What Is a Restrictive Covenant Agreement?
Restrictive Covenant Agreements ("RCAs") are contractual provisions that limit the use of certain information, personnel or property by one party to the benefit of another party. These types of agreements are often used in business settings both prior to and after the time an employee or other person has access to confidential information, trade secrets, personnel or other information belonging to their employer or other third parties. They are also commonly found in contractual agreements related to the sale of a business or can occur even without any contractual principles, simply by virtue of common law principles, where one person intrudes upon another for improperly removing or stealing trade secrets, confidential information, or customers. For instance, a former employee may go to a customer and make a false claim that their new employer offers the better product or better pricing, and without such a truthful representation or comparison, that claim may have constituted an improper "poaching" of that customer, wherein the former employee "de-fectively" stole or poached that customer from the former employer’s business .
Moreover, restrictive covenants can also be used (with limitations) to bar or prevent one party from de-fectively "poaching" personnel from an employer. This would usually happen in a managerial position, where one manager or executive leaves a company and attempts or succeeds in convincing their former sub-ordinate employees to leave the former employer and join the new employer. If done in violation of an enforceable non-compete or non-solicitation clause in the former employee’s employment contract or other agreement with her former employer, this act could violate the restrictive covenant agreement and the damages perpetrated by the individual who "poaches" employees from their former employer may be actionable and potentially compensable in court.
Restrictive covenant agreements typically provide for the following measures:
What Is a Non-Compete Agreement?
A non-compete agreement is a type of restrictive covenant. Its purpose is to limit competition by former employees. Traditionally, a non-compete agreement is an employment contract clause. It typically dictates with whom and in what ways the employee cannot compete after leaving the employer. More specifically, it often describes a physical region the employee has agreed not to do business in, a defined client base they may not work for, a period of time they may not bill in aggregate or on an individual basis, or some other metric of their competition with the employer. In contrast to confidentiality agreements, which protect an employer’s intellectual property from disclosure, non-compete agreements are different in that they limit the employee’s rights to do business with some of the employer’s clients and on the former employee’s own terms. Because of that, they can be more restrictive.
Restrictions Imposed Through Restrictive Covenants v. Non-Compete Agreements
Key Differences Between Restrictive Covenants vs Non-Compete Clauses
If you currently have, or are thinking about entering into an agreement that contains a restrictive covenant, you should understand how restrictive covenants differ from non-compete clauses. A restrictive covenant is an agreement that prohibits employees from taking certain actions after termination of employment, whereas, a non-compete is a type of restrictive covenant that specifically restricts employees in seeking employment with or providing services to some or all of the employer’s competitors. The primary difference between a restrictive covenant and a non-compete clause is that the former may cover a broader range of prohibited activities. In contrast, a non-compete usually only prohibits employees from working for competitors, usually regardless of the geographic region in which they work. In most cases, the only type of activity that an employee is prohibited from doing in a non-compete is working in a competitive business. It does not typically include other forms of competition such as solicitation of customers or theft of proprietary information. While many restrictive covenants may not prohibit any activity therein other than competing with an employer, it is not uncommon for such agreements to also include a broad range of prohibited activities similar to a non-compete. In other words, employees must be careful in reading any agreement not to merely look for a non-compete but also review the restrictive covenant section to understand the other types of conduct an employee is prohibited from taking post-employment. If brought in a lawsuit for breach of a restrictive covenant, complaining employers are not limited to just enforcement of a non-compete agreement, and can also seek to enforce other restrictive covenant provisions that are in their agreements with employees. A distinguishing factor for both types of agreements is enforceability, as most restrictive covenants and non-competes are only enforceable if they are reasonable and protect legitimate business interests. Some factors that courts will consider in determining reasonableness and enforcement are, nature of the industry the employer is in, whether you will be unemployed upon termination, whether it is common practice for employment agreements to contain restrictive covenants, your level within the employer’s hierarchy, if the agreement and enforcement of it is necessary to protect proprietary information and/or customer relationships, the breadth and scope of the prohibited conduct, and important public policy factors like professional licensing requirements. It is incumbent on both employers and employees to carefully review these agreements before signing, or if they are presented after termination factors such as, length of employment and whether or not the employer is continuing to fulfill its contractual obligations to the employee, including paying the employee.
Enforceability of Contracts
These agreements, whether they are labeled as non-compete provisions or restrictive covenant agreements are enforceable only to the extent that they are reasonable in scope. And – this is a hotly contested issue, most likely, related to the expenditure of time, money and emotion.
First, it is important to recognize that when these issues are presented to the court, the court will seek to balance the need of the employer to protect their business interests against the need of the employee to earn a living. The validity and enforceability of these agreements is determined on a case by case analysis.
As a general rule, courts enforce restrictive covenants this way: they need to be in writing and signed by the person against whom enforcement is sought. The language in the document needs to be reasonably clear so that the employee knows what they are agreeing to do or not to do.
Also, it is important that the agreement specify a certain period of time that the restriction applies and a specific geographic area where the restriction applies. There is no one way to determine how long or where the restriction can be applied. Most courts have looked to see whether the employer has an interest worth protecting and the restriction is reasonable in terms of time.
From the experience of the author, the usual time period for an individual to make a living in a particular industry is one (1) year to eighteen (18) months.
Pros and Cons to an Employer
Employers pursue restrictive covenant agreements because they believe they will prevent, or at least deter, unfair competition. However, the degree to which that is true is subject to debate. Many employers include a non-compete in their standard employment agreements or updates from the time to time. Non-competes are generally easy for employers to understand and have the potential to make it easier for the employer to prove a case against the employee who brings unfair competition. Non-competes are particularly effective in those industries, such as restaurants, where employees have a significant amount of access to the employer’s trade secrets.
But for many employers the disadvantages of non-competes outweigh their advantages. For example, many employers find non-competes exceedingly difficult to enforce because they are too broad to be enforced or because they are old. In states that allow "blue penciling , " courts will enforce only the valid portions of the non-compete with modification. In some states restrictive covenants that are overly broad in terms of geography or duration may cause the entire agreement to be invalid and unenforceable. It is up to the employer to protect itself with reasonable limits.
A major disadvantage of non-compete agreements is the potential for recruitment litigation. A lawsuit filed by a previous employer over a non-compete agreement can be expensive and time consuming. Employers get sued by their previous employers when the new employees they hired leaves after shorter periods of time or engages in other conduct in violation of a non-compete. Sometimes recruitment litigation is frivolous but even frivolous suits require accompanying legal fees and time away from the business by the owner or human resources staff.
Some industries have been able to avoid some of the disadvantages associated with non-competes by using nonsolicitation clauses instead. These agreements are proving to be at least as effective at preventing unfair competition as non-competes when they are written correctly.
Effects to the Employee
Employees are key parties to restrictive covenant agreements. Accordingly, it is important for you to understand such agreements and their implications on your future career. In the context of non-compete clauses, for example, an employer will likely position the agreement as a tool to protect its business interests from unfair competition by its former employees. While this may in fact be true, the scope of the restriction likely runs deeper.
The implications of restrictive covenants on employees can be profound. Beyond their immediate impact on employment opportunities, such clauses can curtail your options in other areas of your professional life. For instance, your ability to earn money is clearly impacted – if you are unable to perform the job you do because you have been restricted from working or communicating with former clients, business opportunities or industry contacts for a period of time, it can directly impact your ability to put food on the table.
Employers may skirt around the legal requirement that such clause be a reasonable means to protect their legitimate interests by arguing that they are in place to prevent employees from actively soliciting clients away from the company, rather than claiming to be a blanket prohibition on the employee’s ability to work.
If you are unsure whether your rights have been breached, consult a lawyer. Meeting with a lawyer is not only helpful, it is also most cost-effective if done early on. Generally speaking, the quantum of damages an employee can obtain from a breach of a restrictive covenant is lower than what it would have been had the employee continued working with the clients or customers in question.
Recent Trends and Legal Issues
Several recent legislative changes to the restrictive covenant law have had a meaningful impact on how these agreements are crafted and interpreted. Since 2014, Massachusetts, New York, Kentucky, and Colorado have enacted legislation regulating the use of non-compete clauses. In 2019, Utah and Rhode Island have followed suit to join the trend. Although the 2019 laws introduced only minor amendments to the law, they show that momentum is continuing for states to enact restrictive covenant reform.
Massachusetts recently overhauled its non-compete statute to reflect a growing recognition that these restrictive clauses are harmful because they tend to limit competition in an increasingly globalized world. The new statute clearly defines when a non-compete agreement is enforceable and when it is not . Under Massachusetts’ new law a non-compete clause will be enforceable if: This shift in the Massachusetts legislature’s standpoint is an example of the growing trend throughout the nation to limit the scope of agreements sought by many employers.
To the contrary, the Ohio legislature considered bills in early 2019 to ban the use of non-compete clauses with Home Health Care Aides, Registered Nurses and Physicians but failed to pass either of those legislative initiatives. Recent states’ laws suggest that the tide is turning against broad-based use of these employer-seeking clauses. There has long been debate about the appropriateness of broadly limiting employees right to engage in their trade. This is undoubtedly a debate that will continue for the foreseeable future.