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Post-Employment Restrictions: Justifiable Business Protection or Unreasonable Restraint of Individual Freedom?, Contributed by Marguerite S. Walsh, Littler Mendelson, P.C. and Jean-Yves Verslype, Clae

Thursday, November 17, 2011

Introduction

This article examines the current legal landscape with regard to the enforcement of post-employment restrictions by companies against former employees. While primarily focused on developments in the United States, given the increasing incidence of cross-border enforcement efforts, the discussion also includes reference to European enforcement issues. It is not surprising that the challenging economic climate has brought an increase in activity, including litigation, involving the obligations of former employees. Employees who have lost their jobs, and who thus feel the need to find every possible “leg up” to secure future employment, seem more inclined than ever before to consider—and possibly implement—steps to download sensitive information belonging to their former employers,1 solicit customers who may be off-limits and recruit key employees who remain with the organization. Companies, of course, face the same economic crunch and conversely can ill afford to turn the proverbial other cheek to actual or even potential wrongdoing, for fear of losing their competitive advantage. The convergence of these circumstances has led to a significant increase in court decisions and legislative developments in the United States.

Post-Employment Restrictions: A Brief Perspective

It is little wonder that employers are often confused, and sometimes disheartened, by the seemingly Byzantine maze of post-employment restrictions. What seemed like a simple agreement at the outset of employment becomes anything but when the time comes to enforce it. The two primary reasons for this are: (1) enforceability is highly dependent on state law, which can vary widely and (2) even within a particular jurisdiction, enforceability in a given situation requires an intensely fact-specific inquiry. Adding to the challenge is that—even apart from any agreement the former employee may have signed—statutes such as state adaptations of the Uniform Trade Secrets Act2 or the federal Computer Fraud and Abuse Act often come into play. Common law doctrines such as inevitable disclosure or breach of the duty of loyalty may lend yet another layer of analysis to an already complicated plot. On top of all this, employers are faced with making critical decisions about whether and how to proceed at the most inopportune time possible—when their business is threatened. Notwithstanding these variables, there are of course certain overarching principles that United States courts apply in assessing the enforceability of post-employment restrictions and that inform legislation on this topic. First, courts tend to disfavor covenants not to compete3 because they restrict an employee’s ability to earn a livelihood. Second, courts attempt to strike a balance between an employee’s right to make a living and an employer’s legitimate interests in protecting its proprietary information, goodwill and business relationships. Third, as a practical matter, courts have had to grapple with the realities of the Internet and the global reach of competition in interpreting and applying post-employment restrictions that may not have been drafted with these factors in mind.

Some Recent Trends: A Summary

Against this background, certain themes have emerged in recent court decisions and legislation, which are summarized below.

— Technical Issues Are Increasingly Important

The need for compliance with the “technical" aspects of the law relating to post employment restrictions is nothing new, but it has taken on new importance as courts confront the “new world order” of competition without traditional boundaries of time and location. Thus, before even reaching issues relating to the actual scope of the restriction in question, courts are placing more emphasis than ever on such preliminary questions as duress and the sufficiency of consideration for the promises made. For example, in Cummings, Inc. v. Dorgan,4 the employee, Dorgan, signed a noncompete when hired. Thereafter, the employer changed the employee’s compensation and required a new noncompetition agreement, which Dorgan reluctantly signed. Dorgan resigned and started work for a direct competitor in violation of his noncompete. The employer filed an action to enforce the noncompetition provisions of the agreement. Dorgan argued the second agreement was void because he signed it under duress. The court disagreed, holding that because Cummings had the legal right to terminate Dorgan’s employment at the time he executed the later agreement, asserting an intent to fire Dorgan if he refused to sign was simply an assertion of a legal right and could not legally constitute duress. In another case involving a technical issue, Mann Frankfort Stein & Lipp Advisors, Inc. v. Fielding5, the court addressed the specific language required in Texas to create a mutually binding obligation and eliminated a technical argument against enforcement. The employee signed an employment agreement containing a “client purchase provision” but there was no specific promise by the employer to give the employee access to confidential information, and the employee did not acknowledge that he had received or would receive such confidential information. The employee argued that, absent this specific promise, the agreement was unenforceable, but the court disagreed, holding that the employer made an implied promise to provide confidential information when it hired him. Once the employer had provided confidential information, the noncompete became enforceable. The lesson here is that employers who seek to enforce noncompetition provisions must be mindful of the fact that courts are paying increased attention to technical aspects of the underlying agreements that have little or nothing to do with the substance of the restrictions themselves. State law varies widely with regard to these issues, which adds to the challenge.

— Courts Are Moving Towards a More Nuanced View of The Critical Elements of Time and Geography

As noted above, the digital age and the increasing ease of acquiring a company’s proprietary information have required courts to view issues relating to post-employment restrictions in more nuanced ways. As early as 1999, a federal court sitting in New York recognized the new reality that non-competes of one or two years, which had for the most part been previously considered reasonable, had to be judged in a different light. The court noted, in striking down a one-year non-compete: “[W]hen measured against the IT industry and the Internet environment, a one-year hiatus from the workforce is several generations, if not an eternity.”6 This phenomenon has continued, with courts striving to find a more realistic way to balance the competing interests of the employer and the employee in a world where competition is no longer primarily defined by time and place. A more recent example, also in the Southern District of New York, is PrecisionIR, Inc. v. Clepper.7 PrecisionIR provided webcasting services to companies in the United States and Canada. Clepper signed a six month noncompetition agreement with PrecisionIR, covering the United States and Canada. One week after leaving PrecisionIR, he accepted employment with a competitor. PrecisionIR sued Clepper and his new employer to enforce the agreement. The issue was whether the geographic limit of the United States and Canada was reasonable for a company with internet sales. The court held that it was: “[The six month limitation] serves to counterbalance the effect of what is a relatively large, although reasonable, geographic scope.” A key takeaway from these and similar cases is the need for employers to be proactive and creative in the drafting of their agreements so that they protect what is legitimate, without overreaching. The longest period and the broadest geography may not be enforced and in some jurisdictions a court will not reform or rewrite the offending provisions of the agreement, leaving the employer unprotected by the agreement if it is held unenforceable.

— Legislatures Are Becoming More Active in the Area of Non-Competes

While several states have long had in place statutes governing the enforceability of non-compete agreements, the past few years have seen a marked increase in legislative activity. What is particularly striking about such legislation is its extraordinary specificity. For example, in 2008, Oregon implemented sweeping changes to its noncompete statute. Among the Oregon law’s requirements, for example, are that an employer notify an employee at least two weeks before the commencement of employment that a noncompete agreement is a condition of employment; that the term of the noncompete be limited to no more than two years; that the employee be engaged in administrative, executive or professional work and earn a salary or be otherwise exempt from Oregon’s minimum wage and overtime laws; and that the total amount of the employee’s annual gross salary and commission, calculated on an annual basis, exceed the median income for a family of four as determined by the United States Census Bureau. The statute contains a savings provision with specific and detailed requirements—in the nature of the “garden leave” concept that is popular in some European countries—that can render an otherwise invalid provision enforceable under limited circumstances. Significantly, the law specifically states that non-solicitation provisions covering customers and employees—which have traditionally been viewed more leniently by courts—are to be judged in the same manner as “pure” noncompetes. Other jurisdictions, notably Massachusetts and Illinois, have introduced but not yet enacted legislation that would also restrict the enforceability of non-competes. Like the Oregon statute, these proposed bills are remarkably specific and seem to indicate that legislatures are becoming less willing to allow courts the wide latitude they have traditionally enjoyed to interpret and enforce noncompetes.

— California Is (Still) Different

No discussion of United States noncompete law would be complete without mention of California.8 Under Business and Professions Code 16600, agreements containing provisions that restrain employees from engaging in competitive employment after leaving a former employer are void as against public policy. However, until 2008, it was at least debatable whether more lenient restrictions were valid; that question was answered in the negative by the California Supreme Court in Edwards v. Arthur Andersen,9 which held that all restrictive covenants, except those covered by express statutory exceptions, are void. This includes not only “pure” noncompetes but also customer nonsolicitation clauses. One possible (although small) window of opportunity for employers post-Edwards was whether California law would allow the enforcement of a post-employment restriction to protect a former employer’s trade secrets (known as the “trade secret” exception). While the Edwards court declined to address this specific issue, until very recently subsequent decisions in California have reinforced the difficulty of obtaining anything more than an injunction to prohibit the misappropriation of trade secrets.10 However, two recent decisions, both in federal court in the Northern District of California, suggest that courts, at least in the context of granting a temporary restraining order and denying a motion to dismiss, respectively, may be willing to consider severing or reforming offending provisions under Section 16600.11 Whether these cases truly mark a change in approach in California remains to be seen, but given California’s strong and long-standing public policy against restrictive covenants, employers would be wise to continue to proceed with extreme caution12.

Non-Compete Clauses: A European Perspective

As soon as they work in Europe, U.S. citizens and U.S. companies are confronted with the views of European countries on the validity of non-compete clauses. Of course, and as always, the legal treatment of such clauses is different from one European country to another. But a thorough analysis of the regulations relating to non-compete clauses in more than 20 European countries allows us to state that the general principles are mainly the same in these different countries. Indeed, and as a first step, we can generally state that there is indeed a legislation governing non-compete clauses in the main European countries.13 Surprisingly, only France and Ireland handle the legal regime of the noncompete clause by jurisprudence alone, without any law to specify the conditions of validity of such a clause. The only country where the conclusion of non-compete clauses is not authorized is the Slovak Republic. In other countries, non-competition clauses are considered valid if they meet legal conditions, which generally means, as long as it can be proved that they were concluded in order to avoid the disclosure of confidential business information related to the company or to protect the company against the massive poaching of its employees. These legal conditions are generally more or less the same in the different European countries. Thus, the scope and geographical area to which the clause extends should be kept as narrow as possible whilst still being adequate to protect the legitimate business interests of the employer in the particular circumstances. It is generally required to limit the scope of the clause to precisely the type of professional activities the employee undertook during the last year of his or her employment with the employer.14 Of course, the geographical restriction must take into account the type of business and the specialization of the activities undertaken within it. As a rule, the geographical area should be limited to the country or region the employee was in charge of and the place where he or she actually worked during his/her employment. Parties will also have to foresee a term (maximum between one and three years depending on the country). One of the main issues is generally the financial compensation to which the employee is entitled. In some countries, like the Czech Republic, the employer will have to pay compensation for the entire period covered by the noncompete clause. This, of course, limits a company’s interest in having such a clause. In other countries, this compensation will cover, for example, the remuneration for half of the term of the clause or will have to be determined according to the prejudice suffered by the employee as a result of the clause. Finally, a lot of countries foresee that this kind of clause cannot be enforced if the employment contract is terminated by the employer without a serious cause of termination. All these conditions are deemed to ensure that non-competition clauses will not be used as unacceptable restrictions on the freedom of competition, but will be justified by reasonable and proportionate interests of the company. In the framework of these legal limits, European legislations generally consider that non-compete clauses do not constitute such a prohibited restriction. On the contrary, the clauses which are concluded, for example, after the termination of an employment contract and which are not submitted to these legal provisions are very often considered null and void in Europe. Indeed, jurisprudence generally considers that any limitation on competition is prohibited if it is not regulated by the law. As often in Europe, the law is considered as the best guarantee for a fair and healthy competition. The authors gratefully acknowledge the contributions of Pamela S.C. Reynolds and Natalie M. McLaughlin, both associates at Littler Mendelson, P.C., to this article.Marguerite S. Walsh is a shareholder and co-chair in the Competition and Trade Secrets Practice Group at Littler Mendelson, P.C, a member of Ius Laboris, the world’s largest alliance of HR law firms. Marguerite focuses her practice on representing companies, as both plaintiffs and defendants, in matters involving protection of intellectual capital and customer relationships.Jean-Yves Verslype is a partner at Claeys & Engels, also a member of Ius Laboris, the world’s largest alliance of HR law firms. Jean-Yves focuses his practice on employment law and labor relations, with a special interest in personnel representation, termination of contracts, harassment, discrimination and non-competition issues.
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