Noncompetition clauses are gaining traction once again as distributors try to protect the investments they make in employee training and development. But more cases involving these clauses are also making their way into courts around the U.S. This article examines how restrictive clauses are being used and provides best practices for implementing such covenants.
Because competition for skilled employees is so high, more distributors and manufacturers are shifting their focus to hiring a candidate that is a cultural fit and investing in the training themselves. But training can be costly and time-consuming, and as a result, companies are also looking for ways to ensure they get a return on that investment.
Often that means including restrictive covenants, such as noncompete clauses, in employment contracts. These clauses seek to limit where an employee can work after separating from the company.
While these types of employment restrictions are not new – there are records of them dating back to the 1400s – labor market conditions have prompted broader proliferation of them. More companies are using them for more classes of employee. Even sandwich shop Jimmy John’s requires its employees to sign agreements stating they will not work for any business that derives more than 10 percent of its revenue from the sale of sandwiches that is within three miles of a Jimmy John’s franchise or affiliate for two years after separating from the company.
But the proliferation of restrictive clauses has also led to a proliferation of lawsuits against enforcement of the clauses. And the results of such lawsuits may depend significantly on where the clause is being enforced, says Michael Greco, a partner with labor law firm Fisher & Phillips.
The key is to make sure a clause is necessary to protect a legitimate business interest – simply wanting to keep the employee is not enough – in the least restrictive manner possible, Greco says.
What could go wrong?
The legal goal of noncompete and restrictive covenants is to prevent unfair competition. But too often, executives think they can simply create a one-size-fits-all agreement for all of their locations, without considering the geography where the agreement will be enforced.
“There are a lot of differences from state to state,” Greco says. “And there are some very stark differences.”
For example, a California statute bans noncompete clauses except for in a few very limited cases. Hawaii recently passed a law with much the same standards. On the other end of the spectrum, these types of clauses tend to be more broadly enforceable in states like Ohio or Pennsylvania. Many other states fall somewhere in the middle of the spectrum.
But even within the same jurisdiction, application of restrictive covenants can vary. “It all depends on the specific circumstances of the individual case,” Greco says. As a result, reliance on a one-size-fits-all agreement for companies that operate in multiple jurisdictions usually results in problems.
Another common issue with restrictive clauses is that companies write them too broadly or don’t clearly define restrictions on geography or industry.
“Essentially some of these can take you out of your industry altogether and prevent you from making a living,” says Skip DeVilling, president of DeVilling & Associates LLC, a recruiting firm focused on industrial and construction markets. “Almost no jury in the U.S. would allow for that to stand.”
In many states, the agreement must also provide some concrete benefit to the employee in exchange for signing it. This could be increased pay or the promise of severance package on separation. Often, though, companies have stated that the promise of continued employment is incentive enough – though courts are divided on this issue, as well. A Supreme Court of Wisconsin ruling from earlier this year supported the claim of continued employment being enough benefit, but suggested that it must include a guaranteed time for employment after the signing. (Runzheimer International v. David Friedlen and Corporate Reimbursement Services)
To enforce or not to enforce
While businesses may find restrictive covenants attractive, their popularity among the general population appears to be waning. More lawsuits are being filed as challenges to the clauses in a number of jurisdictions around the country.
Last year, the noncompete clause used by Jimmy John’s was challenged on the basis that its application was too broad – all employees, including low-paid hourly workers, had to sign it – and that it offered no
benefit to the employees for signing it. The challenge was dismissed, however, because there was no evidence that Jimmy John’s ever enforced the clauses laid out – meaning there was no evidence that actual damages had occurred or would occur.
But businesses aren’t stepping aside either. Many more are also turning to the courts for enforcement of the provisions.
For example, in March 2013, Stuart C. Irby Company Inc. filed a complaint against former employees Brandon Tipton, Michael Gilbert and Steven Padgett alleging that they had breached the noncompetition and nonsolicitation agreements they signed while under the employ of Treadway Electric Company. When Treadway was acquired by Irby in 2012, the agreements were assigned to Irby. About a year after the acquisition, Tipton, Gilbert and Padgett quit Irby and went to work for Wholesale Electric Supply Company Inc., Texarkana, TX.
In addition, Irby claimed that Tipton had actively recruited other employees to leave Irby and join them at Wholesale Electric, leaving the Conway, AR, branch of Irby basically unstaffed.
In April 2014, the U.S. District Court for the Eastern District of Arkansas Western Division issued a summary judgment, dismissing the case. The court ruled that because the agreements were signed while under the employ of Treadway, their enforcement ended one year after the employees’ technical separation from Treadway through its acquisition by Irby.
The court also ruled that even if the agreements could be assigned to Irby – rather than having the employees re-sign new agreements under the new entity – that they could not be enforced because they were too broad. For one, the customer base already overlapped.
“First, it appears that the only interest Irby seeks to protect is competition,” U.S. District Judge Billy Roy Wilson wrote in the judgment. “Irby lists several customers who have done business with Wholesale after this exodus; but nothing in the record indicates those customers began doing business with Wholesale only after the exodus.”
In addition, Wilson ruled that the contracts lacked “reasonable geographic limitation” because they were too vague. The territory limitation was left open for definition by Treadway and its successor Irby.
The court also ruled that Irby would pay more than $200,000 in legal costs for the defendants.
In August 2015, however, the U.S. Court of Appeals for the Eighth Circuit overturned the summary judgment, saying it was “inappropriate.” The appellate court negated every position laid out by Wilson and declared a trial would be necessary to resolve the existing disputes of material fact.
There is no such thing as an ironclad noncompete agreement, Greco says, but there are steps that can be taken to improve a restrictive clause’s enforceability and compliance.
Begin by determining the legitimate interests the company needs to protect. Is there confidential information that the employee was privy to that could be used to unfairly benefit a competitor? Does the company have a particularly innovative way of approaching training that needs to be protected?
Once the interests have been identified, determine what sort of agreement is actually necessary to protect them. A full-blown noncompete may not be the best course of action in all cases, Greco cautions. For an executive assistant, a nondisclosure agreement may be sufficient – and in many cases, more readily enforceable with the backing of other trade secret protections.
If it’s the cost of training that’s a sore spot, consider implementing a training cost agreement to ensure the company gets a return on its investment, Greco says. Assign a reasonable monetary value to the training provided over a set amount of time and how long the employee would have to work there for the company to recoup the investment. The agreement would then assess a “penalty” based on where the employee is in that recoupment period when they decide to separate.
Whatever restrictive clause is chosen, make sure that the provisions are narrowly tailored “so that you can stand up and tell a judge ‘We were really careful and thoughtful about this so as to not overreach,’” Greco says. Many cases fail because they are just too broad or unclear.
An effective way to tailor such agreements is to clearly identify what competitors are included in the agreement, DeVilling says. By providing this distinction, employees know exactly how they’re limited.
A successful agreement is one that an employee doesn’t mind signing, DeVilling says. A former employee is less likely to challenge the agreement if they gained benefits from signing it. But the benefits have to be commensurate with what they’re giving up, he says. “You simply can’t keep someone from making a living in their field altogether.”