Common Flaws that Undermine the Enforceability of Restrictive Covenant Agreements

William R. Horwitz

A restrictive covenant agreement can be an effective tool for employers seeking to protect confidential information and business relationships.  Courts, however, closely scrutinize these agreements, which many judges consider to be an impediment to competition and the free flow of labor.  Accordingly, employers should be especially careful to ensure that their agreements can withstand close review.  Unfortunately, restrictive covenant agreements often contain flaws that undermine their enforceability.  Some of these flaws are particularly commonplace.  In fact, many of the same unenforceable provisions appear in different agreements used by different companies in different industries – and even appear in agreements drafted by experienced attorneys for sophisticated employers.
 
This article highlights some flaws common to restrictive covenant agreements and proposes solutions.  It does not address the most basic flaws that can undermine these types of agreements, such as that they are not supported by adequate consideration or that their restrictions are too broad.  Instead, it focuses on less obvious, but equally problematic, flaws.  Employers should review their restrictive covenant agreements to determine whether they contain these flaws and, if they do, consult counsel about correcting them.

1. Provisions That Prohibit But Do Not Define “Competition.”

Employers often justifiably wish to ensure that certain employees cannot leave their employment and immediately go to work for a competitor.  Such employers may require those employees to sign agreements containing “non-compete” provisions.  These provisions commonly state either that the employee cannot “compete” or cannot engage in “competition” with the employer for a specified amount of time within a specified geographic area.  A common flaw in non-competition agreements is a failure to define the term “compete” or “competition.”  Unless the agreement defines these terms, this restriction is arguably unenforceable, because the former employee will not know what he or she is prohibited from doing.

Generally speaking, courts will not enforce agreements lacking sufficiently definite terms to enable each party to reasonably ascertain the performance that is required.  This proposition is especially true in the context of judicially disfavored non-compete and other restrictive covenant agreements. 

Although it may seem obvious, the identity of a company’s competitors is often actually not very clear.  For instance, does a pharmaceutical company developing a vaccine for bacterial meningitis compete with a pharmaceutical company developing a drug to treat that illness?  Does a company that sells cars compete with a company that sells car parts?  Does a company that provides home health aides for the elderly compete with a company that provides on-site day care to the same population?  An employee of one of these companies arguably will not know what a prohibition on undefined “competition” bars him or her from doing.  As a result, many courts will not enforce the prohibition.

Instead of vaguely barring “competition,” an agreement should narrowly and precisely define the type of business in which the employee is prohibited from working.  For instance, an agreement may bar the pharmaceutical company employee from any business “engaged in the narrow field of developing vaccines to prevent bacterial meningitis.”

Even better, an agreement can set forth the names of the competitors for which the employee is barred from working – as long as the named companies truly are direct competitors.  An employer that uses this degree of specificity can be fairly confident that a court will not find the restriction too vague.  The downside of this approach is that it does not prevent the employee from starting his or her own competing company.  While an employer may not be very concerned about this risk in certain industries, such as banking or car manufacturing, employers that are concerned should address the issue through a restriction on competition that narrowly and precisely defines the restricted field.

2.  Customer Non-Solicitation Provisions That Do Not Define “Customer.”

Courts are reluctant to enforce restrictive covenant agreements that purport to bar a former employee from soliciting all of an employer’s “customers,” without defining that term.  An employer typically only has a legitimate business interest in preventing a former employee from soliciting a customer if, during the employment relationship:  (1) the employee received confidential or trade secret information about the customer; or (2) the employee had direct contact with the customer.  Non-solicitation provisions extending beyond these categories are arguably overly broad and unenforceable. 

Thus, an individual often objects when his or her former employer tries to enforce a non-solicitation provision applying vaguely to all “customers” (or “clients”).  Former employees invariably argue that they cannot be barred from soliciting the business of a customer they know nothing about or with which they never had any contact. 

To avoid this argument, non-solicitation of customer provisions should apply only to any “customer” that, for instance, “Employee received confidential information about or that Employee serviced on behalf of Employer at any time during the twelve months prior to the termination of Employee’s employment.”

3.  Employee Non-Solicitation Provisions That Do Not Define “Employee.”

Employers often use restrictive covenant agreements to prevent a departing employee from raiding their workforce.  Restrictions that simply bar a departing employee from soliciting the employer’s “employees” are commonplace, but in most cases arguably unenforceable.  A former employee would genuinely have an unfair competitive advantage in soliciting personnel for employment only if he or she received confidential information about or developed a personal relationship with the personnel as a result of his or her employment. 

Therefore, a restrictive covenant agreement seeking to limit the ability of a departing employee to solicit former co-workers should restrict solicitations of any of the employer’s “personnel,” which it should define as, for example, “any employee, independent contractor or other personnel employed, retained or engaged by Employer at any time during the twelve (12) months prior to the termination (for any reason) of Employee’s employment and:  (1) with whom Employee worked or whom Employee directly or indirectly supervised during Employee’s employment with Employer; or (2) regarding whom Employee received Confidential Information by virtue of Employee’s employment with Employer.”

4. Restrictive Covenant Agreements That Do Not Describe Consideration Or Legitimate Business Interests.

Because courts are often reluctant to limit a former employee's ability to earn a living, employers face certain obstacles when trying to enforce a restrictive covenant agreement.  One way to make that task easier is for the employer to address, in the agreement, the points that it may someday have to establish in court.  Two particularly important points that an agreement should address are the consideration that the employee received in exchange for agreeing to the restrictions, and the employer’s legitimate business interest in the restrictions.

With regard to consideration, employers seeking to enforce restrictive covenants must establish that the employee received adequate consideration in exchange for signing the agreement.  Nonetheless, agreements often contain vague, conclusory acknowledgements that the parties “received good and valuable consideration.”  While such language is not fatal, more helpful language expressly identifies the consideration, such as hiring or a bonus or promotion.

In court, employers must also be able to articulate their legitimate business interest in restrictive covenants.  Articulating them in the agreement itself is the best approach.  For example, an agreement may describe the resources the employer expended in developing and safeguarding the assets at issue and explain that protecting them is critical to the employer’s survival and success.

5. Restrictive Covenant Agreements That Do Not Explain The Reason For Their Geographic Scope Or Duration.

In a non-compete agreement, another area best addressed in the agreement itself is the reason for a particular geographic restriction, especially if the employer is using a nationwide or broader restriction.  The agreement should include a provision stating, for instance, “Employee acknowledges that the geographic scope of this restriction is particularly reasonable given that Employer does business and has competitors throughout the United States and the world.”

It may, likewise, be beneficial for employers to explain in their agreements the reason for the duration of a restrictive covenant agreement.  An explanation is especially advisable if the duration is unusually long, such as over two years.  In the context of customer non-solicitation restrictions, employers typically base the duration on an estimate of how long it will take for the employer’s new employee to develop a relationship with the customer.  Another consideration may be the length of time it takes for confidential information in the industry to become stale or worthless.

Although these types of explanatory provisions will probably not convince a judge to enforce a blatantly overly broad restriction, they will help demonstrate that the employer acted in good faith and had a reason for the scope of the restrictions.

6. Conclusion

A well-drafted restrictive covenant agreement is among the most effective ways for an employer to protect its confidential information and business relationships.  An employer should be careful, however, to avoid relying upon agreements that are flawed and arguably unenforceable.  Although courts in New Jersey (and other states) have the discretion to modify overly broad restrictions to make them enforceable, they will decline to do so if they perceive that the employer was overreaching and relying upon the court to fix the agreement.  Moreover, the potential harm to an employer when a court declares its restrictive covenants unenforceable is usually great.  The best time for an employer to review its restrictive covenant agreements for the potential flaws set forth above is, of course, before it needs to enforce the restrictions.

This article is based upon restrictive covenant law in New Jersey and New York, which is similar in most material respects to the laws of the majority of other U.S. states.  Employers should consult with counsel regarding the particular law in any specific jurisdiction.

William R. Horwitz, counsel at Porzio Bromberg & Newman, P.C., with offices in Morristown, Princeton and Manhattan.  Mr. Horwitz focuses his practice on the areas of employment litigation and counseling.  He has extensive experience handling matters involving trade secrets and the enforcement of restrictive covenants.  He also works with companies to develop new or improve existing policies, procedures and agreements to safeguard confidential information and business relationships..