Restrictive covenants defined
Restrictive covenants are contractual agreements between an employer and employee in which the employee agrees not to engage in certain activities either during the employment period or after the termination of that employment. For an employee, restrictive covenants often appear most commonly in the guise of non-competition or non-solicitation clauses. These restrict commission salespersons from taking up similar work with competitors in order to discourage them from taking the clients they have developed during their employment and transferring them directly to a future employer. Despite the common notion , these clauses can be enforceable so long as they are reasonable in the determination made by a court. What is reasonable however remains a case by case basis.
The idea behind restrictive covenants is that a business will have spent time and money developing expertise and contacts and holds a valid proprietary interest over this. This means that any property should be protected against unwarranted interference by a departing employee who, with the information obtained during employment, may be able to offer a similar service at the expense of the business’s business. The goal is to protect what you built during employment, while allowing the employee to continue with their career.
Different types of restrictive covenants
Restrictive Covenants have become quite prevalent in employment agreements. They are contractual clauses that limit the conduct of the employee both during and for a specified time after leaving the employment. While the most well known of the restrictive covenants is the non-compete clause, the other forms of restrictive covenant are equally significant. The most common types of restrictive covenants are the following:
Non-Compete
A non-competition covenant is an agreement between an employer and an employee which states that the employee will not be able to compete with the company for the prescribed period of time after he/she leaves the employment.
Non-Solicitation
In a non-solicitation covenant, an employee agrees not to solicit the customers and/or employees of the employer for the specified period of time.
Non-Piracy
In a non-piracy covenant, the employee agrees not to "poach" his/her co-workers for the specified period of time.
Non-Disclosure
Some agreements contain covenants highlighting the confidentiality obligations of the employee during employment and or post-termination.
Peever Covenants
Section 231.1 of the Canada Business Corporations Act ("CBCA") allows for companies governed by the CBCA to include a "peever" covenant in a unanimous shareholders agreement, which provides that the shares of the company are subject to the terms and conditions of the unanimous shareholders agreement.
Garden Leave/Pay in Lieu of Notice
There is also a non-compete variation commonly known as a "garden leave" clause whereby the employee is notified that he/she does not have to report for duty upon termination but that he/she must stay at home for his/her notice period. During this time, the company will pay in full. Accordingly, even if the employee wishes to start a business and/or compete with the employer immediately, the employee cannot do so since he/she is still employed by the employer. This variation clause may also be used to burn off the employees vacation days but more commonly is used in a real estate context where the employees have a client base which is difficult to transition to new brokers.
Are restrictive covenants legally binding?
Employers at the outset of the employment relationship often require employees to enter into restrictive covenants, including non-solicitation and non-competition clauses. These provisions are intended to ensure that departing employees do not unfairly compete against their employers or solicit their customers after leaving the employment relationship. While legitimate, these types of restrictive covenants are not always readily enforceable either in Canada or the United States.
Whether a restrictive covenant is enforceable will depend on whether the clause is reasonable, in light of a number of considerations that differ from one jurisdiction to another. Typically, the courts will be least willing to enforce those clauses that are tantamount to a restraint of trade. As such, depending on the jurisdiction, the restrictions placed on the employee must be reasonable as to the duration of time and the extent they are imposed geographically. Other factors the courts will consider include assessing the circumstances surrounding the creation of the contract to determine the intention of the parties, and whether the restriction is necessary to protect an employer’s legitimate interest.
Benefits, risks and consequences for employers and employees
Employers have a clear commercial advantage in that restrictive covenants can protect their business interests. However, for the employees subject to such onerous covenants they are generally impinging upon their livelihood, something which has repercussions for their physical and mental health, as well as that of their families.
Employers
Protection of business interests – it would be difficult to protect customer/clients without safeguarding the exact manner of that direct contact for example.
Retention of staff – staff are more likely to stay with a company if they know they cannot work for a competitor for a period of time.
Greater contractual control over employees – covenants are enforceable for the duration of their fixed term.
Employees
Covenants can be enforced for a year which could have the effect of preventing employees from re-entering the job market for far longer than that. This is in contrast to the short notice periods employers generally have to abide by.
Employees are aware that when agreeing to a contract, covenants can be contained. By signing the contract they are accepting the risk that this may affect their future employability.
Do employers have an undue advantage in negotiating the terms of these agreements when the applicant is hungry to get their first position?
How to write robust restrictive covenants
Effective restrictive covenants require careful drafting to ensure they are easily understood by employees, contain acceptable restrictions as to duration and geographic area of the restrictions, and are reasonable and defensible if enforceability is challenged. Because restrictive covenants are contracts, the legal enforceability of these contracts is determined by the law of the state that governs the contract. Regardless of the jurisdiction, however, it is preferable to have a restrictive covenant provision that is clearly drafted so that the intended restrictions are easily grasped by the reader. It is also best practice to limit the restrictions in the covenant to the restrictions to which both parties agree are necessary to protect the employer’s proprietary business interests. Often an employer may wish to rely on industry standards to support a proposed restrictive covenant, but caution should be exercised when relying exclusively on what others in the industry are doing. Even if the industry standard aligns with the jurisdiction, it will not necessarily mean that the restriction is reasonable, particularly if the jurisdiction’s position, as is true in most jurisdictions , is that each case must be judged on its own merits. A court can always decide to invalidate what a majority of employers in a given industry are doing.
States differ in the amount of information they require of an employee with respect to the restrictions in a restrictive covenant; however, most states’ restrictions do not require specific notice of the restrictions. Although it may be beneficial (and, in some states, necessary) to identify the specific conduct that will not be permitted, the courts will often not void a restrictive covenant for a failure to provide specific examples of restricted conduct. When drafting a restrictive covenant, it is generally a good rule of thumb to draft the following four provisions: (1) the specific activity that will not be allowed (i.e., solicitation or competition); (2) the duration of the restriction (i.e., no less than six months in the year following termination, or the period of time it takes the company to dissolve its customer relationship with a client); (3) the scope and geographic area of the restriction (i.e., no less than 100 miles from the office of the employer); and (4) any exceptions to the restriction (i.e., the prohibition on competition will not apply to any employee terminated by the company without cause).
Challenging your restrictive covenants
Employees who feel that their employer’s restrictive covenant is too wide can attempt to negotiate it. This might be a case of declining to sign the restrictive covenant until the employer will make concessions.
In such circumstances, it could become necessary for the employee to commence a legal action seeking a declaration that the restrictive covenant in its existing form is not enforceable against him. Alternatively, an injunction could be sought against the employer preventing it from enforcing the restrictive covenant in its current form against him. In such cases, the question would then arise as to whether there was a threat of the employer actually enforcing it and whether the employee would suffer some irreparable harm if it did.
A resolution of the controversy is often best obtained not by way of legal proceedings but by negotiation. In many instances common sense will break the logjam. The common sense solution may also be the obvious one: to simply restrict the covenant territory to those areas which the employee actually served or had knowledge of during his employment with the employer. It is also sometimes possible by negotiation to restrict a covenant as to time and territory so that it will only apply to clients/customers with whom the employee actually dealt during the time of his employment.
At times it is necessary for the employee to commence a legal proceeding to get a decision on the enforceability of the covenant. Nevertheless this will often lead to a negotiations of the matter and to some possible resolution.
There may also be cases where the dispute between the parties is such that the employee fears that if he negotiated with the employer, the employer would use the occasion to intimidate him to such a degree as to make the employee feel that he must accept the covenant as it stands in order to keep his job. In this situation an application against the employer seeking to get it to remove the employee’s fear of unjustified intimidation could be brought.
Recent developments and case law relating to restrictive covenants
Past litigation regarding restrictive covenants in non-competition or non-solicitation agreements has primarily focused on the employer’s ability to enforce the provision in Connecticut or to obtain injunctive relief against the employee for violating such a provision. However, recent trends have provided that even if an agreement in Connecticut is found to be unenforceable, Connecticut courts may issue a nationwide injunction due to the employer’s legitimate business interests. In the 2013 case of Cintas Corp. v Lee’s Nightvision Service, LLC, the Court issued a nationwide injunction even though the non-competition agreement with the employee had been found to be unenforceable because the scope of the agreement was too broad. The Court found that since the provision protected the employer’s trade secrets (even though it was still too broad), the employer had sufficient justification for a nationwide injunction due to its trade secrets , customer loyalty and customer relationships.
Connecticut courts have also recently modified the doctrine that "blue pencil" clauses will be enforced and have instead adopted the "modified blue pencil" rule, which allows the Court to modify overbroad covenants. In 2015, the Connecticut Appellate Court ruled in Pactiv Corp. v Duffy a restrictive covenant not in compliance with Connecticut General Statute ยง 34-43(b) (a statute that regulates restrictive covenants) was still enforceable and subject to blue pencil modifications. The Court found that if the covenant otherwise satisfied the requirements of section 34-43, and the only thing preventing its enforcement was the lack of consideration for its term length, then the agreement could be deemed valid by curing the defect by limiting the duration of the covenant to one year. The Court also held that the legality of the agreement is governed by the law of the place where the contract was made (in this case, Connecticut) and therefore the modification would be made under Connecticut law.