Limiting competition from former employees in the US and Latin America
Like toothpaste squeezed from the tube, corporate goodwill, trade secrets and confidential business information are virtually impossible to recover once stolen by a former employee. To secure your business’s prized assets, restrictive covenants limiting the post-termination activities of former employees are an effective tool in the corporate arsenal. These agreements are generally enforceable in the United States, provided they are supported by adequate consideration, narrowly drafted to protect a legitimate business interest and reasonable in geographic scope and duration. There are, however, substantial differences in Latin American approaches to comparable restraints.
Drafting an Effective Non-compete Agreement in the U.S.
Historically disfavored because they restrain an employee from practicing her chosen trade, courts may nonetheless enforce non-compete agreements after carefully scrutinizing them and all surrounding facts. Enforceable post-employment restraints function as a “shield” to protect a legitimate business interest and not a “sword” to impede fair competition. The standards of enforcement vary from state to state, and many states take different (at times opposing) approaches to common issues, such as whether and to what extent a reviewing court can modify an overbroad agreement to make it enforceable. Only California, North Dakota and Oklahoma do not enforce post-employment restrictions as a matter of law.
Noting the absence of federal regulation, Congress began to stir this summer when the Senate introduced the “Mobility and Opportunity for Vulnerable Employees” (MOVE) Act. MOVE would bar employers from demanding that low-wage earners sign non-compete agreements and require that employers disclose to every employee at the beginning of the hiring process that a non-compete agreement is required.
Largely a reaction to high-profile litigation involving the enforceability of restrictive covenants against hourly sandwich shop employees, MOVE fails to consider serious issues for employers. For example, the establishment of an earnings threshold would exempt myriad part-time employees with high-level access to confidential information and trade secrets. It is little wonder the act is languishing in committee, and political experts give it virtually no chance of becoming law.
Absent MOVE, non-competes must meet all of these general requirements to be enforceable:
Adequate Consideration: A common question in enforcement actions is whether the employee received something of value in exchange for the restriction. In most states, the job itself is sufficient consideration to justify enforcement of a non-compete signed at the beginning of the employment relationship. Some states, like Illinois, require the employee to remain employed for a specific time frame (i.e., two years) to validate a non-compete. Others, like Missouri, require no continued employment of any duration. For a non-compete rolled out to an existing employee, many states (including Connecticut, Pennsylvania and South Carolina) require something of additional value (i.e., additional compensation or a promotion) beyond merely continuing the same employment.
Legitimate Business Interest: Because they are disfavored, the restraint must protect an employer’s legitimate business interest. These can include corporate goodwill generated by the corporation after expending time, money and effort; substantial customer relationships developed by the employee during her employment; trade secrets (i.e., a formula, pattern, compilation, program, method); and confidential information not considered a trade secret (customer information, financial plans, business strategies). Courts will not enforce restrictions greater than necessary to protect these legitimate needs.
Duration: The length of a non-compete is reasonable if it achieves the goal of protecting the employer’s legitimate business interests while not unfairly harming the former employee. It is easier to enforce a restraint that is comparatively brief. Though highly case-specific, most states enforce restraints of one or two years in length.
Geographic Scope: The area covered by the restriction should again be as small as needed to protect the employer’s interests. Geographic scope can be measured by distance (e.g., a 50-mile radius from employer’s office) or by the area in which the company conducts business or, in the right situation, by preventing the former employee from doing business with the employer’s customers wherever located. It is possible to have a global non-compete if the company conducts business around the world.
Effective Alternatives: Agreements governing confidentiality, customer non-solicitation and employee non-solicitation provide even more targeted protection than non-compete agreements. These effective tools are often more palatable to reviewing courts.
Confidentiality Agreements: Every state recognizes that trade secrets and confidential information are worthy of protection, and agreements that safeguard an employer’s confidential information and trade secrets are enforced with near uniformity. Adopted in some form in nearly every state, the federal Uniform Trade Secrets Act also provides a measure of protection from a former employee’s misappropriation of trade secrets or confidential information.
Customer Non-solicitation Agreements: Courts commonly favor customer non-solicitation clauses because they allow former employees to immediately work anywhere, even for a direct competitor. Because they protect the employer’s customer base while allowing the employee to work in her chosen field, the employee is not unduly burdened if she must wait a period of time before conducting business with customers developed or serviced during her employment. Many states, however, will not prohibit a former employee from soliciting, prospective customers, customers the employee brought with her to the former employer or customers whom the employee never solicited during her employment.
Employee Non-solicit Agreements: Likewise, an employee non-solicit only stops a departing employee from hiring away or “lifting out” another employee or group of employees, most commonly the former employee’s subordinates. Though designed to protect a legitimate business interest, namely the stability of an employer’s relationships with its workforce, enforcement often turns on the impact of the clause on the mobility rights of otherwise at-will employees who may be mere bystanders to the employer’s agreement with the departing employee.
Garden Leave and Paid Non-competes: Garden leave refers to a post-employment time period during which the former employee remains employed and continues to receive normal compensation and benefits but does not report for work. Garden leave allows the employer to freeze the employee in place and protect itself from competition. The leave has minimal negative impact on the former employee because she continues to be paid as an employee during this period. The paid non-compete also has little impact on the former employee because she receives a set payment during the non-compete period. She need not, however, receive her normal salary and benefits because she is no longer an employee.
Clawbacks and Employee Choice: A clawback provision gives an employer the right to recover compensation paid to an employee upon breach of a restrictive covenant. States like New York also are more likely to enforce restrictive covenants that offer employees a choice—either comply with post-employment restrictions or risk forfeiture of compensation (often called the “employee choice doctrine”). Because the employee controls her own fate, the restraint against competition is reasonable. Employers must be aware, however, of potential drawbacks, including whether such provisions are enforceable under the particular state’s law and ERISA and tax implications.
Effective Restrictive Covenants in Latin America
As in the United States, post-employment restrictions in Latin America are scrutinized for reasonableness of scope and the impact on the former employee. There are key differences, however, that employers must remember when drafting such agreements. For example:
In Argentina, enforcement is more likely when post-employment restraints are clearly stated, individualized and specific to the employee (rather than a class of employees). Also, they are more effective when reasonably limited in time and geographic scope, and they define the employer’s business. If possible, the competing entities should be identified by name and the parties should agree to the sufficiency of consideration supporting the agreement. Unlike in the United States, Argentinian employees must receive more than a nominal payment during the period of post-employment restriction.
Courts in Brazil carefully scrutinize restrictive covenants to ensure fairness. Compensation is required, normally based on the former employee’s salary; and the length of the restraint usually does not exceed one year. Noncompetition agreements are enforceable against management and employees with access to sensitive information, but generally unenforceable for manual workers and average administrative staff. Restrictive covenants must be executed at the beginning of employment (or as a condition of separation), because agreements entered during employment are viewed as coercive and lacking consent due to economic, psychological or hierarchical pressures on the employee.
Noncompetes violate the Constitution of Mexico, which expressly prohibits a person from contractually waiving her right to work in “a determined profession, industry or business activity” and grants every individual the right and freedom to engage in any lawful activity. Because these rights are inalienable, any agreement to the contrary is unenforceable. Restrictive covenants may nonetheless be enforceable to the extent that they require the former employee to strictly maintain the confidentiality of information or trade secrets learned because of the work, position, duties or performance of any work during her employment. When drafting restraints in Mexico, careful attention should be paid to the confidentiality and nondisclosure aspects of any agreement.
Should Your Business Implement Restrictive Covenants?
Some thought leaders discourage using restrictive covenants because they harm marketplace efficiency, citing California’s total commitment to employee mobility as central to the success of Silicon Valley. Yet several unique factors (steady government spending, plentiful venture capital, a skilled research base in area universities and proximity to Stanford University) created the foundation of the Silicon Valley we know today. Indeed, if a ban on non-competes triggers a tech boom, how does one explain the lack of high-tech centers in North Dakota or Oklahoma—and the number of high-tech companies in states that honor non-competes like New York, Massachusetts and North Carolina? Even California-based tech companies recognize the value of post-employment restrictions, most recently demonstrated by a massive class action settlement resolving claims that significant area employers created de facto non-competes by agreeing not to hire away each other’s workers.
A narrow and precise restrictive covenant can, therefore, target specific risks and protect a business’s valuable intangible assets, including confidential information and trade secrets, while minimizing undue impact to former employees. Employers have many options and can use non-competes, nondisclosure agreements and non-solicitation clauses by themselves or in combination. To maximize enforceability and effectiveness, these agreements should be carefully drafted by competent counsel familiar with all state and local nuances.
This article was originally published in Corporate Counsel [link requires registration] with input from ius laboris Alliance members FordHarrison, Basham, Ringe y Correa S.C. and Funes De Rioja & Asociados.