Fixing Your Non-Compete Agreements Before You’re In A Fix: Ten Common Employer Mistakes That Threaten Your Non-Compete

In a Good Company article from 2005, Noncompetes Can Protect Your Company’s Goodwill[1], my colleague James Harris and I reported on a recently decided case, Merrimack Valley Wood Products, Inc. v. Near, in which the New Hampshire Supreme Court addressed important issues concerning post-employment restrictions. Recently, inSyncom Indus., Inc. v. Wood (March 16, 2007) and ACAS Acquisitions Inc. v. Hobert (May 3, 2007), the Court provided employees and employers with additional guidance relevant to the enforceability of noncompetition, nonsolicitation and nondisclosure agreements. Extracting the lessons from these and other cases, below are (a) ten common employer mistakes that threaten the enforceability of restrictive agreements; (b) brief explanations of the circumstances that give rise to those mistakes; and (c) recommended best practices aimed at significantly increasing the likelihood that the agreements will be enforced.

  1. Mistake: Using the same agreement in multiple jurisdictions

The laws can be very different from state to state and your agreements should take account of those differences.

BEST PRACTICE: Obtain guidance from Company counsel regarding differences in the laws in all areas in which employees will be asked to sign restrictive agreements and modify agreements accordingly.

  1. Mistake: Failing to update your agreements to comport with changing law

Laws change and judges’ interpretation of the laws evolve over time. For example, in the past couple years, the New Hampshire Supreme Court has handed down three important decisions concerning non-compete agreements, which have provided significant guidance to employers and their counsel.

BEST PRACTICE: Keep abreast of changes in the law through seminars, publications and communications with counsel. Have counsel assist in updating restrictive agreements as necessary.

  1. Mistake: Failing to adopt sound implementation practices

It is not enough for employers to obtain good, up-to-date agreements. They must also adopt and consistently employ sound implementation practices. In the Merrimack Valley case from 2005, the Court found that the employer acted in bad faith and struck down the entire agreement in part because the employer had not adopted sound implementation practices.

BEST PRACTICE: In addition to advising all prospective new hires that they will be required to sign agreements with post-employment restrictions, the employer should (a) separate non-compete agreements from the stack of new hire documents given to incoming employees; (b) highlight the restrictive covenants to incoming employees; (c) give incoming employees time to review the agreement carefully — with counsel (at the employee’s expense) if they so choose; and (d) make sure new employees sign the agreement before commencing work.

  1. Mistake: Requiring that all employees – from executives to low level hourly employees – sign a non-compete agreement

Non-compete agreements should be utilized only where necessary to protect legitimate business interests, such as customer goodwill. There is no real goodwill between customers and the custodian (as example) and no real need to limit his or her post-employment activities. Any attempt to do so may compromise the company’s legitimate efforts to restrict appropriate employees’ post-employment activities.

BEST PRACTICE: Spend time realistically assessing what legitimate interests are at stake and identifying those employees who need to be restrained in some way in order to protect those interests.

  1. Mistake: Using a non-compete agreement to protect anything other than confidential business information, customer goodwill and employee relationships

Because non-compete agreements are disfavored, employers must use them only when necessary to protect their confidential business information (including but not limited to actual trade secrets), customer goodwill and employee relationships. In normal circumstances (e.g. where the employer has not agreed to pay the employee to stay out of competition for some period of time), courts in New Hampshire will uphold a covenant that restricts a former employee’s ability to solicit a former customer, but will not uphold a post-employment restriction that prevents a former employee from working in the industry. Similarly, courts in New Hampshire do not consider the fact that an employer has paid for an employee’s training to justify a post-employment restriction on that former employee’s competitive activities.

BEST PRACTICE: Make certain that use of restrictive agreements is supported by one or more of the legitimate interests identified above. They should not be used, for example, as a tool to recoup training costs or to retain employees by making it exceedingly difficult for them to go elsewhere.

  1. Mistake: Overreaching in agreements with the expectation that courts will simply lessen the restrictions where appropriate, but otherwise enforce them

Courts have been increasingly unwilling to scale back agreements (often referred to as “blue penciling”) that are too broad in scope or duration, or that are otherwise obtained in ways the court determines to be unfair (e.g. demanding the employee sign the non-compete agreement on the spot along with a dozen other “new hire” documents without advance notice of the requirement in, say, an offer letter). In these instances, courts may refuse to enforce any part of the agreement.

BEST PRACTICE: Similar to the preceding “best practice”, ensure that the restrictions are only as tough as needed to protect legitimate interests. So, for example, an employer should restrain a former sales employee’s ability to solicit former customers with whom he interacted for 12 months if that is the likely amount of time needed to obliterate in the minds of the customers that former employee’s association with the Company. Don’t expect courts today to simply pare back an unenforceable 36-month restriction because the court may refuse to enforce any restriction if it determines that the employer has overreached.

  1. Mistake: Requiring an existing employee to sign a non-compete agreement without providing him or her with additional consideration for it

While the law in New Hampshire is a still unsettled on this point, employers should seriously consider providing existing employees with some additional consideration (beyond continued employment) to support a non-compete agreement presented during the employment relationship.

BEST PRACTICE: Understanding that there may be economic realities that prevent substantial payments to existing employees, employers may increase the chances that restrictive agreements given to existing employees are enforced if some meaningful additional consideration is provided. For example, an employer may (a) pare back an old agreement’s restriction from 18 months to 12 months and in so doing provide additional consideration to the employee in the form of 6 fewer months of restriction, or (b) provide $500 that the employee is encouraged (but not required) to use to obtain legal advice concerning the agreement before signing.

  1. Mistake: Failing to update a non-compete agreement when an employee’s job changes in some significant or “material” way

Whenever an employee’s job changes significantly, employers should consider whether the existing non-compete is appropriately restrictive. For example, if an employer transfers an employee out of sales to an administrative position and reduces his or her pay, the non-compete agreement may be unenforceable as written.

BEST PRACTICE: Employers need to monitor significant changes in their employees’ jobs and adjust non-compete agreements if necessary. Although not every change in the employment relationship is significant enough to require an amendment to an existing restrictive agreement, substantial changes in compensation or job duties should trigger a careful review of the affected employee’s agreement.

  1. Mistake: Inconsistently enforcing your agreements

When deciding whether to enforce a non-compete agreement, courts will look at an employer’s practice of enforcing the agreements. If employers have been sporadic in their efforts to enforce courts may be more likely to find that there is no legitimate interest justifying the restriction.

BEST PRACTICE: In addition to securing good, up-to-date agreements from all appropriate employees, employers must take reasonable steps to police the agreements. This does not mean that employers must institute lawsuits every time a breach is suspected, but it does mean that they must consistently take steps to investigate suspected breaches and to pursue those who they reasonably believe have breached their agreements. While litigation is sometimes required, in many cases a “cease and desist” letter to a former employee and her new employer is sufficient to send the right message and to protect the company’s interests.

  1. Mistake: Failing to preserve electronic evidence

Oftentimes employers fail to obtain and preserve electronic evidence. This has primarily two negative effects. First, employers never learn the true extent of the breach, the seeds of which may have been sown during the employment relationship. Second, if not properly secured, electronic evidence may be lost and an employer held responsible for the loss in a subsequent lawsuit with the former employee.

BEST PRACTICE: When unlawful disclosure of confidential information or competition is suspected, employers should consult with counsel who can arrange for an independent forensic specialist to secure and preserve all electronic evidence, including that found on the former employee’s old desktop, lap-top and hand-held computers. These specialists are usually able to recover information that would not be evident even to most IT professionals.