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Labor and Employment Law: A Practice Focus
April 19, 2004
RESTRICTIVE COVENANTS WORK BEST WHEN WRITTEN WITH AN EYE TO THE FUTURE
An employee has a common law duty to serve her employer diligently and faithfully, to refrain from knowingly or willfully injuring the employer’s business, and to avoid any conflict between the employer’s interest and the employee’s self-interest. But what happens when the working relationship ends? The now-former employee’s duty of loyalty ends, too.
To pick up where the common law duty leaves off, an employer may ask the employee to sign a restrictive covenant — also known as a noncompete, nonsolicitation, or confidentiality agreement. The ex-employee thereby promises not to engage in certain activities for a certain period of time that could damage the former employer.
While some states have a well-developed body of law evaluating the enforceability of restrictive covenants, the District of Columbia does not. The few D.C. Court of Appeals decisions on the matter have looked to the Restatement (Second) of Contracts for guidance.
The general rule that has emerged is that a D.C. court will enforce a restrictive covenant if it meets the following criteria: First, the covenant must be ancillary to the employment relationship. Second, it must be no wider in scope and duration than reasonably necessary to protect the employer’s business. Third, it must not impose undue hardship on the employee or disregard the public interest. And fourth, it must be supported by consideration.
In other words, D.C. courts will not simply rubber-stamp every noncompete contract as enforceable. D.C. employers and employees must take equal care before drafting or signing any such agreement. Instead, they should analyze the contract in four general areas — purpose, benefit, scope, and enforcement.
Purpose: Why does the employer want the employee to execute this agreement? More specifically, what are the employer’s interests, needs, and concerns regarding the employee’s post- separation activities, and are those interests, needs, and concerns legitimate?
Benefit: What benefit does the employee receive for signing? Depending on whether the contract is presented before, during, or at the end of the employment, the benefit may be a job offer, the promise of continued work, or severance pay.
Scope: What is the scope of the contract? Typically, various provisions will discuss the duration of the restrictive covenant; the requirement to keep sensitive information confidential; the obligation not to solicit and/or hire the company’s other employees; and descriptions of some combination of the following: the clients that the employee may not solicit (or attempt to solicit) during the term of the covenant, the clients with which the employee may not do business (or try to do business), the type of competitors for whom the employee may not work, and the type of work the employee may not perform.
Enforcement: Will a court deem the restrictive covenant reasonable as written? If not, does the jurisdiction have a blue pencil rule permitting the court to modify the contract, or will the court simply find an unduly severe covenant altogether unenforceable?
Let’s look at each of these in greater detail.
WHAT’S OUR PURPOSE HERE?
In crafting the restrictive covenant, the employer’s counsel should first ask whether it is necessary at all. What is so special about the employee that her future activities could harm the company? Is she a salesperson or high-level executive who has (or will have) regular contact with customers and whose development of good will and personal relationships with those customers has driven the company’s success? Has the company expended (or will it expend) considerable resources providing specialized training and education to the employee? Or is she an unskilled, entry-level worker without client contact, who represents no competitive threat if and when she leaves?
Another factor to consider is the reason why the employment relationship ends. If the company thinks an employee is such a poor performer that it terminates him for good cause (which must be a defined term), is he really a threat to the company post-termination? On the other hand, if the covenant disappears for any worker terminated for cause, there is clearly incentive for the next worker to get himself fired on purpose, to avoid the restraints of the covenant.
Similarly, the I don’t want him but you can’t have him issue arises if a company seeks to enforce a covenant against an employee whom, through no fault of his own, the company can no longer employ. The court may well ask whether it is fair to restrict that person’s job prospects.
WHAT’S IN IT FOR ME?
While the company decides whether a restrictive covenant serves any good purpose, the employee must ask why she should sign.
An employee may be required to sign a restrictive covenant as a condition of employment. But if the company presents the covenant at the time of hiring, is it, in exchange, promising employment for a definite term or just promising that termination will only be for good cause? If the company asks an employee to sign after she has begun working, will the company promise to continue employing her for a definite and substantial period of time?
Attempts to include a restrictive covenant as part of a severance agreement are not unusual. The common practice is to offer to pay the departing worker her monthly wages — or some percentage thereof — for each month that she is under the covenant. But if the departing person is easily re-employable, she might well demand a premium, not a discount, on her former wages. Unless the employee will have trouble finding a job in her field anyway, intends to work in an unrelated field, intends not to work at all, or otherwise has no intent to do whatever the contract forbids her from doing, there is no reason why she should take a discount on her fair market value, allow her skill set to rust, permit her industry knowledge to fade, and watch her professional reputation and contacts atrophy from disuse.
YOU CAN’T DO THIS OR THAT
The heart of most disputes over restrictive covenants is, of course, the covenant’s scope: What activities are covered and for how long?
The duration of the covenant should not be greater than reasonably necessary to protect the employer. Restrictions of three years and longer have been sustained by D.C. courts, although the cases upholding longer terms tend to be considerably older. 12 F.2d 491 (App. D.C. 1926) (yes to 10 years); 110 F. Supp. 957 (D.D.C. 1953), 221 F.2d 543 (1955) (yes to five years). 155 F.2d 422 (D.C. Cir. 1946) (no to three years).
What happens if the company should close its doors or substantially change the nature of the business? It is hard to argue that a protectable interest would survive and that a covenant should remain valid.
Noncompete clauses must describe as accurately as possible the type of product or service the company provides so that it is easy to determine who is a competitor. Employers will want the description to be broad; employees will want it to be narrow.
Noncompete clauses must also define confidential information. Besides trade secrets protected under the D.C. Uniform Trade Secrets Act, confidential information might include customer lists, business methods, marketing strategies, and pricing methods. Be clear as well about the duration of the confidentiality provision: Is it indefinite or until such time as the information becomes public (except if it becomes public through an unlawful disclosure)?
Provisions barring solicitation of company clients must carefully define who is a client. It is reasonable to include clients at the time of the employee’s departure, but not those who become clients afterward. What about clients with whom the employee had no contact? Listing them by name removes uncertainty but also clearly identifies them to an ex-employee intent on breaching or willing to dispute the enforceability of the covenant.
Prospective clients, a category that might literally encompass the world, should not be off-limits, unless the company has already made personal contacts or a deal is in the pipeline. But what about past clients with whom the company has not done business recently? Should the list go back one year or five? Drawing this line properly can determine whether the covenant will be enforceable.
Then there are pre-existing clients of the employee herself. By law, clients who are brought to the company become the company’s. Thus, the employee who wants to claim these clients after leaving needs to specifically identify and exclude them from the scope of the restrictive covenant.
There is an important distinction between forbidding the former employee to solicit the company’s clients and forbidding her to perform work for them. If the client approaches her, may the former employee accept its business? If the client is no longer getting that particular employee’s services, will the client continue to use the company at all, or will it go elsewhere — rendering the ex-employee’s exclusion unreasonable?
Similar concerns arise regarding the active solicitation of the company’s current workers versus the hiring of current workers who themselves initiated contact with the former employee.
It is also hard to imagine what legitimate interest the company could have in barring a former employee from contacting other former employees. Yet despite questionable validity, such restrictions are commonly inserted.
What about geographic restrictions? If client solicitation is the only real concern, a geographic limit may prove unnecessary since the clients’ locations are irrelevant. Also, geographic limits may ill-serve high-tech businesses that are global in nature. Otherwise, it is appropriate to define a geographic area within which the ex-employee may not compete.
BUT WILL IT STICK?
Finally, there are issues of enforcement. Begin with the question, Is it worth enforcing? A restrictive covenant should always provide for injunctive relief. It should also include a formula for calculating monetary damages. To avoid uncertainty later, spell it out now.
More broadly, to be enforceable in the D.C. courts, a restrictive covenant must define a legitimate business interest. General restraints of trade are void as against public policy, and the purpose of the covenant cannot be simply to restrain competition. 156 F. Supp. 408 (D.D.C. 1957). The company must be able to describe the extent to which the employee may unjustly enrich himself by appropriating an asset of the employer for which the employee has not paid and using it against the very employer. 795 A.2d 669 (D.C. 2002).
To avoid enforcement, the ex-employee must be prepared to demonstrate the nature of the undue hardship she faces. Mere personal hardship is not enough. 795 A.2d 669 (D.C. 2002). This can be much more difficult if the covenant contains, as many do, a clause whereby the employee expressly warranted that enforcement would not cause undue hardship.
If all else fails, the employee may be able to argue injury to the public if the covenant is enforced. But can she state how the public would be harmed? For instance, the people’s interest in going to the medical specialists of their choice might overcome a prohibition on an orthopedic surgeon’s activities.
In the District, strategic drafting of restrictive covenants is critical because D.C. courts have not specifically adopted a blue-pencil rule, which would allow courts to strike unenforceable language when it is easily divisible and then enforce the rest of the covenant. Some courts will rewrite an invalid covenant drafted in good faith (for example, reducing the duration from seven to two years) to uphold the parties’ presumed intent. Other courts simply refuse to enforce the entire covenant if portions are overbroad, unreasonable, or otherwise unenforceable.
In 565 A.2d 615 (D.C. 1989), the only D.C. case to discuss the blue-pencil rule, the D.C. Court of Appeals held that the trial court did not abuse its discretion by entering a preliminary injunction that did not purport to enforce a restrictive covenant. In that case, the enforceable and unenforceable terms were severable on their face. But the outcome is far from guaranteed in other cases. Thus, when drafting restrictive covenants in the District, counsel is advised to get it right the first time.