Beware the Outdated Form: Updating Older Non-Compete Agreements

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Nov 16, 2012

By Linda K. Stevens

Non-compete covenants appear in an increasing number of employment-related contracts.

The language used in these covenants has become familiar, and many view it as “boilerplate.” Indeed, most HR departments use standard forms or templates when a non-compete or non-disclosure covenant is needed.

Unfortunately, such forms often contain dated language, and such language can pose risk. Developments in the legal, technological, and business landscape have rendered some older non-compete boilerplate language less effective, and potentially less enforceable.

Basic principles

Historically, courts have viewed non-competition agreements with disfavor because they are anti-competitive, and if reducing competition is the only purpose behind a non-compete, it will not be enforced. However, the courts of most states have recognized that there are situations in which an employer does not seek to restrict appropriate and fair competition, but rather wishes to prevent the employee from exploiting some unfair advantage in post-employment competition.

In such cases, the employer is said to have a legitimate reason for wanting to restrict the post-employment competition of its employee. In many states, that reason is known as a “legitimate protectable interest.” The most commonly recognized “legitimate protectable interests” are:

  1. Long term customer relationships (sometimes referred to a company’s “good will”); and,
  2. Confidential or trade secret information. Under this mainstream approach, only if the court finds a legitimate protectable interest will it then analyze the reasonableness of the restrictions set forth in the non-compete, and, generally speaking, a non-compete covenant is reasonable when it restricts the employee no more than necessary to protect that legitimate interest.

Reviewing “boilerplate” language

With these principles in mind, a review of some standard “boilerplate” language often used in non-compete and non-disclosure covenants reveals potential problems posed by its use.

  • Executive shall not engage in a competitive business anywhere that the Company does business …” Non-compete covenants frequently prohibit the employee from engaging in a competitive enterprise “anywhere that the company does business,” making the geographic reach of the competitive restriction coextensive with the company’s footprint. Traditionally, many courts have accepted such language. However, depending on the circumstances and which state’s law applies, such language now may be vulnerable to challenge.

An increasing number of courts are stating their preference for customer-based limitations over the more traditional geographic restrictions in certain circumstances, primarily for sale executives and other employees whose value (and corresponding threat) to the company arises primarily from their bond with, and knowledge about, certain customers.

Some courts are viewing with heightened skepticism any restrictive covenant that would prohibit such an employee from working for a competitor anywhere that the company has done business, because such a restriction places off-limits all potential customers within that geographic area – even those with which the company had made no contact and had no relationship.

The rule of thumb here is to assess whether the potential threat posed by a particular employee relates solely to a particular subgroup of customer relationships, and if so, consider limiting the post-employment competitive restriction only to those particular customers.

  • “ … any entity that was a customer of the Company …” For the same reasons, attempting to bar a former employee’s contact with all of the company’s customers might also go too far. Historically, employers have sought to safeguard their protectable interest in customer relationships by placing off-limits their entire customer base. However, if the employee at issue had contact with, and knowledge about, only a subset of the company’s customers, a court might reject non-compete language purporting to bar the employee from competing for the business of each and every one of the company’s customers.

Courts in some jurisdictions are questioning why an employee should be prohibited from competing as to all of a company’s customers, when he has an unfair advantage only as to those with whom he actually had contact, or about whom he had access to confidential information, while he was employed by that company.

Consequently, depending on applicable law and the particular circumstances, a better drafting option might be to consider placing off-limits only those customers with whom the employee had contact (and/or about whom he had access to confidential information) during his employment.

  • “ … anywhere that the Company does business…” Neither geographic boundaries nor customer-based restrictions will do much to protect or comfort the employer who loses – and then faces competition from – an employee possessing confidential information (e.g., strategic plans or confidential manufacturing processes). Especially in the computer age, such an employee may pose a serious threat, no matter where he is physically located.

This reality often causes companies draft their non-compete provisions with the broadest possible geographic limitations, prohibiting competitive employment across entire continents and even worldwide. While certain circumstances might justify such restrictions, geographically broad non-competes are often challenged as overreaching and, if invalidated as overly broad, can leave the company with no protection at all.

Employers, therefore, are finding it increasingly important to utilize geography-based non-compete restrictions in conjunction with other contractual provisions (e.g., imposing customer-based and other activity restrictions, restricting the use of company computer systems and hardware, and requiring the submission of personal computer equipment for removal of company files,) to more effectively protect confidential information in the event of a key employee’s departure.

Crafting a more cohesive and effective – and enforceable – set of contractual provisions requires up-to-date knowledge of the ever-shifting landscape of statutes and court decisions regarding such contracts, and a thoughtful analysis of the particular combination of restrictions that will best protect a particular employer.

  • “ … The Company and all of its affiliated entities …” Similarly, companies often use non-compete language that restricts employees from competing, not only with the company, but with all “affiliates.” Unless the employee’s duties related directly to an affiliated company, or resulted in his having access to confidential information impacting an affiliate’s business, it might be difficult to convince a court that post-employment competition with an affiliate endangers a legitimate protectable interest.

Companies therefore may wish to consider drafting their employment-related non-competes to define “affiliates” to include only those affiliated entities as to which the employee performs services, or has access to confidential information, during his employment.

Increase the chances of enforcement

These are just a few examples of boilerplate language often used in non-compete covenants that might, depending on the facts and which state’s law applies, be invoked in support of a challenge to enforcement.

The outcome of such a challenge will, of course, depend upon the particular facts and applicable law. Many jurisdictions, for example, follow a “blue pencil” rule allowing judicial modification of non-compete provisions deemed to be overly broad. But the most prudent – and most cost-effective – strategy is to avoid such challenges altogether.

Legal counsel knowledgeable about current developments in applicable law regarding non-competes can identify and replace boilerplate language requiring an update. Giving standard non-compete forms and templates this critical read can both improve the effectiveness of those form contracts and increase the chances of enforcing them.

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