Non-Compete Agreements: Valuable Protection or Mere Deterrent
By Alan M. Briskin and Michael D. Cross, Jr.
At a time when many companies are downsizing, your customers remain your most valuable asset. Therefore, like many employers, you want some assurance that an employee will not someday use their specialized skills and training for their own personal benefit or the benefit of a competitor to your financial detriment. This objective can be accomplished by requiring an employee as a condition of employment to sign an agreement containing a restrictive covenant.
There are several types of restrictive covenants. The most common ones are covenants not to compete, covenants not to solicit customers, covenants not to recruit personnel, and covenants not to use or disclose trade secrets and confidential information. A covenant not to compete is the broadest of all restrictive covenants and typically prohibits an employee from engaging in a business activity that will compete with the employer. A covenant not to solicit customers typically prohibits an employee from soliciting business from the employer’s customers or prospective customers. A covenant not to recruit personnel typically prohibits an employee from luring away the employees or personnel of the employer to a competing business. Finally, a covenant not to use or disclose trade secrets and confidential information typically prohibits exactly that (disclosing trade secrets and confidential information).
Because of the conflicting judicial decisions and varying standards applicable to each type of restrictive covenant, rather than providing a general overview of the subject, this article will focus on the first type of restrictive covenant – the covenant not to compete.
Generally, contracts restraining trade or tending to lessen competition are against the public policy of this State. Restrictive covenants in employment contracts, however, are deemed only in partial restraint of trade and will be upheld if they are reasonable, founded on valuable consideration, reasonably necessary to protect the interest of the party in whose favor it is imposed, and do not unduly prejudice the public interest.
In determining reasonableness, consideration must be given to the employee’s right to earn a living and the employee’s ability to determine with certainty the area within which his post-employment activities are restricted. The employee’s interest must be weighed against the employer’s interest in protecting the customer relationships formed by its former employee and/or nurtured by the employee during the period of his employment. Georgia courts have routinely protected an employer from the risk that a former employee might appropriate customers by taking unfair advantage of the contacts developed while working for the employer. In determining the enforceability of the restrictive covenant the courts have established a three-part test which analyzes the length of time it binds the employee, the scope of conduct it prohibits and the geographical territory it encompasses.
To better understand the current position of Georgia courts on the enforceability of covenants not to compete consider the following factual scenario and illustrative restrictive covenants:
You own U.S. Video, Ltd., which develops and customizes licensed interactive computer software for use in training law enforcement and military personnel and provides software maintenance and support services to its licensees. You do business throughout the United States. In January 2004 you hired three employees – Employee 1, Employee 2, and Employee 3. At such time, you had 150 licensees. You divided these licensees equally among the three employees. During their employment, the employees provided software maintenance and support services to each of your licensees.
At the time of their hiring, each of the employees signed an employment agreement containing the following restrictive covenants:
Employee 1’s Employment Agreement:
I agree upon termination of my employment, whether by my act or by discharge (whether wrongful or otherwise), I will not directly or indirectly, provide computer software installation, consulting, training, testing, implementation, programming, maintenance, or modification services, directly on or affecting any computer software product supplied by U.S. Video, Ltd. to any licensee with whom I had contact while an employee of U.S. Video, Ltd.
Employee 2’s Employment Agreement:
I agree upon termination of my employment and for a period of two (2) years thereafter, whether by my act or by discharge (whether wrongful or otherwise), I will not directly or indirectly, provide computer software installation, consulting, training, testing, implementation, programming, maintenance, or modification services, directly on or affecting any computer software product supplied by U.S. Video, Ltd. to any licensee of U.S. Video, Ltd. in the United States of America.
Employee 3’s Employment Agreement:
I agree upon termination of my employment and for a period of two (2) years thereafter, whether by my act or by discharge (whether wrongful or otherwise), I will not directly or indirectly, provide computer software installation, consulting, training, testing, implementation, programming, maintenance, or modification services (whether intended for training purposes, amusement purpose, or any other purposes), either individually, as a partner or joint venturer, as an employee, or as an agent, officer, director, or shareholder of any entity or person.
In June 2004 the employees terminate their employment with U.S. Video, Ltd. and form American Video, Inc., to provide the same software maintenance and support services to its licensees. American Video, Inc.’s prices are substantially lower than those offered by U.S. Video, Ltd. As a result, 120 of your 150 licensees switch to American Video, Inc. You file suit against your former employees and American Video, Inc. seeking injunctive relief for violation of the restrictive covenants contained in their respective employment contracts.
The Superior Court denies your request for an interlocutory injunction, finding that each of the restrictive covenants contained in your former employees’ employment agreements were unenforceable. You appeal. The Supreme Court would likely hold as follows:
As to Employee 1, the covenant fails to limit the restraint to a specified period of time, and is, therefore, indefinite and limitless. Moreover, it prohibits not only solicitation of your licensees, but would also prohibit acceptance of requests for services from your former licensees, regardless of who initiated the contact and request. Thus, this restriction unreasonably impacts on the ability of the former employee to earn a living and also limits the public’s ability to chose the provider of such software maintenance and support services. Accordingly, the restrictive covenant is unenforceable.
As to Employee 2, the employee is not, for any length of time, prohibited from all post-employment servicing of every computer software product. The only proscription is a limited two-year restriction upon his performance of services in connection with the specific software which you developed and customized for your licensees. The employee is free to perform services in connection with any other software at any time and for anyone who is willing to hire him, including your competitors and licensees. Thus, as to duration and proscribed post-employment competitive activity, this restrictive covenant is not unreasonable in its scope. The territorial restriction, however, is “anywhere in the United States of America” that you do business through the licensing of your software, without regard to whether the employee may have done any licensed software business on your behalf at any specific location in the country and/or whether any relationship existed between the licensee and the former employee. Such a prohibition is overbroad and is, therefore, unenforceable.
As to Employee 3, the covenant prohibits the employee from working in any capacity in the world in the business of computer software installation, consulting, training, testing, implementation, programming, maintenance, or modification services for the two-year period following termination of his employment. Such a covenant imposes greater limitations on the employee than is necessary for your protection. Moreover, the covenant restricts the employee from working with any competitor in the world although your activities are limited to the United States. Accordingly, the restrictive covenant is unenforceable.
As you can see, the key to enforceability is to narrowly tailor the covenant to reasonably protect a legitimate business purpose of the employer. As a general rule limiting a former employee for a limited period of time from post-competitive activity with the customers of employer with whom the former employee actually dealt will be upheld. If, however, the covenant imposes a greater limitation than is reasonably necessary for protection of the employer it will be held unenforceable.
In the absence, therefore, of a properly drafted restrictive covenant, the non-compete agreement you presently have with your employees could be held unenforceable. Although, in reality, such an agreement will often act as an effective deterrent to a former employee’s competitive conduct, it is imperative that you carefully review your restrictive covenants to ensure that you are adequately protected should a similar situation as that described above arise. The cost of assuring protection now is minimal compared to the potential loss of business you might suffer. As the saying goes, “an ounce of protection is worth a pound of cure.”
The information you obtain at this site is not, nor is it intended to be, legal advice. You should consult an attorney for individual advice regarding your own situation.