Non-compete and Non-solicitation

📖 Review the sections on non-competes and non-solicitation agreements in Unit 5. Here we will focus more on the company than on the former employee who was our focus in Unit 5.

Consider the fiduciary duty of loyalty: The employee must “act solely for the benefit of [the employer] in all matters connected with” their employment. (Rest. 2d of Agency § 387). Part of the duty of loyalty is not to compete. This duty terminates with the termination of the employment relationship. Employers seek to extend this duty beyond termination of employment via a restriction on competition.

In order to protect its business, a company may require that a key employee (or founder) sign a contract containing certain restrictive covenants. Here we will look directly at non-compete and non-solicitation provisions. Both restrictive covenants are a restraint of trade, meaning there is a limitation on one’s ability to pursue a trade or profession. See Restatement 2d of Contracts § 186, “A promise is unenforceable on grounds of public policy if it is unreasonably in restraint of trade. A promise is in restraint of trade if its performance would… restrict the promissor (employee) in the exercise of a gainful occupation.” Such promises are unreasonable if they are greater than needed to protect the employee’s interests or the employer’s need is outweighed by the hardship to the employee or likely injury to the public. When restraints are reasonable in scope and protect a legitimate business interest, they are permissible.

📖 Read: DeLeo v. Equale & Cirone, 202 Conn. App. 650 (2021).

 

Non-compete

A covenant not to compete (“non-compete”) is a promise by an employee that they will not compete with the employer during the employment relationship or after it terminates. This promise can be a stand-alone agreement or as part of an employment agreement.

Absent a non-compete or breach of a confidential (fiduciary/agency) relationship, employees may plan to compete with their employer while still in its employ, and an employee is free to leave their employment and enter into competition with their former employer. Metal Lubricants Co. v Engineered Lubricants Co., 411 F2d 426 (8th Cir. 1969).

There is a movement on the state level to ban non-competes altogether. Often these laws provide that non-competes are valid as part of a business sale – between sellers of a business and the new buyer.

Washington DC passed a ban that will become effective in Fall, 2021. The District of Columbia’s Ban on Non-Compete Agreements Amendment Act of 2020 states that “[n]o employer operating in the District of Columbia may request or require any employee working in the District of Columbia to agree to a non-compete policy or agreement.” The prohibition applies only to non-competes entered on or after the Act’s applicability date; thus, existing non-competes are exempted. Interestingly the Act defines “non-compete provision” as one that “prohibits the employee from being simultaneously or subsequently employed by another person, performing work or providing services for pay for another person, or operating the employee’s own business.”

💡 Think about different scenarios and how the aforementioned provisions could play out. Will businesses find a way around the provisions so that they can continue to use non-competes? What will happen to moonlighting or anti-moonlighting provisions?

📖 Read the District of Columbia’s Ban on Non-Compete Agreements Amendment Act of 2020. Does it answer all of your questions? 💡 Answer the following:

  • Does the Act exclude any workers from its coverage?
  • Does the Act apply to the government employer?
  • How does the Act preserve the ability of employers to still protect their legitimate business interests?
  • Does the Act contain a business sale exemption?
  • What are the Act’s notice provisions? What purpose do they serve?
  • What are the penalties?

💡 Say you represent a company that will be subject to the Act, how would you advise it?

If you are in a state that does not have a statutory ban on non-competes, you need to know the common law in your state to be able to draft such provisions. Each state will be different, but many have similar considerations. Also remember that if your client has employees who are working in other states that you know what the laws are there.

When considering whether to restrain an employee with a non-compete, we must consider the reasonableness of the restraint. Reasonableness must be looked at in light of the following:

  1. Time (Temporal Scope)
  2. Territory or Market (Geography)
  3. Activity (Job Duties)

As you can see, one must consider: how long it applies, where it applies, and what it applies to. If a non-complete is litigated, the employer bears the burden to prove that the restraint is no more than necessary to protect its legitimate business interest, is not unduly harsh or oppressive in curtailing an employee’s ability to earn a livelihood and is reasonable in light of sound public policy. Roanoke Engineering v Rosenbaum, 223 Va. 548 (1982).

So, what is reasonable when it comes to each of the three enumerated considerations?

  1. Time – many common law states will find that 1 – 3 years is reasonable, but often the courts consider the context and the industry in which the employer operates. For instance, tech companies have a lower reasonability time threshold. The reasonableness of the temporal limitation depends upon the time required to obliterate in the minds of customers the identification formed during the period of employment. Pollack v Calimag, 157 Wis.2d 222 (Wis. Ct. App. 1990).
  2. Territory or Market – the geographical restriction must be reasonable. One must consider where the employer operates, where the employee worked or held responsibilities, the type of industry in which the employer operates, etc. Ask, does the employer’s business touch the territory or market that it is trying to restrict the employee from working in? For example, “a geographical limitation would make almost no sense in the context of the internet-cloud-based product that Datto and competitors sell.” (Datto, Inc. v. Falk, 2018 WL 1307633 at *6 (D. Conn. Mar. 13, 2018). However, note: A court will accept as prima facie valid a CNC related to the territory where the employee was employed as a legitimate protection of the employee’s investment in customer relations and good will, but not where the employer does business simply because the employer wants to avoid the competition with the employee in that area. W R Grace & Co v Mouyal, 262 Ga. 464 (1992).
  3. Activity – The non-compete needs to put forth what exactly the employee is not allowed to do. For instance, if an employee is an adhesive chemist for X Corp, can the employer prohibit the employee from being a chemist at Z Corp if the employee would not be doing any adhesive chemistry work? Could the non-compete stop the employee from being the Vice President of Marketing?

Because the court will look to all of the facts and circumstances surrounding the non-compete, it is important to draft the restrictions carefully.

An additional concern is ensuring that there is consideration for the non-compete – remember it is a contract. In Pennsylvania, an employer must provide adequate consideration when asking a current employee to sign a non-compete. Determining what qualifies as “adequate consideration” is not an easy task and there is no formula. When confronted with this situation in practice, I asked what precipitated the non-compete all of a sudden, and quite often the reason is due to a promotion or change in responsibilities. (See, M. S. Jacobs & Associates, Inc. v. Duffley, 452 Pa. 143 (1973) A beneficial change in an employee’s status is sufficient consideration to support a restrictive covenant agreed to after employment commences.)

Non-compete agreements should be utilized only where necessary to protect legitimate business interests, such as customer goodwill.

There is no real goodwill between customers and the custodian (as example) and no real need to limit his or her post-employment activities. Any attempt to do so may compromise the company’s legitimate efforts to restrict appropriate employees’ post-employment activities. 💡 What advice do you have for a business client that wants to require non-compete agreements of all employees?

Drafting Considerations

1. Know your client’s needs.

    • What is the company trying to protect, and what is the nature of the employee’s position within the organization?
    • What does the company want to accomplish? – ie. protection of trade secrets/IP, preservation of goodwill, protection of an interest arising from the reliance on an employee’s unique abilities and/or the costs of specialized training.

2. Definition of Business

    • Need specificity!
    • Will someone (court/jury/prospective employer) be able to determine what the company does from the contract?
    • Watch for “catch-all’s”
    • “Any business in which the Company (or employee) is engaged…”

3. Customer-based Restrictions

    • Prospective (identified?) v Actual
    • Geographic limitation required

4. Timing of Execution

    • Whenever an employee’s job changes significantly, employers should consider whether the existing non-compete is appropriately restrictive. For example, if an employer transfers an employee out of sales to an administrative position and reduces his or her pay, the non-compete agreement may be unenforceable as written.
    • Employers need to monitor significant changes in their employees’ jobs and adjust non-compete agreements if necessary. Although not every change in the employment relationship is significant enough to require an amendment to an existing restrictive agreement, substantial changes in compensation or job duties should trigger a careful review of the affected employee’s agreement.
    • If additional consideration is required, consider the language you would draft:
      • Example: The parties acknowledge Employee’s existing employment with the Company, and, upon the effectiveness of this Agreement, the parties wish to replace all prior employment agreements between the parties, including the Employment and Non-Compete Agreement, dated as of _________, 2021, between Employee and the Company, with this Agreement, which is executed in connection with Employee’s promotion and an increase in Employee’s compensation.

5. Damages

    • Injunction and/or
    • Equitable damages

Non-solicitation

A non-solicitation provision prohibits a former employee from soliciting or raiding the customers or employees of the ex-employer for some period of time post-employment. Because non-solicitation provisions are less restrictive than non-competes, courts are usually willing to uphold them. However, non-solicitation provisions are subject to a common-law reasonableness test, similar to (or the same as) non-competes, in most states. Example: Texas courts apply the Covenant Not to Compete Act to non-solicitation agreements as well. See TX BUS & COM § 15.50. Conversely, South Dakota has a statute that directly addresses non-solicitation provisions: “[a]n employee may agree with an employer … at any time during his employment … not to solicit existing customers of the employer within [a specified area] … for any period not exceeding two years from the date of termination of the agreement,” as long as the employer remains in that business for that time. S.D. Codified Laws § 53-9-11.

But if a company is going to bring suit over breach of a non-solicitation clause, it has to prove that solicitation actually occurred. 💡 How does one prove that the former employee actually solicited the customer or employee? If you engage in discovery, is it good business practice to subpoena documents from one’s customers?

In some jurisdictions, courts have held that “soliciting” encompasses any form of contact with the former employer’s customers. Others have held that a former employee sending a general notice to customers about new employment does not rise to the level of “solicitation.” This is more of a substance over form type of view.

Consider the use of social media and how its use can violate a non-solicitation provision. What if the former employee has a LinkedIn or Facebook account and the ex-employer’s customers are contacts or friends, respectively, and they see the job change or comments about switching employers? Remember the Bankers Life & Casualty v American Senior Benefits, LLC and the Mobile Mini, Inc. v. Vevea cases? Assessing social media posts as solicitations is difficult but courts seem to focus on how “passive” the social media comments or activity is. The more passive, the less it is like solicitation; the more active (if they seem more like oral solicitations), the more like a solicitation that will violate a non-solicitation provision. Courts are not willing to draw lines without proof. For example, when an individual left H&R Block to start their own tax preparation business (“Latino Tax Services”) and promoted their new business on Facebook (which had numerous H&R Block customers), the court declined to rule on that part of the case without the parties briefing the issue.

IT IS FURTHER ORDERED that, the parties supplement their briefing with legal authority regarding the limited issue of whether social media posts are solicitations. The supplemental briefing is limited to 5 pages. Plaintiff shall file its supplement on or before February 23, 2018, and Defendant shall file its supplement on or before March 2, 2018.

This case is an interesting read because it also includes a non-compete. H&R Block Tax Servs., LLC v. Frias, No. 4:18-00053-CV-RK, 2018 U.S. Dist. LEXIS 25667 (W.D. Mo. Feb. 16, 2018).

💡 What public policy arguments would you make when it comes to social media being used to promote a new business or a new job? Think about the arguments you would make on behalf of the ex-employee versus those you’d make if you represented the company.

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To the extent possible under law, Samantha Prince has waived all copyright and related or neighboring rights to Entrepreneurship Law: Company Creation, except where otherwise noted.