How to Protect Your Business with Covenants Not to Compete
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. Today’s businesses are often based on the workings of a particular patent or idea, or may depend on a carefully developed client list—information that must be kept secret if they are to maintain a competitive edge. An employee with access to these assets could be seen as an asset to competitors, or could decide to start his or her own version of the business. One of the best ways to protect your company from this 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.
In this article, we will discuss what kinds of covenants not to compete are legally enforceable, how they can be implemented in your business, and what kinds of remedies are available to employers in addition to covenants not to compete.
1. The Limits of Non-Compete Agreements
While courts are willing to enforce covenants not to compete, judges will construe the terms of those covenants strictly, against the employer. Only “reasonable” provisions will be enforced since covenants not to compete inhibit the freedom of trade. Therefore, it is important to carefully craft any covenant with the assistance of legal counsel so that it will withstand scrutiny of the courts.
The most important consideration in drafting a covenant not to compete is to identify what the particular needs of your business are. Where do you compete for business? What is the exact nature of your business? What are the duties of the employee who will be signing the covenant, and what kind of trade secrets or other private information does he or she have access? This is important because the courts will only enforce “reasonable” covenants, and will ask these three questions to determine if a given covenant is reasonable:
a.) Is the restraint, from the standpoint of the employer, reasonable in the sense that it is no greater than necessary to protect the employer in some legitimate business interest?
b.) Is the restraint, from the standpoint of the employee, reasonable in the sense that it is not unduly harsh or oppressive in curtailing his or her legitimate efforts to earn a livelihood?
c.) Is the restraint reasonable from the standpoint of good public policy?
Ultimately, “reasonableness” is a balancing act between the three different kinds of restrictions that covenants not to compete offer: the duration of the restriction, the size of the geographic area where the restriction applies, and breadth of activity to be restricted. The broader any one of these restrictions is, the more narrow the others will need to be in order for the covenant to be reasonable, and all three will be assessed within the perspectives of the employer, the employee, and the public.
In general, courts find reasonable those covenants that restrict an employee from engaging in the same kind of work he or she performed for the employer in the geographic area the employer does business for a period of up to two years after termination. Courts are also willing to enforce prohibitions on former employees soliciting current employees, or business clients, for the same period. However, the facts and circumstances of your business may require broader protection in one area than another.
The Virginia Supreme Court, in New River Media Group, Inc. v. Knighton, 245 Va. 367, 429 S.E.2d 25 (1993), upheld a covenant against an employee disc jockey wherein the employee could not join a competing radio station within 60 air miles of the employer’s broadcast station for twelve months after termination. The radio station evidently decided that it was willing to make the covenant enforceable for only one year instead of two in order to make sure that the coverage area was suitably large to protect the station. In Advanced Marine Enterprises, Inc. v. PRC, Inc., 256 Va. 106, 501 S.E.2d 148 (1998), the same court upheld a covenant that prevented former employees, for a period of eight months, from “rendering competing services to” or “solicit[ing] any customer of [the employer] for whom Employee performed services while employed by [the employer], within 50 miles of [any of the employer’s] office[s],” even though the employer had ove r 300 offices worldwide. The duration and breadth of activity were narrow enough to allow the broader geographic scope to be reasonable.
Covenants not to compete that do not specify a duration, a geographic area, or the particular activities at issue will typically be read as though being unlimited in nature, and thus unreasonable restraints on trade. Ambiguities in non-compete agreements will also be read against the employer and in favor of the employee, making it much more likely that the covenant will be found to be unreasonable. Thus it is critical to draw clear restrictions on each aspect of the covenant.
Should any part of a covenant not to compete be deemed unreasonable by a court, the tendency in Virginia has been to not enforce the entire covenant. This makes it all the more important that each covenant be carefully drafted. Since the covenant is a contract like any other, it is typical to include a severability provision so that if one part of the covenant is unreasonable, the other parts may still be enforced. Virginia courts have been reluctant to honor such clauses, however.
As a final matter, it is always a good idea for employers to include a provision in the covenant whereby the employee agrees to pay the employer’s attorneys’ fees if the employer has to enforce the covenant against the employee in a later legal proceeding.
2. Implementing the Covenant not to Compete
Once you have decided that you want to have a covenant not to compete as part of an employee contract or business asset transaction, and you have worked with legal counsel to create the terms of the covenant, those restrictions will not be enforceable unless the covenant 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 as described above. 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, the best way to ensure that a covenant has consideration when given to a current employee is to provide some kind of additional benefit, such as a raise or bonus, as a reward for accepting the covenant. Thus, a good time to institute a covenant not to compete with a current employee would be when he or she is already being promoted—the raise for the new position would al so serve as consideration for the new covenant.
In addition to consideration, there needs to be acceptance of the covenant. The acceptance needs to be explicit and not merely assumed. In Persinger & Co. v. Larrowe, 252 Va. 404, 477 S.E.2d 506 (1996), the Virginia Supreme Court held that a general partner was not bound by a noncompete covenant that he did not sign, but by its terms was to be automatically applied to all the partners of the partnership. Mere awareness of the covenant was not sufficient. Therefore, make sure the employee signs the covenant.
3. Remedies for the Employer
An enforceable covenant not to compete affords the greatest access to legal remedies. Without such a covenant, the options are much more limited. Under the common law, an employee, including an employee-at-will, has a fiduciary duty of loyalty towards his or her employer during the course of employment. In Virginia, the duty of loyalty requires, among other things, that an employee not compete with his or her employer during the course of employment. Hilb, Rogal & Hamilton Co. of Richmond v. DePew, 247 Va. 240, 440 S.E.2d 918 (1994). While not a cause of action in itself, an employee who engages in one of the acts described below while still an employee with your firm is violating their duty of loyalty, whether a covenant not to compete is in effect or not. However, once the employee leaves your company, the duty of loyalty ends and the employee is free to compete against you, with some limited exceptions as described below Therefore, covenants not to compete afford the employer more legal protections, and also continue to provide protection after the term of employment.
Here’s an overview of the legal avenues available to employers:
An injunction is an equitable request that a court issue an order preventing the former employee from continuing to act in violation of the covenant or other applicable laws—to stop an employee from working for a competitor, for example. The purpose of the injunction is not to recover damages—it is only to prevent certain conduct that is in violation of the covenant or the law. As such, an injunction is often not the only remedy that an employer might request.
A preliminary injunction—which is granted at the outset of litigation—is of particular importance in the enforcement of a former employer’s rights since otherwise the offending conduct, along with the damage caused, will not stop until the conclusion of the trial, at best—something that may take over a year.
II. Tortious Interference with Contractual/Business Relations
Both tortious interference claims are geared to address the business that an employer loses or may lose as a result of the former employee luring clients to a competitor. For interference with contractual relations, an employer must show that there is (1) an existing contract or covenant with a third party (the former employee in the first instance, the client in the latter); (2) knowledge of the existence of the contract by the wrongdoer; (3) intentional interference with the contract by the wrongdoer; (4) a breach of the contract by the third party induced by the wrongdoer; and (5) resulting damages. Chavez v. Johnson, 230 Va. 112, 335 S.E.2d 97 (1985). Interference with business relations does not require the presence of a contract—there need only be a “business relationship or expectancy,” along with a “probability of economic benefit,” for the employer to recover damages. Glass v. Glass, 228 Va. 39, 321 S.E.2d 69 (1984).< br>
III. Civil Conspiracy
In some cases where one of the above interference claims can be alleged, there may also be a claim for civil conspiracy against the former employee and the competitor that hires the former employee. A civil conspiracy exists where there is an agreement between two or more persons to accomplish an unlawful purpose or to accomplish a lawful purpose by unlawful means, resulting in damages. Glass v. Glass, 228 Va. 39, 321 S.E.2d 69 (1984). While there cannot be civil conspiracy between a corporation and an employee of that corporation, since they are considered as one entity under the law, there can be civil conspiracy between a competitor and one of your employees, such as when the competitor and your employee agree to wrongfully cause your clients to break contracts with your company as the employee leaves to join the competitor. Under civil conspiracy, you can recover from the former employee and the competitor any damages proximately resulting from the wrongful conduct, in addition to punitive damages.
IV. Misappropriation of Trade Secrets and Proprietary Information
Misappropriation of trade secrets is a statutory basis for relief under the Uniform Trade Secrets Act, with or without a covenant not to compete in effect. The Act defines “trade secrets” broadly as information that derives economic value from not being generally known or ascertainable to those who could make economic use of it, and which is subject to reasonable efforts to keep the information secret. See Virginia Code § 59.1-336. It is “misappropriation” under the law when an employee receives a trade secret from his or her employer and then discloses that trade secret, without the employer’s consent, to a future employer.
For misappropriation that is “willful and malicious,” the courts will award attorney fees to the prevailing party, and for especially egregious conduct, punitive damages up to $350,000 are available.
Consult legal counsel as soon as you discover that a covenant not to compete may have been violated by one of your current or former employees so that you can discuss what remedies may be appropriate in your situation.
The matters discussed in this newsletter are for informational purposes only and no legal advice is intended.