What to Consider When Drafting a Covenant Not to Compete

David Keene, II
October 27, 2008 — 1,985 views  
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A covenant not to compete is a contractual limitation on an employee’s ability to work in a given field after they leave your employment.  Most employers don’t consider a covenant not to compete until a key employee leaves for the competitor across the street.  A covenant not to compete, however, should be considered long before an employee leaves.

 

When considering whether a covenant not to compete is appropriate for your workforce and, if you decide it is, there are six issues to consider.

 

1.         Consult your attorney

 

The first thing to do when considering a covenant not to compete is consult with your labor and employment attorney.  I don’t recommend this because I am such an attorney, but you should hear an honest assessment whether the covenant will be enforceable.  In some states, such as California, they are unenforceable—a covenant not to compete is literally not worth the paper it’s written on.  In some states, they are unenforceable against certain professions.  In others, the terms of the covenant are so limited that it may not be worth having one in place.  Your attorney should provide an honest assessment of the usefulness of a covenant not to compete.

 

Where I primarily practice, my clients’ employees travel across state lines all the time—from Tennessee to Virginia to North Carolina and back—while working for the employer.  Therefore, I have to draft covenants that can be enforced across state lines.  When drafting a covenant not to compete for a client, the first thing I need to know is where this person works so that the covenant can be drafted to comply with each states’ law.  Your attorney must be able to draft an enforceable covenant and, if it cannot be enforced in certain areas where you do business, he or she must inform you as such.

 

2.         Draft a reasonable agreement

 

The key to a covenant not to compete is reasonableness.  It must be reasonable as to time, geography, and business necessity.  Remember, the goal is to protect your business, not make it impossible for the former employee to earn a living.

 

·         Time—A two year prohibition is likely the lengthiest restrictive period of time a court will enforce.  Most courts hold that circumstances, relationships, and business opportunities have sufficiently solidified after two years allowing the former employee’s departure that allowing him or her to pursue his trade, in competition with his former employer, will not unduly harm the employer.

·         Geography—It is important that the covenant is tailored to the area in which the employee works.  If the employee is a salesperson who travels throughout the country, then a covenant that prohibits him or her from selling a product similar to yours throughout the country is reasonable.  If the employee only sells your product in Florida and Georgia, then a nationwide covenant is very unlikely to be enforced.

·         Business necessity—In most jurisdictions that enforce non-competition agreements, an employer must demonstrate that the covenant protects the legitimate interests of the employer.  In the covenants I prepare for clients, I include a comprehensive list the company’s interests—current customers, trade secrets, confidential information, employee training, etc.  This way, if a court holds that one of those interests is unenforceable or insufficient, I have several other interests on which to fall back.

 

3.    Include certain key provisions

 

There are several clauses you absolutely must include.  They are:

  • A choice of law/venue provision—This should be the state, or one of the states, where the employee works.  By tying the choice of law provision to the state where the employee works, a company can spread its risk and minimize the chance that the choice of law or venue provision will be rejected or will result in the application of an unfavorable precedent at some time in the future.
  • Trade secrets—The employee should acknowledge that he may have access to the company’s trade secrets, that he will treat such trade secrets as confidential, and that he or she will not use trade secrets for his or her own behalf or disclose them, in any way, to any third party.  The covenant should require the employee to return any information or documents relating to the company immediately upon termination of employment.
  • Termination of employment--Include language that in the event employee is terminated by the company, the employee remains bound by the covenant.  Some states hold that if the employee is terminated by the employer, then he or she must not have been a good employee, and therefore there is no reason to enforce the covenant.  If you are in such a state, include this provision anyway—you may be able to formulate an argument that averts this issue.  For example, if a well-connect employee stole from the business and was terminated for theft, he or she may still be a threat to the business.  He or she should not be allowed to compete with you after they have tried to harm your business.
  • Injunctive relief and attorneys’ fees--It is a good idea to include provisions providing for a presumption that any harm done is irreparable and difficult to quantify. That sets the groundwork for obtaining an injunction in the event of a violation, or threatened violation, of the covenant. This provision will typically state that injunctive relief is in addition to other available remedies.  Also, include a provision providing that the company will be reimbursed for reasonable attorney's fees and costs in the event that litigation is required to enforce the restrictive covenants. This gives an employer a significant amount of leverage in the litigation.
  • Modification/Severability--Include language stating that if any provision of the covenant is unenforceable in whole or in part, either in a court decision or a change in the law, it shall be deemed modified to the minimum extent necessary to make it reasonable and enforceable under the circumstances, and the rest of the covenant remains in place.
  • Successors and assigns--Make sure that, in the event the company undergoes a transition, e.g., is bought by another company, the covenant remains enforceable by the new owner. 
  • Entire agreement--Include language to the effect that the written covenant is the entire understanding and agreement of the parties, and that any prior writing or conversations are terminated and canceled in their entirety.

4.                  Provide adequate consideration

Unless the covenant is signed at the start of employment, you should provide fresh consideration. This raises two issues:

 

·         What is the start of employment?  The start of employment does not mean three days, a week, two weeks, or four months after the employee has started working for you.  Start of employment means start of employment—the same day as the employee’s first day of work.  The covenant should be presented as part of the orientation process.  In some circumstances, the employee should be given the covenant prior to the start of employment—to make sure they won’t balk at signing on the first day—or, ideally, the covenant should be negotiated with the employee.  Negotiation is ideal, as it shows that the employee played a role in the drafting process and was not forced to accept the agreement.

·         What is fresh consideration?  Fresh consideration is the quid pro quo for accepting the covenant not to compete.  At the start of employment, the offer employment is the quid pro quo for accepting the covenant not to compete.  If you decide to require a covenant not to compete at a later date, make the consideration considerable, for example, $1,000.00.  Thus, the quid pro quo for signing the covenant at a later date is a reasonable sum of money.  Employers sometimes try to provide $1 dollar, or the continuation of employment, as the fresh consideration.  If you do this, a court is unlikely to enforce the covenant, as you’ve not provided any real consideration, and you’ve shown that the covenant really isn’t worth anything.

5.         Enjoy the benefits of the covenant.

It is important to include language stating that, if a former employee's violation of a non-competition agreement is not discovered until months after it has begun, the time period covered by the covenant will automatically be extended by a length of time equal to the time period during which such a violation occurred.  This way, your relief isn’t cut short by the period of time it took you to learn of the violation.

 

6.         Don’t wait to enforce your rights.

 

If you’re not going to enforce the covenant not to compete, there is no point in hiring an attorney to draft one.  Failure to enforce defeats the entire purpose. 

Immediately upon learning of a breach of the covenant, or the possibility of a breach, you must act to enforce your rights.  Send a letter to the former employee and the new employer reminding them both of the covenant not to compete, and its terms.  If this does not provide sufficient assurance of compliance, seek a temporary restraining order or preliminary injunction.  You must stop the prohibited conduct immediately, before it further damages your business.  Failure to act renders the covenant worthless, and empowers future former employees to flout the covenant.

 

Another reason to move quickly is that you don’t want the former employee to strike first.  How could the former employee strike first?, you might ask.  The answer: through a declaratory judgment.  He or she could go to a court—possibly different from the one listed in the covenant not to compete—and seek to have that court hold that the covenant is unenforceable.  This could be a court far from corporate headquarters.  This could be a court in a different state, a state that is known for striking down covenants.  Meanwhile, as you are battling in a court you don’t want to be in, paying your attorneys to travel, and perhaps hiring local counsel, the former employee is stealing your clients.

 

In conclusion, a covenant not to compete that is properly drafted can be an excellent way to protect your business.  If you’re not going to act to enforce it, however, don’t waste your time and resources having one drafted.

David Keene, II

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David Keene, an associate in Baker Donelson's Tri-Cities office, concentrates his practice in the area of labor and employment law. Mr. Keene has experience in a multitude of labor and employment areas including negotiating collective bargaining agreements for both private and public sector employers; representing employers in grievance and issue arbitrations; representing employers in all matters, including elections and unfair labor practices, before the National Labor Relations Board and state labor boards; helping clients maintain union-free workforces; handling unemployment claims from initial applications for benefits through court appeals; counseling clients on a multitude of federal employment laws, including the ADA, FMLA, ADEA, and FLSA; litigating employment discrimination claims; and representing individuals against unions. Mr. Keene has been published in The Labor Lawyer, Labor Law Journal, and numerous other publications, and has taught seminars on a wide variety of labor and employment topics.