Drafting Restrictive Covenants in a Multistate Business Labor & Employment Educational Webinar Series Jill Kirila, Partner Squire Sanders (US) LLP Labor & Employment jill.kirila@squiresanders.com +1.614.365.2772 Stacie Yee, Senior Associate Squire Sanders (US) LLP Labor & Employment stacie.yee@squiresanders.com +1.213.689.5135 37 Offices in 18 Countries
Restrictive Covenants: What’s at Stake? • Your Intellectual Property May Walk Out the Door • Employee Mobility – Competition At-will employees change employers freely They can plan to compete while still working for you (as long as its not on your time) • May Affect Your Ability to Hire • To protect your IP, as a multi-state business you must understand how the laws of the various states in which you do business view restrictive covenants and generally understand which laws are likely to apply to your agreements 2
Legal Framework • Non-compete Agreement : a contract that seeks to protect legitimate business interests: Long-term customer relationships Confidential information/trade secrets • No federal trade secret/non-compete law: law of restrictive covenants is almost completely a state law question. Law can vary dramatically from state to state • As a result : Some US states will enforce restrictive covenants Others essentially do not enforce them at all. • Employers cannot rely solely on choice of law and/or forum clauses Employers must anticipate and consider the laws of each states which may potentially “touch” the business, the employee, or the agreement at issue. 3
Types of Restrictive Covenants • Non-competition “no work” • Non-solicitation Customers Suppliers Employees • Non-d isclosure: Not talking about this today! – However, are occasional state variations » E.g., Georgia and two years 4
Non-competes: Choice of Law Issues • Choice of law provisions are not always respected/applied Depends on public policy of the state with the material interest • Employer may decide to include a choice of law provision, but should also assume it may not work For instance, choice of law provisions generally are unsuccessful with respect to California employees • Unpredictability: Out of state non-compete may be enforced against employee who moved to California, but entered into a valid non-complete while out of state, if the agreement is governed by out-of-state law Who can get a favorable judgment in their state first? 5
Considerations for States that Generally Do Not Enforce Post-Termination Noncompetes (E.g., CA, ND, OK) 6
Non-competes do not fly in California California greatly restricts the enforceability of noncompete agreements – such agreements are void as against public policy except in very limited situations Cal. Business & Professions Code § 16600: “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” Cannot fire or refuse to hire an employee for refusal to sign An employer can still prevent employee from misappropriating • trade secrets, even without a non-compete agreement 7
Non-competes in California: Exceptions Sale of business Must include sale of good will Sale of all of shareholder’s stock Dissolution of partnership Restriction can only run in favor of the buyer, not the seller • Restrictions have been narrowly construed, to only apply to • existing customers/employees of the business at the time it was sold Strategix, Ltd. v. Infocrossing West, Inc. (Cal. App. 2006) (nonsolicit covenants “wrongly” barred seller from soliciting employees/customers of buyer rather than former customers/employees of seller) Alliant Ins. Services v. G. Scott Gaddy (Cal. App. 2008) (CA-wide noncompete applied to seller, when seller’s business pre-sale was conducted in all CA counties) Possibility of extended protections when seller becomes employee of buyer 8
California: Enforceability of Non-solicits • Non-solicitation of employees: likely enforceable if reasonable in duration (short term) What constitutes solicitation? • Non-solicitation of customers: rarely ever enforceable Only enforceable if: – Reasonable – And necessary to protect trade secrets or confidential proprietary of the employer. Very Rare . Remember merely informing employer’s former clients of new employment/transition is not solicitation 9
What Do California Employers Do? • Agreements acknowledging employees’ obligations to keep confidential proprietary and trade secret information confidential “After Employee’s termination of employment, Employee shall not compete with Employer by using any confidential proprietary or trade secret information . . . “ Drafting Tip: – Specify precise categories of information to keep confidential – If possible, describe “competition” – The more specificity the better • Include employee non-solicit in agreement if a concern • More options later 10
California: Danger of Overbroad Agreements • Some businesses (particularly multi-state employers who can institute valid restrictive covenants as to non-CA employees) nevertheless distribute overly broad agreements because of the perceived deterrent effect • Dangers: Employee can preemptively sue, requesting a court to invalidate the agreement – Declaratory relief – Injunctive relief – Contractual attorneys fees – Employer pays employee’s costs Cal. Bus. & Prof. Code § 17200 Unfair Business Practice Cal. Labor Code § 432.5 – No employer shall require any employee or applicant to agree, in writing, to any term or condition which is known by such employer to be unlawful. – Private Attorney General Act, Lab. Code § § 2699: enforcement mechanisms for Labor Code sections that do not carry penalty provisions. 11
Drafting Considerations for States that Do Enforce Post-Termination Noncompete (the other states) 12
Restrictive Covenants: “reasonableness” • Enforceability: Rule of reasonableness • Restrictive covenants are recognized in many states as valid and enforceable so long as they impose reasonable restrictions upon an employee that are no greater than necessary to protect the employer’s legitimate interests . • Means different things under different state laws/different applications of “reasonable” test 13
Critical Elements of Non-Compete Agreement Four General Requirements : 1. Consideration in exchange for non-compete Offer of employment / continued employment Promotion/change in job duties 2. Tailored to protect legitimate business interest Long-term customer relationships Goodwill Trade secrets Other confidential information 3. Non-compete reasonably related to legitimate business interest in terms of time, geographical area, and scope of the prescribed activity 4. Non-compete must not run counter to public policy of the state in which it is enforced 14
State law variations: Consideration • At-will Employment Beginning v. Continued – Most states: at-will employment at inception is sufficient » And some of these say continuing at-will employment enough – E.g., AZ, OH, NJ, NY – yes; DC – likely • More than At-Will Employment Something more needed: E.g., CT, MN, NC, OR, SC, TX, VA, WA, WV, WI, TN—unless employment continued for long period after – E.g., Promotion, term employment/notice, bonus, stock options 15
State law variations: Judicial Review • Reformation (reform to make reasonable) E.g., DC, FL, OH, NJ, NY, (now GA) • Blue Pencil (strike from existing K) AZ, CO, CT, DC, ID, IN, MD, LA—if K permits, NC, SC, WI • Red Pencil (“All or Nothing”) NE, VA (formerly GA) 16
Blue Pencil Drafting Example • During the term of employment and for the period of twelve (12) months following the termination of employment for any reason (or for no reason), the Employee shall not, directly or indirectly, anywhere within (i) the United States, (ii) within 50 miles of any city or other geographic area in which the Company engages in business, and iii) within 50 miles of any city or other geographic area in which the Employee engaged in business for the Company, develop website content for pharmaceutical companies, physicians, practice managers or patients similar to that which Employee developed for the Company, or engage in any other business activities similar to the business engaged in by the Company,… 17
Restrictive Covenants: Scope • Customer Restrictions Only those with whom personally dealt/responsible: (e.g., NY, MD, Cal, Tex) All customers of company (e.g., OH) • Geographic Where employer v. employee did business • Length of Time Some State Statutes Identify Reasonable/Unreasonable Length of Time – E.g., Florida and 2 years Others establish through decisions • Exemptions E.g., attorneys, professionals (AL); broadcasters, physicians (DE, KY, MA, TN/TX—certain circs); other ethics codes/industry regulations—e.g., financial services) 18
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