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Drafting RestrictiveCovenants in aMultistate BusinessLabor & Employment EducationalWebinar Series

Jill Kirila, PartnerSquire Sanders (US) LLP

Labor & Employmentjill.kirila@squiresanders.com

+1.614.365.2772

Stacie Yee, Senior AssociateSquire Sanders (US) LLP

Labor & Employmentstacie.yee@squiresanders.com

+1.213.689.5135

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Restrictive Covenants: What’s at Stake?

• Your Intellectual Property May Walk Out the Door

• Employee Mobility – Competition

At-will employees change employers freely

They can plan to compete while still working for you (as long as its not

on your time)

• May Affect Your Ability to Hire

• To protect your IP, as a multi-state business you mustunderstand how the laws of the various states in which you dobusiness view restrictive covenants and generally understandwhich laws are likely to apply to your agreements

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Legal Framework

• Non-compete Agreement: a contract that seeks to protectlegitimate business interests:

Long-term customer relationships

Confidential information/trade secrets

• No federal trade secret/non-compete law: law of restrictivecovenants is almost completely a state law question. Law can vary dramatically from state to state

• As a result: Some US states will enforce restrictive covenants

Others essentially do not enforce them at all.

• Employers cannot rely solely on choice of law and/or forumclauses Employers must anticipate and consider the laws of each states which

may potentially “touch” the business, the employee, or the agreementat issue.

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Types of Restrictive Covenants

• Non-competition “no work”

• Non-solicitation

Customers

Suppliers

Employees

• Non-disclosure: Not talking about this today!

– However, are occasional state variations

» E.g., Georgia and two years

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Non-competes: Choice of Law Issues

• Choice of law provisions are not always respected/applied

Depends on public policy of the state with the material interest

• Employer may decide to include a choice of law provision, butshould also assume it may not work

For instance, choice of law provisions generally are unsuccessful with

respect to California employees

• Unpredictability:

Out of state non-compete may be enforced against employee who

moved to California, but entered into a valid non-complete while out of

state, if the agreement is governed by out-of-state law

Who can get a favorable judgment in their state first?

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Considerations for States that Generally DoNot Enforce Post-Termination Noncompetes

(E.g., CA, ND, OK)

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Non-competes do not fly in California

California greatly restricts the enforceability of noncompeteagreements – such agreements are void as against public policyexcept in very limited situations

Cal. Business & Professions Code §16600:

“Except as provided in this chapter, every contract by which anyone is

restrained from engaging in a lawful profession, trade, or business of

any kind is to that extent void.”

Cannot fire or refuse to hire an employee for refusal to sign

• An employer can still prevent employee from misappropriatingtrade secrets, even without a non-compete agreement

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Non-competes in California: Exceptions

Sale of business

Must include sale of good will

Sale of all of shareholder’s stock

Dissolution of partnership

• Restriction can only run in favor of the buyer, not the seller

• Restrictions have been narrowly construed, to only apply toexisting customers/employees of the business at the time it wassold

Strategix, Ltd. v. Infocrossing West, Inc. (Cal. App. 2006) (nonsolicit

covenants “wrongly” barred seller from soliciting employees/customers

of buyer rather than former customers/employees of seller)

Alliant Ins. Services v. G. Scott Gaddy (Cal. App. 2008) (CA-wide

noncompete applied to seller, when seller’s business pre-sale was

conducted in all CA counties)

Possibility of extended protections when seller becomes employee of

buyer

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California: Enforceability of Non-solicits

• Non-solicitation of employees: likely enforceable if reasonable induration (short term)

What constitutes solicitation?

• Non-solicitation of customers: rarely ever enforceable

Only enforceable if:

– Reasonable

– And necessary to protect trade secrets or confidential proprietary of theemployer. Very Rare.

Remember merely informing employer’s former clients of new

employment/transition is not solicitation

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What Do California Employers Do?

• Agreements acknowledging employees’ obligations to keepconfidential proprietary and trade secret information confidential

“After Employee’s termination of employment, Employee shall not

compete with Employer by using any confidential proprietary or trade

secret information . . . “

Drafting Tip:

– Specify precise categories of information to keep confidential

– If possible, describe “competition”

– The more specificity the better

• Include employee non-solicit in agreement if a concern

• More options later

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California: Danger of Overbroad Agreements

• Some businesses (particularly multi-state employers who caninstitute valid restrictive covenants as to non-CA employees)nevertheless distribute overly broad agreements because of theperceived deterrent effect

• Dangers:

Employee can preemptively sue, requesting a court to invalidate the

agreement

– Declaratory relief

– Injunctive relief

– Contractual attorneys fees

– Employer pays employee’s costs

Cal. Bus. & Prof. Code § 17200 Unfair Business Practice

Cal. Labor Code § 432.5

– No employer shall require any employee or applicant to agree, in writing, toany term or condition which is known by such employer to be unlawful.

– Private Attorney General Act, Lab. Code § § 2699: enforcementmechanisms for Labor Code sections that do not carry penalty provisions.

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Drafting Considerations for States that DoEnforce Post-Termination Noncompete

(the other states)

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Restrictive Covenants: “reasonableness”

• Enforceability: Rule of reasonableness

• Restrictive covenants are recognized in many states as valid andenforceable so long as they impose reasonable restrictionsupon an employee that are no greater than necessary to protect

the employer’s legitimate interests.

• Means different things under different state laws/differentapplications of “reasonable” test

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Critical Elements of Non-Compete Agreement

Four General Requirements:

1. Consideration in exchange for non-compete

Offer of employment / continued employment

Promotion/change in job duties

2. Tailored to protect legitimate business interest

Long-term customer relationships

Goodwill

Trade secrets

Other confidential information

3. Non-compete reasonably related to legitimate business interestin terms of time, geographical area, and scope of theprescribed activity

4. Non-compete must not run counter to public policy of the statein which it is enforced

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State law variations: Consideration

• At-will Employment

Beginning v. Continued

– Most states: at-will employment at inception is sufficient

» And some of these say continuing at-will employmentenough

– E.g., AZ, OH, NJ, NY – yes; DC – likely

• More than At-Will Employment

Something more needed: E.g., CT, MN, NC, OR, SC, TX, VA,

WA, WV, WI, TN—unless employment continued for long

period after

– E.g., Promotion, term employment/notice, bonus, stockoptions

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State law variations: Judicial Review

• Reformation (reform to make reasonable)

E.g., DC, FL, OH, NJ, NY, (now GA)

• Blue Pencil (strike from existing K)

AZ, CO, CT, DC, ID, IN, MD, LA—if K permits, NC,

SC, WI

• Red Pencil (“All or Nothing”)

NE, VA (formerly GA)

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Blue Pencil Drafting Example

• During the term of employment and for the period of twelve (12)months following the termination of employment for any reason(or for no reason), the Employee shall not, directly or indirectly,anywhere within (i) the United States, (ii) within 50 miles of anycity or other geographic area in which the Company engages inbusiness, and iii) within 50 miles of any city or other geographicarea in which the Employee engaged in business for theCompany, develop website content for pharmaceuticalcompanies, physicians, practice managers or patients similar tothat which Employee developed for the Company, or engage inany other business activities similar to the business engaged inby the Company,…

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Restrictive Covenants: Scope

• Customer Restrictions

Only those with whom personally dealt/responsible: (e.g., NY,

MD, Cal, Tex)

All customers of company (e.g., OH)

• Geographic

Where employer v. employee did business

• Length of Time

Some State Statutes Identify Reasonable/Unreasonable

Length of Time

– E.g., Florida and 2 years

Others establish through decisions

• Exemptions

E.g., attorneys, professionals (AL); broadcasters, physicians

(DE, KY, MA, TN/TX—certain circs); other ethics

codes/industry regulations—e.g., financial services)

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Restrictive Covenants: other terms to consider

• Terms Beneficial to Employer

Term requiring employee to pay attorneys fees expended by employer

to enforce the agreement

Exclusive/consent to jurisdiction

Successorship clause

Consent to inform subsequent employers of agreement

• “Program” Issues (restrictive covenants for multi-stateemployers)

Consistency of use

Restrictions tailored to individuals to the extent possible

– “One size fits all” approach can be a costly mistake

Know your objectives: true enforceability v. presumed deterrent effect

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Noncompetes: Critical Tips

• Anticipate the jurisdiction inwhich you will litigate your clause

• Know that jurisdiction» What is sufficient consideration?

» Do state laws/court opinionsrestrict scope/enforcement

» Choice of jurisdiction v. publicpolicy

» Will a court in that jurisdictionmodify an otherwiseunenforceable clause, and if so,by:

» Blue pencil? Red pencil?

» Reformation?

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Alternatives Ideas

• Benefits/Comp Forfeiture

Varies state-by-state.

– Generally not enforceable in CA if it pertains toaccrued/vested compensation.

Disincentives to competition as opposed to a complete

bar

• Post-termination consultancy agreements aka “gardenleave” clauses

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Questions?

Jill Kirila, PartnerSquire Sanders (US) LLPLabor & Employmentjill.kirila@squiresanders.com+1.614.365.2772

Stacie Yee, Senior AssociateSquire Sanders (US) LLPLabor & Employmentstacie.yee@squiresanders.com+1.213.689.5135

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Credit Information

• At the conclusion of this program you will receive a surveyto complete. Once you complete the online survey, pleaseemail Robin Hallagan at robin.hallagan@squiresanders.comwith the affirmation code, your bar number and the stateyou require CLE and she will send you the Certificate ofAttendance.

• If you require credit in a jurisdiction not pre-approved wecan still apply to get you credit.

• Please feel free to call Robin anytime at +1.216.479-8115with any questions.