Created November 19, 2009
It would be devastating for a Coca-Cola executive to jump ship to Pepsi Co. and spill all of his or her accumulated knowledge about how Coca-Cola does its business to its longstanding competitor. The same may be true of your company. Your business may be based on the workings of a particular patent, or may depend on a carefully developed client list—information that must be kept secret if you are to maintain your competitive edge. An employee with access to these assets could be seen as an asset to your competitors, or could decide to start his or her own version of your business. One of the best ways to protect your business from this potential threat is through a covenant not to compete.
A covenant not to compete is a contract between an employer and an employee whereby the employee agrees not to work for a competitor or become a competitor for a certain period of time after leaving the employ of the employer. A covenant can prevent a former employee from (1) forming a new business in competition with yours; (2) working for a competitor; (3) taking your business’ proprietary information to a competitor; (4) luring your clients away from you; and (5) luring current employees away from you. Although historically disfavored as a restraint to open trade, courts today have recognized that the modern economy thrives on innovative technology and intense competition, and, thus, allow for covenants that place reasonable restrictions on how long a former employee must wait before being able to compete against your business.
So when do you need a covenant not to compete? You should strongly consider covenants for employees who have access to nonpublic information, such as trade secrets and client lists, and employees that provide unique services—especially those that require state licensing or certification. You need to ask yourself, “If this employee became a competitor, would they have a special edge against my business?” As an example, McDonald’s does not have covenants preventing its fry cooks from working for other fast food chains, but surely has covenants with the marketers that conducted and compiled the consumer research McDonald’s relied upon to craft its next ad campaign. Also consider covenants for employees that have developed relationships with your clients, as those relationships could be used to lure your clients to a competitor.
Covenants not to compete are also essential in the sale and purchase of businesses. If your business purchases the assets of another, you do not want the former owners using the old business’ assets, such as its client list, to start a new firm to compete with yours. The covenant can protect the rights of the buyer from unexpected competition down the road and ensure that the assets purchased truly belong to the buyer and are not subject to unauthorized dissemination.
Implementation. If you have decided that you want to have a covenant not to compete as part of an employee contract or business asset transaction, that covenant will not be enforceable unless it has the basic elements of any other contract, namely consideration and acceptance.
In Virginia, requiring a prospective employee to sign a covenant not to compete as a condition for employment is considered legal consideration and will make the covenant enforceable, assuming that the covenant’s terms are reasonable (the subject of another article in this publication). But what if you want to impose a covenant on a current employee? The Virginia Supreme Court held in Paramount Termite Control Co. v. Rector, 238 Va. 171, 380 S.E.2d 922 (1989), that continued employment after the acceptance of the covenant constituted sufficient legal consideration to make the covenant enforceable. However, in Mona Electric Group, Inc. v. Truland Service Corp., 193 F. Supp. 2d 874 (E.D. Va. 2002), a federal district court applying Virginia law apparently overlooked the Rector decision and held that continued employment was not sufficient consideration to enforce a covenant.
Since the Virginia Supreme Court is the ultimate arbiter of the status of Virginia law, the Rector decision should be the most authoritative. However, the best way to ensure that a covenant has consideration when given to a current