QUESTION:

Are restrictive covenants enforceable and if so, what critical elements must be satisfied in order for these provisions to be legally binding?

REPLY:

Restrictive covenants and nonsolicitation clauses are genuinely enforceable.

[Editor’s note: Restrictive covenants are primarily protective mechanisms used by employers to shield their customer bases and referral sources from competition.]

The law recognizes that covenants, designed not to compete and/or for nonsolicitation are genuinely enforceable and can be a powerful tool in protecting the legitimate business interests of a company. Courts, however, will not enforce a restrictive covenant or nonsolicitation clause where its sole purpose is to restrict and/or limit competition.

In order to overcome this significant hurdle, the employer must first establish that it has a legitimate business interest worthy of protection. Legitimate business interests have been defined to include the protection of customer relations; confidential business information; trade secrets; and customer lists (with key customer contacts) where not readily available to the public. The presence of such a legitimate business interest is, of course, aided by a demonstration that the employer has invested significant resources in furthering the development of its customer relationships or protecting its confidential information.

In a majority of jurisdictions, postemployment covenants not to compete or for nonsolicitation will be enforceable if they are not only reasonably necessary to protect an employer’s legitimate business interest, but also do not impose an undue hardship on the employee or adversely affect the public interest. Such terms will, however, only be enforceable to the extent that they are reasonable in terms of the geographic scope and duration involved and the scope of activities prohibited.

Consequently, attempting to prohibit your former employees from engaging in solicitation of your customers or engaging in the same business across the entire nation for a period of more than one year will likely be viewed by courts with a jaundice eye. Simply put, restraints will be enforced if, considering the employee’s situation and circumstances under which the covenant was made, the restraint appears to have been for a just and honest purpose.

Conversely, a covenant will be deemed unenforceable if its true purpose is merely to repress the employee and/or impair or restrict competition; a public interest which is of paramount concern.

While generally enforceable, these covenants represent a form of restraint on trade and as such are disfavored and typically strictly construed against the employer. As a consequence, the need for careful drafting is essential. To determine whether a restrictive covenant is appropriate and how far the restriction may extend can thus only be assessed after close consultation with your counsel.

If drafted providently, however, with the legitimate business interests in mind, the employer will be best able to ensure that its employees are not free to simply walk out the door with the employer’s confidential business information/contacts and open up a competing business right next door with impunity.

Note: This feature is intended only as a forum for information and general discussion. Any information provided is not in the nature of legal representation and is not intended to establish any attorney-client relationship. Any information provided should not be relied upon without consulting an attorney to discuss the specific facts relevant to your particular situation.

Publication date: 12/10/2007