Tip the Scales on Non-Compete Agreements

As the manager of HR, you work hard. One of the things you’ve worked hard to develop is an agreement—often called a covenant not to compete—that forbids employees from working for a competitor if they quit.

You start with boilerplate language—but you don’t stop there. You include language forbidding the disclosure of trade secrets and other confidential information. You ask all employees to sign the agreement, and wisely limit the covenant’s geographic scope and duration.

You include an admission that your company has no sufficient legal remedy if the covenant is breached, so the only way you can be protected is with injunctive relief. This, you believe, should help you to get that injunction if you need it.

You include language making it clear that you would not have made the decision to hire the employee if he or she had not agreed to the covenant.

Then, your agreement is put to the test: A high-level employee who knows almost everything about your business unexpectedly resigns and begins working for your main competitor. She’ll be working a few blocks down the street, doing exactly the same work she did for you.

You call your attorney immediately, fax her your non-compete agreement and ask her to get an immediate injunction that will stop this employee from competing with you.

Your attorney pulls together the materials and rushes into court. The court schedules a quick hearing. The disloyal employee testifies and the cross-examination goes well. The judge takes a 15-minute break and announces his decision.

You’re stunned when he denies your request for preliminary injunctive relief.

What You’re Up Against, Historically

Is the judge crazy? Can’t he read? How could this have happened?

One explanation, which few people know about, is rooted in history—a lot of history over a very long period of time: Plain and simple, courts do not like restraints on trade, and they have not liked them since nearly the birth of our legal system.

Take this decision issued by Judge Macclesfield and published in 1711: Covenants not to compete are subject to “great abuses” by employers, who are “perpetually laboring for exclusive advantage in trade, and to reduce it to as few hands as possible.” (Mitchell v. Reynolds, 24 Eng. Rep. 347 (Q. B. 1711)) In case there was any doubt about how Judge Macclesfield feels, he concludes that as to “all restraints of trade, where nothing more appears, the law presumes them bad.”

Of course, as a good English judge steeped in common law, Judge Macclesfield needed to find precedent for his view. Incredibly, it was there to be found. A full 100 years earlier, an English court had refused to enforce a similar covenant in the Case of Tailors of Ipswich (77 Eng. Rep. 1218 (K. B. 1614)).

But even those judges were not making law. Two hundred years before that, in 1414, an English court held in The Dyer’s Case that it was then “old and settled law” that covenants not to practice one’s trade are against the common good. (Y.B. Mich. 2 Hen. 5, pl. 26 (1414))

These old precedents have stuck. In an article titled “Employee Agreements Not to Compete,” published in the Harvard Law Review in 1960, the author, Harlan M. Blake, stated that: “There is very little in the modern approach to the problem [of restraints of trade] for which a basis cannot be found in Macclesfield’s opinion.”

And the courts’ disdain for covenants continues to be expressed in the same language. In a relatively recent decision in New York, the court found that “the effect of these provisions is to indenture the employee.” (Earthweb v. Schlack, 71 F. Supp.2d 299, 311 (S.D.N.Y. 1999))

Overcoming History​

What can you do in the face of these 600-plus years of judicial antagonism? Here are several tips, all grounded in case law:

Don’t make covenants sound they like took 700 years to write. I was recently asked to review the following text, which defines what employees are barred from revealing: “All ideas, potential marketing and sales relationships, inventions, copyrightable expression, research, plans for products or services, business development strategies, marketing plans, computer software (including, without limitation, source code), computer programs, original works of authorship, characters, know-how, trade secrets, information, data, developments, discoveries, improvements, modifications, technology, algorithms and designs, whether or not subject to patent or copyright protection, made, conceived, expressed, developed, or actually or constructively reduced to practice by the employee solely or jointly with others during the terms of his employment with [company], which refer to, are suggested by, or result from any work which the employee may do during his employment, or from any information obtained from [company] or any affiliate of [company], such that said information is obtained in the performance of duties related to employment at [company].”

This passage illustrates the first—but not the only—problem with using boilerplate covenants. Lawyers often start with covenants drafted by their predecessors but they don’t take anything out—whether they understand it or not—because it is safer to leave everything in. What lawyers do, however, is add more restrictions, so that covenants that could have seemed reasonable 200 years ago are now a hodgepodge of restrictions. Who, for example, remembers what an algorithm is, let alone gains access to confidential algorithms at work?

Don’t get carried away. Many decisions in this area of the law turn on how the covenant “feels,” although a judge will not often say as much. And how these covenants are packaged can influence how judges feel about them.

For example, when covenants are included as part of a larger document that sets forth the terms and conditions of employment, the judge may examine that larger document as well. (See, for example, the case of Earthweb v. Schlack, 71 F. Supp.2d 299 (1999).)

Say that your covenant resides in a hiring package. Other documents in that package might remind employees that they are employed “at will,” describe the rights they do not have as a consequence of their lowly status, and state that you reserve the right to change the terms and conditions of employment at any time, with or without notice.

These provisions, which might protect you in other contexts, will hurt your chances of enforcing the non-compete covenant because they suggest that you have overreached, trying to “indenture”—rather than employ—the individual in question.

Keep the time period covered by the covenant short. The days of enforceable multi-year covenants are effectively over, particularly in the kinds of industries that have arisen in the information age. A recent decision from the New York State courts found that a covenant restricting an employee from working for a competitor for 12 months is “too long” in the Internet business. (Doubleclick v. Henderson, 1997 WL 731413 (N.Y. Sup.))

And when you think about it, does such a provision really make sense? Are you really going to follow the activities of a former employee for several years, making certain that she or he doesn’t get a job in your industry with a competitor? Will that former employee really be in a position to hurt you with insider information 18 months after she’s resigned? As a practical matter, isn’t the real issue the immediate fallout from an unexpected resignation and re-employment?

In my experience, the initial panic—and consequent willingness to take on substantial legal fees—subside once an employer learns that it can thrive, or at least survive, without the former employee.

Keep the geographic area covered by the covenant narrow. We have come a long way from the time of Judge Macclesfield’s decision, which sought to prevent bakers in a village outside of London from cornering the market. However, some things haven’t changed: Geographic limitations are still one of the two key areas courts consider when determining if a covenant is reasonable.

Of course, the business reality in the Internet age is that former employees may now compete with you from anywhere. But, until the legal framework is changed by the courts, you must ask yourself if it is worth restricting a former employee from working for a competitor in New Delhi when a worldwide scope will almost certainly push a judge to find that your covenant is too broad.

Don’t ask all employees to sign boilerplate covenants. You are mistaken if you think that it is cost-effective to ask new hires (or existing employees, for that matter) to sign the same version of a non-compete agreement, no matter how well crafted.

The courts try to balance an employer’s legitimate need to protect its business against an employee’s legitimate need to make a living in the trade of his or her choice. If your covenant is “way too” broad, the courts won’t enforce it at all. If it is only “too” broad, the courts may be willing to edit your version, and enforce one or more aspects of the covenant.

One way that courts assess whether a covenant is too broad is to see how the employer tailored its covenants to the particular circumstances involved. If all employees—from the accounting clerks to the vice president for research—are required to sign an equally restrictive covenant, this becomes evidence that an employer did not approach the need to protect itself from illegitimate competition in a reasonable way.

Judges dislike covenants, but they hate thieves. Your chances of getting a non-compete agreement enforced are substantially enhanced if a former employee dirtied his hands on the way out the door. It is not enough, however, if he is venal enough to attempt to recruit from your employees before he leaves, or shameless enough to rifle through your files to find and copy your trade secrets, or adept enough to copy the entire memory of the company’s computers onto a disc or two. He also must be stupid enough to get caught.

This makes it critical that you act decisively. If you get a reliable tip that an employee is engaging in such conduct, don’t hesitate to shut down his access to your company’s computers and demand that he turn over his laptop the moment he is terminated for breaching his fiduciary duty. It is incredible what you are likely to find, from new business plans (often cut and pasted from your business plans), to customer lists, to e-mail messages you might not be very proud of.

If it’s confidential, treat it that way. Courts look beyond the documentary trail when figuring out if information taken by a former employee is truly confidential. One thing courts look at is how you treated the information that you now claim would devastate your business if a competitor were to obtain it.

For example, was this data marked “confidential?” Were copies floating all over the place? When meetings were held and documents distributed, was there any discussion about their confidentiality? Were copies collected at the end of the meeting?

You must be alert to these issues as you conduct your business on a day-to-day basis.

Beware of state statutes. Many states have statutory provisions governing covenants, so beware—particularly if you are hiring employees who have worked elsewhere and might be covered by a competitor’s covenant. Some of these state statutes are quite precise about what will, and will not, be enforceable.

Don’t hide restrictive covenants under the guise of something else. Historically, the courts have hated indirect restrictions with an almost greater passion than direct restrictions. Take “training agreements,” for example, which require an employee to pay back the costs of her training if she leaves your employment sooner than you would like and takes “her” training with her. Yes, someone who takes the training and runs is irritating. No, you cannot punish her for it.

This is not to say that training agreements are per se unlawful, but you must be aware of such decisions as Heartland Securities Corp. v. Gerstenblatt, et al., (2000 WL 303274 (S.D.N.Y.)), in which the court found that “refunds of training costs provisions are designed to chill people from changing jobs, and thus, function as restrictive covenants.” The court ruled that enforcing the training agreements in this case would have been tantamount to “indentured servitude,” precisely the kind of label used by Judge Macclesfield 400 years earlier.

What Does the Future Hold?

Employee mobility is an exploding phenomenon that shows no sign of abating. In this context, employers must pare down their expectations about the extent to which they will be able to keep former employees from moving to competitors.

That isn’t to say employers must give in to despair. It is still possible to craft a covenant not to compete that is enforceable. However, slowing employee mobility has been a rough road to travel for 600 years, and it is getting rougher.

Author’s note: Credit for the historical findings cited in this article goes entirely to Dan Messeloff, whose article “Giving the Green Light to Silicon Alley Employees: Non-Compete Agreements Between Internet Companies and Employees Under New York Law,” appeared in the Spring 2001 edition of the Fordham Intellectual Property, Media and Entertainment Law Journal.

David M. Wirtz has been representing management in the public and private sectors for 25 years. He is a principal at Grotta, Glassman & Hoffman, P.A., in New York, and is a member of the Section on Labor and Employment Law of the American Bar Association.