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The ABC's of Restrictive Covenants on Employees

Many misconceptions exist about the efficacy and need for non-disclosure, non-competition, and non-solicitation agreements, so it is important to keep a few simple facts in mind.

A. The Law Prohibits Disclosing Confidential Information

Many employers believe they must require employees to sign contracts prohibiting the disclosure or use of the employers’ confidential information and trade secrets if they accept jobs with other employers or quit to set up their own business. However, courts and legislatures in virtually all states have developed rules that preclude such use and disclosure, even if an employee has not signed a contract prohibiting that conduct.

The courts have predicated their decisions on the concept that, independent of any contractual restrictions, employees as agents owe a duty of loyalty to their employers as principals that prohibits agents from acting in way that harms their principals and that, in some respects, survives the termination of their relationship. Under that common law rule, employees occupy a position of trust and confidence while performing services for employers that precludes them from using or disclosing their employers’ confidential information obtained while working for the employer. That obligation survives the termination of the employment relationship.

In addition, most states have enacted statutes that prohibit employees from using or disclosing their employers’ “trade secrets”, which is a term generally defined in a way that is narrower than how the courts have defined “confidential information.” In either case, however, employers can sue to obtain injunctions that bar a former employee’s ability to use or disclose confidential information and trade secrets and to recover the economic losses caused by that type of unlawful conduct. 

Thus, employers need not require employees to sign contracts in order to protect their confidential information and trade secrets. Indeed, the fact that a contract defines certain information as being confidential does not mean that a court will automatically accept that classification. To the contrary, courts generally apply their own definition of what constitutes confidential information when deciding whether a former employee has misused it.

As consequence, a non-disclosure agreement does not expand the scope of the protection afforded employers, but such contracts may remind employees of their legal obligations and entitle employers to recover attorneys’ fees incurred in enforcing the agreement that otherwise would not be recoverable. A contract may also require employees to participate in litigation is a state specified in the agreement and require the application of the law of a particular jurisdiction. 

B. Competition and Solicitation – The Important Difference

The courts recognize the difference legal between non-competition and non-solicitation agreements. Broadly speaking, a non-competition agreement prohibits a former employee from engaging in the employer’s line of business in a specific market for a period after employment terminates. For example, the agreement may preclude the former employee for a two-year period from selling or servicing computer equipment and working for a company engaged in that business in Maryland, Virginia, and the District of Columbia. 

A non-solicitation agreement would prohibit a former employee for a particular period from selling or servicing computer equipment to customers that he had solicited or serviced or about whom he had obtained confidential information during a certain period before his employment terminated. As a consequence, the employee could work anywhere for his former employer’s competitor as long as he did not try to service or sell to that limited category of customers. 

As a rule, the courts are generally more willing to enforce non-solicitation agreements than non-competition agreements for at least two reasons. First, a non-solicitation agreement, unlike a non-competition agreement, does not prevent a former employee from using his professional knowledge and experience to earn a living. Thus, enforcement has a less harsh effect on the employee.

Second, a non-solicitation agreement is more narrowly tailored to protect the employer’s interest in preserving its customer relationships and insulating confidential information from being used to compete with the company. For example, the restricted period provides the employer the time needed for a new employee to develop a close business relationship with the customers who had been solicited or serviced by the former employee. The agreement also protects the employer’s legitimate interest in preventing the use of the confidential information procured by the former employee in connection with servicing those customers.

For those reasons, employers should seriously consider using non-solicitation agreements for all but the most senior executive employees who have access to highly confidential information, such as business plans, company finances, marketing strategies, and research and development initiatives. A competitor’s access to that type of information would pose a serious threat to a former employer, regardless of the capacity in which the executive is employed. Accordingly, a judge will be much more likely to be sympathetic to a request to enforce an agreement that prohibits such an employee from working for a competitor in the same market serviced by the former employer.

C. The Peril of Overreaching

When requiring employees to sign agreements, employers should always remember the Wall Street adage: pigs get fat, hogs get slaughtered. Employers frequently demand that most employees sign contracts that impose broad restrictions on their ability to work for competitors. 

For instance, some employers insist upon contracts that prohibit employees from working for competitors even in capacities that clearly would not involve using confidential information or their existing relationships with customers. Courts will not enforce such contracts that go beyond protecting employers’ legitimate interest in protecting themselves from what would reasonably be perceived as “unfair competition” by disloyal former employees. 

Moreover, when presented with a grossly overbroad contractual restriction, a court may refuse to exercise its power to enforce an agreement after reducing the scope of the activities prohibited. Thus, employers should resist the temptation to overreach by demanding that employees sign agreements imposing restrictions that exceed those genuinely needed to protect the employer, without completely impeding a former employee’s ability to work in his chosen occupation.

Conclusion

Drafting these types of agreement is far more complicated and nuanced than ABC. By retaining a knowledgeable attorney, an employer can substantially increase the likelihood that, when crunch time comes, the terms of a contract will stand up in court against competitors poaching valuable employees.

For more information please contact Mike Smith at 410-583-2400 or smith@bowie-jensen.com.  

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