Restrictive Covenant Drafting: Ten Tips to Avoid the Traps

Non-Compete, Non-Solicit, Restrictive Covenants

Tip 1: Choose your choice of law wisely and FIRST.

  • The law you choose to apply to a restrictive covenant is regularly outcome determinative in enforcement proceedings (e.g. Illinois’ rule on at-will employment as consideration, North Carolina’s rule on blue-penciling, Louisiana’s law on geographic scope, Florida’s statute on presumptive validity, etc.) 
  • And there are sometimes three or four states from which to pick:
    • where the employer or seller is located (state of incorporation or principal place of business)
    • where the employee or purchaser is located
    • where the place of performance is located.  
  • So take the opportunity to pick the law that is most likely to do what your client already presumes will be done: your restrictive covenants will be enforced.
  • Relatively speaking, Delaware –often the default state of incorporation– is a solid and defensible choice.

Tip 2:  Consider contractual consideration carefully.

  • Although courts generally say they will not look into the adequacy of contractually bargained for consideration, in most states they will ignore this adage in the context of restrictive covenants.
  • For example, in several appellate districts in Illinois, employment at-will is not enough consideration – by itself—to support restrictive covenants unless it lasts for two full years. FULL STOP.
  • In other states, a restriction entered into at the inception of at-will employment may be enough. In Ohio, however, a court recently held that when the employee started on date x and wasn’t obligated to sign the restrictive covenants until a week or two later, the initial employment could not be consideration for the “subsequent” restrictions!
  • What happens when you enter into a new agreement with new restrictions during the course of existing employment and the new agreement explicitly supersedes the prior agreements? TRAP: this may start your consideration clock running all over again.
  • In states like Illinois, then, consider giving existing employees something additional for signing a new agreement: a signing bonus, an employment agreement for a set period of time, etc.

Tip 3:  Don’t bring a gun to a knife fight!

  • After your first draft, ask yourself two questions:
    • Does this restriction actually promote the interests I am trying to protect?
    • Is there the restriction only as broad as necessary to promote my articulated interest (time, place and activity)?
  • A “no” to either question means you’ve likely drafted something overbroad relative to your legitimate needs.

Tip 4: Don’t violate the janitor rule.

  • It’s a North Carolina rule, but almost all states use something approaching it in assessing whether a non-compete is invalid as overbroad. Does your non-compete preclude the obligor from doing anything at all with or for a competitor? If so, it is almost always going to be deemed overbroad.
    • Example: “During the term of employment and for a period of two years thereafter, regardless of who initiated the separation of employment, Employee shall not, whether directly or indirectly and whether as an officer, employee, consultant…. be employed by, provide any services to any person or entity engaged in the business of ______________ or any related business…”
  • This literally keeps the Employee from performing custodial services for a non-competitive division of a company engaged in the business of __________.
  • How does that promote the legitimate business interests to be served by the restriction? It doesn’t.
  • Non-solicits can similarly overreach:
    • Employee shall not, whether directly or indirectly, solicit, attempt to solicit, accept business from, any customer of Employer…
  • Read literally, this would prevent a former employee from attempting to sell candy bars to a former customer to whom he had sold car parts.

Tip 5: Limit non-solicits to intimates rather than strangers.

  • Courts generally deem it unfair for former employees to solicit their former customers on behalf of a competitor when it was the former employer who had explicitly paid the former employee to establish and/or build that relationship in the first place.
  • That rationale does not apply to other customers with whom the former employee did not come into contact by virtue of his/her employment. In fact, the former employee might not even have known that such a customer was a customer of the former employer.
  • The same goes for prospective customers: there are prospects with whom a former employee was involved and those about whom he/she knows absolutely nothing.
  • So draft your non-solicits to cover customers and prospects with whom the former employee had contact by virtue of his/her employment or, alternatively, about whom they had confidential information.

Tip 6:  Don’t treat former customers and employees like current ones.

  • Too many restrictive covenants attempt to sweep in any person or entity that was a customer or employee within the last 12-18 months prior to the cessation of an employee or owner’s employment, i.e. former customers and employees.
  • Though there may be unique occasions in which a purchaser or employer has a present and valid interest in those former customers and employees (or the information which the former employees still possess about them), generally speaking their interest in such customers and employees is no longer ripe/valid.
  • If so, why imperil the enforceability of your covenants by reference to them?

Tip 7: Include but don’t bank on “blue-penciling” provisions.

  • Example of a blue-penciling clause: “Equitable Modification. If any court of competent jurisdiction shall deem any provision in this Article III too restrictive, the other provisions shall stand, and the court shall modify the unduly restrictive provision to the point of greatest restriction permissible by law.
  • Some states (e.g. N.C.) will refuse to modify any overbroad restrictions altogether, by any means (deletion, addition or modification).
  • Others (e.g. WI) will only strike offending language and enforce the remaining sections if they make sense and are capable of enforcement.
  • In most others, the court has wide discretion to modify an overbroad restriction or not. Arguably, Illinois and some of these states have shown a recent reluctance to do the attorneys’ work for him/her after the fact.[1]
  • Also, there are obvious tension between blue-penciling and severability clauses (the former seeks to modify and the latter excise) that drafters often do not reconcile. To do so, simply: (a) label the clause a “Blue-Penciling and Severability Clause;” and (b) identify the paragraphs containing the restrictive covenants by number and say if any of those provisions are deemed unenforceable, they will be blue-penciled. The other provisions will remain subject to the severability clause.

Tip 8: Toll the term of the restriction for periods of breach.

  • Consider the situation where you have a two-year post-employment restriction on solicitation of customers, but find out about a violation a year late (or spend the remaining term of the restriction litigating over it): how much time, if any, will be left on the term of the restriction by the time you getting a ruling on its breach?
  •  To avoid what might be a pyrrhic victory, use a tolling provision, e.g. “All time periods in this Section 5 shall be computed by excluding from such computation any time during which (a) Employee is in violation of any provision thereof and (b) there is pending in any court of competent jurisdiction any action (including any appeal from any final judgment) brought by any person, whether or not a party to this Agreement, in which action the Company seeks to enforce the agreements and covenants in this Agreement or in which any person contests the validity of such agreements and covenants or their enforceability or seeks to avoid their performance or enforcement.

 Tip 9: Avoid a Prior Material Breach Defense to Enforcement

  • “A material breach of any agreement or promise between the parties not explicitly set forth in this Agreement shall not excuse Employee’s breach or nonperformance of the provisions hereof, including but not limited to any breach of any agreement regarding compensation, bonuses or commissions.”
  • Otherwise, employees or owners will have a defense to enforcement.

Tip 10: Run Away! (Consider Forfeiture-for-Competition Clauses)

  • Forfeiture-for-competition clauses, read literally, do not proscribe competition at all, but merely fix a monetary consequence for doing so, e.g. forfeiture of the capital account of a departing limited partner who goes to work for a competitor. Of course, such provisions require the limited partnership agreement (or an operating agreement, etc.) to have capital account or other payout provisions tied to the length of the restriction and that are explicitly conditioned on compliance.
  • Courts tend to enforce freely such “restrictions.”
  • Compliance is much more likely when the money or benefits withheld are significant.

[1] In contrast, Nevada recently enacted legislation making it easier for courts to blue pencil and enforce restrictive covenants.

by Robert H. Smeltzer

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