court recently re-examined, and to some degree relaxed, the state’s consideration requirement, Texas remains a significant hazard to navigation for many employers seeking to implement noncompete agreements. In Alex Sheshunoff Management Services v. Johnson (Tex. Sup. Ct., Oct. 20, 2006), the court held that a covenant not to compete can become enforceable when an employer provides confidential information or specialized training to an employee, even if that occurs at some point after the employee signs the agreement.
Previously, for a noncompete to be enforceable in Texas, an employer had to unconditionally agree to give the employee confidential information or specialized training, or provide that information or training to the employee at the moment the covenant was signed. Texas courts took the view that a promise to provide confidential information or training in the future was illusory in the context of an at-will relationship because the employer could avoid the obligation by firing the employee at any time.
The Sheshunoff court ruled that in an at-will employment relationship, a noncompete provided in exchange for a promise to provide future confidential information becomes enforceable when the employer actually provides that information to the employee. This modified approach greatly facilitates the creation of covenants that will be enforceable in Texas.
Even now, though, under Texas law any noncompete must be ancillary to the employee’s promise to maintain the information as confidential, and the covenant must be designed to enforce the employee’s consideration or promise not to disclose or use the information. This is still more complicated than the consideration requirements in most states and noncompetes that pass muster in many states may not be enforced in Texas.
In many states, mere continued employment, i.e., the privilege of coming to work the next day, is sufficient consideration for a noncompete, as found, for example, in Lake Land Employment Group of Akron, LLC v. Columber, 101 Ohio St. 3d 242 (2004). In those states, an employer may flatly require employees to sign noncompetes even after many years of employment and the noncompetes will still be enforceable.
In many other states, continuing employment is not sufficient but the commencement of an employment relationship, even an at-will relationship, is. In these states, employers must provide some additional consideration if they seek to enter into a noncompete in the midst of an employment relationship. See, for example, Labriola v. Pollard Group, Inc., 152 Wash. 2d 828 (2004).
Another important issue on which states vary widely is whether courts will modify overly broad noncompetes, narrowing them to make them enforceable. Such modification is permissible in Michigan under Mich. Comp. Laws §445.744a(1). This is a potentially critical issue. In states where courts may not make such modifications, such as Wisconsin (Wisc. Ann. Stat. §103.465), and a court finds a noncompete to be overly broad, the former employer is left with no noncompete protection at all. Other states fall somewhere in between – they will modify agreements provided that those agreements are at least initially reasonable, but they will not entirely rewrite them. See, for example, Freiburger v. J-U-B Engineers, Inc., 141 Id. 415 (2005). Others will “blue pencil” agreements, i.e., strike offending language but not go so far as to add corrective language, as in Bridgestone/Firestone, Inc. v. Lockhart, 5 F. Supp. 2d 667 (S.D. Ind. 1998). Thus, it is critical for employers to anticipate the possibility that their agreement might be scrutinized under the law of such a state and consider the likely impact of these various rules.
While many companies may assume they can use a choice of law provision to select the state’s law they want applied to a noncompete agreement, thereby avoiding application of unfavorable law, it is not always that simple. Choice of law and forum clauses are indeed critical aspects of noncompete agreements, but if an action is brought in another state, the other state’s court may choose not to enforce the clauses.
One scenario: A former employer in State A sends a letter to a former employee, reminding the former employee of his contractual obligations and threatening to file a lawsuit if he does not cease his new employment in State B with a competitor of the former employer. Believing litigation to be inevitable under the circumstances, the employee and his new employer institute litigation themselves, in State B, seeking a declaratory judgment that the noncompete is not enforceable. Applying choice of law principles, the court in State B finds that the law of State A offends the public policy of State B. Therefore, State B’s courts will not enforce the law and forum selection clauses. The court applies the less favorable (to the former employer) law of State B and declares the noncompete to be unenforceable. See, for example, Frame v. Merrill Lynch, Pierce, Fenner & Smith, 20 Cal. App. 3d 668 (1971) (declining to follow a New York choice of law provision).
In short, if somebody can compete with a company in a particular state, then that company needs to consider how the laws of that state might affect its noncompete agreements. Balancing the variations among many states’ laws with an understandable desire to treat employees consistently across geographic lines can be a delicate task, but, as the somewhat unusual laws of Texas demonstrate, it is a necessary process for employers seeking to properly protect their intellectual assets.