Restrictive Covenants with Employees

By Michael Stiegel

Jul. 1, 2004

There was a time when care was taken to make sure a departing employee didn’t leave a company carrying a briefcase stuffed with leather notepads and expensive pens. Today the stakes are far higher, and can cost a company many millions of dollars. Today an employee might stroll off to open his own company taking with him a far more valuable cache: customers and coworkers who suddenly morph into competitors.

    Although a company’s first line of defense against this surreptitious practice is traditionally the restrictive covenant, the enforceability of such covenants is, well, a subject of much debate. While the validity of the restrictive covenant generally depends on the laws of the state where the employee works, most courts, not surprisingly, remain reluctant to enforce restrictive covenants in an economy in which unemployment is high. Most companies recognize the importance of having such agreements and do have employees execute them. Still, a surprising number give little thought to preparing and executing meaningful rules. For example, if a human resources professional has a brainstorm and decides that all the employees should sign restrictive covenants without value for the agreement, such as a bonus or a promotion, the enforcement of the restrictive covenant is, at best, questionable. If the restrictive covenant is too onerous or too anti-competitive, it may not be enforceable. And if the time restraint is too long, the court will not enforce it. Some states will allow continued employment to be sufficient consideration for a valid agreement, others will not. It is important to appreciate that almost any kind of obligation on former employees exists only if there is a valid agreement.

    Second, it is vital to note that your company’s rights of enforcement may depend on where the departing employee fits in the corporate food chain. In legal terms, the employee will have either a fiduciary duty or a duty of loyalty. In many jurisdictions these obligations are one and the same, and in other jurisdictions there are important nuances. For example, if a corporate officer intends to leave and knows that other employees are planning to resign to join him to compete against your company, the officer has a duty of disclosure, an obligation to tell the company that a group of employees is leaving. If the departing employee is not an officer and has only a duty of loyalty, generally there is no obligation of disclosure.

    While the outside parameters of an officer’s fiduciary duty are by no means perfectly clear, this obligation requires an employee to put his own interest behind that of the employer. If, for example, a corporate officer has a lifelong friend who is leaving to be a competitor, the officer should disclose the information to the company. While the law allows even a corporate officer to plan a departure, create a business and even set up that business before leaving, it does not allow the departing employee to solicit coworkers or customers before he officially separates from the company. This is an important distinction that gives a company significant leverage in taking action against the employee.

Have you noticed an employee who never works late or comes in on weekends starting to do so? Have you noticed a particular employee saving or e-mailing herself an unusually large number of documents?

    Beyond simply protecting a firm’s employees and customers, protecting a corporation’s confidential information and trade secrets has become more important than ever. The burden is on a company to make sure that a comprehensive plan is in place to protect any and all corporate assets, and to ensure that the organization’s agreements with employees are comprehensive, clear and current.

    The mistake that many employers make is trying to bootstrap themselves after the fact into creating some form of overall protection by suing for breach of confidentiality. In this case, confidential material that should be protected typically includes information on compensation and productivity of co-employees, customer lists, and buying and pricing. An employer often uses litigation as a strategy to make a statement to stop other employees from divulging information or to prevent other employees from departing. Sometimes it works, but often it does not, and by then, much damage has already been done. Such a mistake could cost a company millions. Unlike the breach of restrictive covenants—the theft of confidential information—breaches of fiduciary duty and loyalty are difficult cases for a company to prove.

    Still, courts have little patience for employees who breach fiduciary or loyalty duties. Even when the damages are difficult to ascertain, courts will figure out a way to punish the wrongdoer. This could mean a forfeiture of salary, seizing the profits of the new venture and/or running the new company out of business. The more egregious the pre-departure conduct, the more likely that the employer will obtain real relief. But the clearer and more reasonable and comprehensive the restrictive agreements are, the less likely the chance of winding up in court.

    Frequently, a dishonorable employee will leave a paper trail or share confidences with an untrustworthy coworker who tries to take advantage by acting as a mole. There are always telltale signs when an employee is trying to ambush an employer by taking coworkers or customers into the new endeavor. You might ask the following questions: Have you noticed an employee who never works late or comes in on weekends starting to do so? Have you noticed a particular employee saving or e-mailing herself an unusually large number of documents? If so, investigate immediately and document your findings carefully.

    Finally, when such covenants are viewed in the broader context of one’s corporate responsibility, the approach to designing them becomes just as important as having them. Before executing restrictive covenants and other agreements with employees, give significant thought to what assets must be protected, how far the company will go to protect them and whether or not the covenant will, ultimately, be enforceable in court.

    And it never hurts to watch out for rogue employees and to investigate suspicious behavior.

The information contained in this article is intended to provide useful information on the topic covered, but should not be construed as legal advice or a legal opinion. Also remember that state laws may differ from the federal law.

Workforce Management
, July 2004, p. 16Subscribe Now!

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