Legal Issues: Restrictive Covenants

Pros and Cons of Restrictive Covenants

It is not uncommon for an employee to leave a company and join a competitor’s business or launch their own shop in the same community. As a practice owner in the highly competitive arena of aesthetic medicine, it is understandable that you would want to protect your business against loss of patients, particularly when that loss may come at the hands of an employee who has benefited from hours of training and years of building professional and patient contacts in your facility.

To minimize the risk, you can require staff members to sign restrictive covenant agreements. These include non-compete, non-solicitation and/or non-disclosure agreements. But are such agreements enforceable? That depends: Enforceability varies from state to state. Understanding the laws of your jurisdiction and the details that must be included in such agreements is the first step in drafting an enforceable restrictive covenant.

Covenant Not To Compete

A covenant not to compete—also called a non-compete agreement—prohibits an employee from working for the employer’s competitors and/or soliciting business from the employer’s customers after the employment has terminated. (Generally, termination of the employment relationship can be done with or without cause upon the initiative of either the employer or employee.)

These agreements are used to protect the employer’s legitimate business interests, which typically include: trade secrets and other valuable confidential information; relationships with specific prospective or existing customers, patients, vendors or clients; customer, patient or client goodwill associated with an ongoing business, commercial or professional practice, specific geographical location or specific marketing or trade area; and extraordinary or specialized training and/or any other economic advantages that the employee has obtained for the benefit of the employer during the course of their employment.

In order to have a valid (read: enforceable) covenant not to compete, it must be “reasonable.” Factors that are considered when determining the reasonableness of an agreement include: the level of the employee’s position; whether the employee possesses unique employer information; the employee’s skills; the nature of the industry; and whether the restriction prevents the employee from employment with comparable opportunities for professional growth and benefits. An overly broad agreement that unreasonably restrains an employee’s opportunity to pursue his/her profession may be unenforceable.

U.S. courts typically consider a non-compete agreement to be unreasonable if the restriction is greater than necessary to protect the employer’s legitimate interests or if those interests are outweighed by the hardship to the employee and the likely injury to the public. This is because a covenant not to compete can leave a former employee unable to work or make a living.

The covenant must also be reasonable in terms of geographical distance and time. If the employer no longer engages in business in the area, the non-compete typically will not be enforceable. In addition, most states that permit covenants not to compete only honor covenants that last for two years or less after termination of employment.

States That Disfavor Non-Competes

Courts have become increasingly unwilling to enforce non-compete agreements, primarily because states do not want to impede an employee’s ability to earn a living. States that either prohibit or do not enforce non-compete agreements include California, Oklahoma, Rhode Island and North Dakota.

California does not recognize a covenant not to compete in an employment context. Not only are non-compete covenants void under California law, but an employer could be liable in tort for wrongful termination if it terminates an employee who refuses to agree to a covenant not to compete. The only exception to California’s prohibition of non-compete agreements is if the covenant is part of the sale of a business or dissolution of a partnership.

Oklahoma, Rhode Island and North Dakota do not prohibit the use of non-competes, but do find non-compete clauses unenforceable. In Massachusetts, Missouri and Oregon, non-competes are disfavored and typically considered not enforceable.

Even states that permit non-compete agreements impose restrictions. For example, in Colorado, a covenant not to compete is unenforceable unless it is related to the purchase or sale of a business, the protection of trade secrets, the recovery of educating and training an employee who has served an employer for a period of fewer than two years; or executive employees or their professional staff.

Some states, such as Georgia, will only enforce restrictive covenants against “key employees.” A key employee is one, who, by reason of the employer’s investment of time, training, money, trust, exposure to the public or exposure to customers, vendors or other business relationships, has gained a high level of notoriety as the employer’s representative or spokesperson.

Many states prohibit the use of non-compete covenants against physicians in the medical industry because they would interfere with patients’ freedom to seek the healthcare professional of their choice.

Non-Solicitation Clauses

A non-solicitation clause seeks to prevent an employee from engaging in any activity that has the purpose or effect of persuading or attempting to persuade another employee to leave your practice or patient from leaving your practice. In short, it prohibits an exiting employee from poaching your employees and patients for the exiting employee’s benefit.
Non-solicitation clauses are held to the same standard as those governing non-compete agreements: They must be reasonable and necessary to serve a legitimate business interest.

Non-Disclosure Provisions

Even if you cannot enforce the non-compete or non-solicitation agreement, you may be able to prohibit employees from using your confidential information to gain a competitive advantage. This is where non-disclosure provisions come in. Even states that do not permit non-compete or non-solicitation agreements, such as California, will enforce a non-disclosure agreement.

To be enforceable, the non-disclosure agreement must be reasonable and the information to be kept confidential must be valuable or protect a legitimate business interest. There is typically no limit on time or geographic scope for non-disclosure agreements.

When drafting a non-disclosure agreement, be specific as to the type of information that is considered confidential. Include a requirement that the employee must deliver promptly to the employer upon termination of employment or at any other time the employer may request, without retaining any copies, all confidential business information. Also include wording that the employee agrees not to transfer any employer information to any personal computer or other electronic device that is not otherwise used for any business purposes relating to the employer.

Key Elements

Carefully draft the restrictive covenant agreement to improve the chances that it will be enforced in a jurisdiction that permits such agreements. Be sure the restrictive covenant includes these key elements:

  • In detail, define the nature of the business and the services provided.
  • Include a geographic area and a time frame of restriction.
  • Insert a clause that the employee agrees and acknowledges that the non-compete provision will not unreasonably affect the employee’s livelihood and that it is reasonable in both temporal and geographical scope.
  • Include a clause stating that a breach would result in irreparable harm to the business.

Some businesses include a clause for liquidated damages if the agreement is breached—a specified sum of money or formula for determining the damages, proportionate to the actual harm done.

It is difficult to estimate the amount of damages caused by a breach of a restrictive covenant, so the primary remedy is a permanent injunction to restrain the breach. In other words, the former employee must stop offering their services in that location, soliciting business from your patients or using your trade secrets. A court also can award monetary damages for the breach along with an injunction.

Allyson Avila is a partner at the national law firm Gordon & Rees Scully Mansukhani. Contact her at 845.406.2935, [email protected].

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