Restrictive Covenants: What Startups Need to Know

What exactly are “Restrictive Covenants”?

“Restrictive Covenants” is a term used to describe provisions in an agreement that purport to restrict an employee from doing certain things after the employee leaves the company.

The two most common forms of Restrictive Covenants are “non-competes” and “non-solicits.”

• A non-compete is a provision that precludes the employee from working for a competitor for a period of time after leaving the company.

• A non-solicit is a provision that precludes the employee from soliciting, or recruiting, and in some cases hiring, company employees for a period of time after the employee leaves the company.  Non-solicits can also preclude the employee from trying to get business from the company’s customers for a period of time after the employee’s employment with the company ends.

So, are Restrictive Covenants enforceable?

Where and What Law?

It depends a lot on where the employee is and what law governs (or purports to govern) the agreement.  Restrictive Covenants are governed by state law so enforceability can differ from state to state.  For example, with very narrow exceptions, a non-compete or customer non-solicit is not enforceable in California.

In other states, non-competes may be enforced where the covenants protect a legitimate business interest (e.g., confidential information or customer relationships are reasonably drafted as to time and geographic (and in some states, the scope of duties covered). Courts generally enforce reasonable non-solicitation provisions.

Quit or Fired?

In states that generally enforce non-competes, another factor that can impact whether a non-compete will be enforced is the reason the employee’s employment ended.  If the employee quit or was fired for misconduct or something else more than general poor job performance, then a court is more likely to enforce the non-compete.  If, however, the employee was fired because of a reorganization or even general poor performance, courts will be less likely to enforce the non-compete or, in some states, won’t enforce the non-compete as a matter of law.

Breadth & Depth

The other key component that factors into enforceability of Restrictive Covenants is their temporal and geographic scope.  Scope means both how long the Restrictive Covenant lasts and the territory it covers.  As you might guess, the shorter the time and narrower the scope, the more likely the Restrictive Covenant is to be enforced.  Courts don’t like to see provisions that try to tie someone up for an unduly long time and/or try to squeeze them out of making a living in a broad field.

Assuming the rest of the provision and the surrounding circumstances favor enforcement, Restrictive Covenants limited to one or two years post-termination are generally viewed as reasonable.  Longer periods are more likely to be enforced when the Restrictive Covenants arise out of a merger or similar transaction where there is a wholesale transfer of company good will and assets.

In terms of geographic scope, Restrictive Covenants that cover a broader territory than necessary may be held unenforceable.  For example, if an employee only deals with customers in certain states, it may be hard to enforce a Restrictive Covenant that purports to cover the entire country.  Similarly, if an employee really only deals with one of the company’s product lines, a Restrictive Covenant that purports to prevent her from taking a job in another area just because the company has a competing product in that area may be hard to enforce.

Common Restrictive Covenant Issues

I want to hire someone who is subject to Restrictive Covenants, how do I know if they are enforceable?

The first step is to determine in what state the employee worked and will work, and the governing law of the Restricted Covenant agreement.  As noted above, some states do not allow, or significantly restrict, noncompetition covenants.

The next step is to see if employment with you company violates the actual terms of the Restrictive Covenant agreement.  If it does not, there is not contract breach if you hire the employees.

The last step is to analyze is the Restrictive Covenants are reasonable.  That includes analyzing the time and geography of the restriction.  A covenant may be reasonable for one type of employee but not another.  For example, in some circumstances, a noncompetition covenant for a sales person should be limited to that sales person’s former sales territory.

I can hire her and if the other company makes a big deal out of it, it’s her problem, not mine, right?

Maybe, maybe not.  If your company is aware of the Restrictive Covenant, the other side may be able to assert claims against your company for interfering with a contract or for unfair competition.  Also, if your new employee faces a claim for breaching a non-solicit provision, based on her conduct after she joined your company, state law may require you to pay for her defense.

What can a company do to enforce a Restrictive Covenant?

Whether you’re concerned about enforcing your own Restrictive Covenants or are facing a dispute because you hired someone arguably subject to restrictions, it is important to understand what can happen and when.  Unlike a lot or areas of litigation, enforcement of Restrictive Covenants is an area where courts are more willing to rule very quickly that the Restrictive Covenant is or isn’t enforceable and that ruling will apply until the case is finally decided, which may not take a year or more.  Often this is done by issuing a Temporary Restraining Order or a Preliminary Injunction.  These types of decisions can come within a month or less of one side filing a lawsuit.

The key is to recognize that threats about enforceability need to be taken seriously no matter what side of the equation you’re on.  Things can move quickly.

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In short, Restrictive Covenants can get complicated on both sides of the equation, i.e., whether you want to have your employees restricted or want to hire someone who may be subject to a restrictions.  Go into this area with your eyes open and an informed understanding of the issues.