Builders and Contractors Exchange
Weekly Bulletin: 03 May 2004
Restrictive Covenants: Protecting Your Company's Competitive Edge
By: Christopher Ambrosio
Generally, absent a written agreement to the contrary, a former employee is entitled to engage in direct competition with his or her former employer. The more senior the employee, the greater the potential harm to the employer in terms of lost or diverted business. To avoid such consequences, many employers have key employees sign agreements containing restrictive covenants, sometimes generically called "noncompetes" or "covenants not to compete."
Technically, there are four separate types of restrictive covenants, each of which is discussed below. Because restrictive covenants can act to restrain the free flow of goods and services, Virginia courts take a critical look at each clause of each agreement to determine whether it is enforceable.
Nondisclosure of Confidential Information. A "nondisclosure" covenant is helpful to protect all information, trade secrets or otherwise, that may allow a departing employee to give an advantage to a competitor. Such information typically includes an employer's financial information, cost data, profit margins, customer lists and databases (if sufficient effort went into their compilation), production data, and the like. Because Virginia courts recognize the protection of confidential information as a legitimate restriction imposed by an employer, nondisclosure covenants are generally enforced.
Nonsolicitation or "Nonpiracy" of Customers. This type of restrictive covenant prevents a departing employee from soliciting or, if drafted properly, doing business at all with an employer's existing customers and clients. If the definition of "existing customer" is narrow enough, Virginia courts will usually enforce such nonpiracy covenants.
Noncompetition or Covenants Not to Compete. A noncompetition covenant prevents a former employee from entering the relevant marketplace at all. Because of its potentially broad reach and its potentially serious effects on a former employee's livelihood, Virginia courts give the most scrutiny to noncompetition covenants. Each covenant is examined to determine whether it is no broader than necessary to protect the employer's legitimate business interests, whether it is unduly harsh or oppressive in restricting an employee's efforts to earn a living, and whether the restriction violates public policy. In making such determinations, courts look at the duration of the restriction, the geographic scope of the restriction, the line or lines of business that are placed off limits, and the types of duties that the employee is prohibited from performing. All of these must match up with the employer's legitimate business interests.
Nonsolicitation of Employees. This type of covenant prevents one employee from leaving and enticing others to join him or her, creating a personnel crisis for the employer. These are generally enforceable, if narrowly drawn to protect the employer's legitimate business interests.
Restrictive covenants are currently an "all or nothing" proposition in Virginia, i.e. a court will either enforce the entire agreement as written or strike it down. For this reason and others, it is wise to consult an employment attorney before preparing an employment agreement containing restrictive covenants.
Questions?
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This article is meant to bring awareness to this topic and is not intended to be used as legal advice.