Podcast: Recent Legal Trends in Restrictive Covenant Enforcement and What Employers Should Know
In this Ropes & Gray podcast, Doug Brayley, employment partner and head of the employment litigation practice, and Greg Demers, counsel in the employment practice, speak with Dan Murphy, an employment, executive compensation & employee benefits associate, about recent legal trends related to the enforceability of restrictive covenants, particularly non-competition agreements, and considerations for employers going forward.
Dan Murphy Hello, and thanks for joining us today on this Ropes & Gray podcast. I’m Dan Murphy, an associate in the employment, executive compensation and employee benefits group. Joining me are Doug Brayley, a partner in the employment specialty group and head of the firm’s employment litigation practice, and Greg Demers, counsel in the employment specialty group. Drafting restrictive covenants and litigating disputes over restrictive covenants are significant components of both Doug and Greg’s practices, and we’ll be discussing recent legal trends related to the enforceability of restrictive covenants, particularly non-competition agreements, and some general considerations for employers going forward.
Let’s start with some context. Greg, what is a restrictive covenant?
Greg Demers Thanks, Dan. So just as a baseline here, a restrictive covenant is a promise by a person or an entity not to do something that would otherwise be allowed—seems pretty straightforward, but there are a lot of layers to it. So in the business context, restrictive covenants most often consist of promises not to compete in the same line of business, promises not to draw away customers or employees, promises not to disclose confidential information, or promises not to disparage or criticize. We see restrictive covenants incorporated into contracts, for example, for the purchase and sale of a business, partnership agreements, equity awards, and, of course, employment agreements, as well.
Dan Murphy: That’s really helpful, Greg. And I know from what little I have seen that promises not to compete are often the most contentious. Doug, you’ve seen a lot more than I have—when a client comes to you for advice about the enforcement of a non-compete, what are the big-picture considerations?
Doug Brayley: Thanks, Dan. You know we have an employer-side practice here at Ropes & Gray, but in the context of non-competition agreements, we can still find ourselves on either the side of the plaintiff (trying to enforce a restrictive covenant) or the defendant (arguing against enforcement).
Whichever side we may be on, the most important considerations usually fall into about three categories:
First, the specific facts of the situation. By that I mean: What industry are we talking about? What are the competing business lines? Are the parties in competition right now, or is it that one of them may be preparing to compete in the future? Do the parties offer products and services that go head-to-head in the marketplace, or are they differentiated? And especially when we represent the side trying to enforce, it is important to understand what we know (and how we know it) as opposed to what we merely suspect.
Second category is the precise language of the non-compete. How long does the restriction last? What geographic areas does it cover—does it cover competing anywhere in the world, or just in certain places, such as within a number of miles of the competitor’s facilities? What exactly does the non-compete claim to prohibit? Does it list out prohibited competitors or prohibited business lines? Does it cover working for a competitor in any capacity, or only in certain roles? What state’s law applies?
And then the third category is: What harm has come, or is likely to come, from a violation? This goes to both the amount of money that would be at stake in any litigation, and also whether there is a need or justification for an urgent request that the court step in and issue a restraining order or injunction.
Dan Murphy: Thanks, Doug. Greg, what are some trends you’ve been seeing in the enforcement of restrictive covenants recently?
Greg Demers: So there’s been a real push to tighten the allowable scope and enforceability of non-competes, both at the state and federal level. California, most of us know, is famously hostile to restrictive covenants, and there’s an open question as to whether California courts will expand their ban on non-competes and customer non-solicits to employee non-solicitation clauses, as well. Other jurisdictions have also cracked down on non-competes in recent years by adding barriers to enforceability, including Colorado just this past summer, as well as Washington, D.C., Massachusetts, and Washington state, among others—and I wouldn’t be surprised if we see more states join the trend in the next few years. Oftentimes, this will involve refusing to enforce restrictive covenants except in the sale of business context, or except when involving company executives or other high-ranking employees who, for example, meet a certain salary threshold. So, this is clearly an evolving legal landscape and it’s come at a time of increasing employee mobility, with lots of employees looking to make a move during the pandemic, which has really brought these issues to the fore.
Dan Murphy: Thanks, Greg. Doug, are any of the issues Greg just highlighted unique to non-competes in employment agreements compared to non-competes executed pursuant to a sale of business, or perhaps more common in one than the other?
Doug Brayley: In our experience in general, courts are more likely to enforce non-competes negotiated as part of the sale of a business, and will allow sale-of-business non-competes to last longer than post-employment non-competes. And that’s true even in places like California that are otherwise hostile to non-competes.
The reasons for that actually make a lot of sense. The purchase of a business includes the purchase of the business’s goodwill—that is, the value of the business’s relationships with customers, employees, the community—not to mention any “secret sauce” or other special way of doing things. If a business’s buyer could not negotiate an agreement prohibiting the seller from turning around and eroding that goodwill or stealing the secret sauce by directly competing, you would expect the price the buyer is willing to pay would go down, or it might not be willing to do the deal at all. That outcome would not be good for sellers, or for buyers, or for the public interest. Also, buyers and sellers of businesses are usually sophisticated parties, represented by lawyers and other advisors—they know what they’re signing up for, and they have other options. And the business seller has been paid—often handsomely—for the business equity and for the agreement not to compete.
Dan Murphy: Got it. So, what about in employment agreements?
Doug Brayley: Non-competes in employment agreements, even in states that do not prohibit them entirely, are usually subject to pretty close scrutiny by courts. Courts pay attention to individual employees’ need to use their skills to earn a living, and courts try not to restrain commerce any more than necessary to protect what they sometimes call “legitimate business interests.”
Dan Murphy: That makes sense, and can you provide some examples of legitimate business interests that support enforcement of non-competes?
Doug Brayley: Sure—I can maybe start with what is not an example of a legitimate business interest, and that is the interest in not having a competitor out there. Here’s what we have seen courts cite as legitimate business interests:
- Protection of an employer’s trade secrets, confidential information, strategy and planning, or other proprietary know-how.
- The employer’s investment in goodwill and relationships with the public, customers, or prospects.
- The employer’s investment in employee recruitment, training, and credentialing.
Dan Murphy: Thanks, Doug. Greg, Doug just touched on employers’ interests in protecting confidential or proprietary information. Could you explain how non-competition agreements interact with trade secret or confidentiality concerns?
Greg Demers: Sure—the issue of trade secrets and misappropriation of confidential information tends to be really at the crux of these disputes, or at least many of them. As Doug was alluding to a minute ago, when a court is assessing whether a covenant is reasonably tailored to support a legitimate business interest, that often involves trying to assess whether the company’s focus is preventing the employee from leveraging confidential information to unfairly compete with his or her former employer—not always, but often.
And this does tend to have a big influence on the negotiation and litigation dynamics, as you might imagine. As one example, I had a case last year where the other side, a large multinational corporation, got really energized to litigate because they believed our client, who was a former executive, had taken sensitive documents on her way out, and left to join a purported competitor. When we were able to disprove that misappropriation theory in expedited discovery, it really took the wind out of their sails—they knew without a misappropriation angle they’d have a hard time establishing any meaningful damages, and the case ended up in a very favorable settlement. So, the potential misappropriation of trade secrets and confidential information tends to be a focal point for both sides, and the court, as well.
Dan Murphy: That makes a lot of sense. And a related issue that we’ve seen pop-up with non-competes that ties into confidential or trade secret information, is the inevitable disclosure doctrine. Greg, could you maybe speak to that doctrine and how employers should attempt to navigate it?
Greg Demers: Sure—the inevitable disclosure doctrine comes up quite regularly in misappropriation cases. Oftentimes, the former employer won’t have concrete evidence that confidential information is actively being used against them, but they have a strong suspicion that it is, or that it could be—so they argue that, in light of the employee’s position and the fact that they were exposed to sensitive information that they can’t extricate from their brain, it’s inevitable, or virtually inevitable, that they will use or disclose that information in their new job.
I had a recent case in a New Jersey state court—the judge found this theory compelling: Even though the company couldn’t prove that the employee actually stole documents on her way out, the judge found that she had been exposed to highly sensitive information in her former role, and there was a significant risk that she could use or disclose that information.
Not all jurisdictions recognize the doctrine, but it can become a useful tool for employers when they suspect wrongdoing by a former employee but they don’t have that proverbial smoking gun.
Dan Murphy: Doug, how have you seen this come up, and how have you approached this when advising clients?
Doug Brayley: Ropes & Gray actually has a product that we call the “Trade Secrets Playbook,” which an interdisciplinary team of intellectual property and employment lawyers has spent a lot of time putting together. That Playbook helps clients to think holistically about methods and systems for protecting trade secrets and confidential information. One part of the Playbook is an approach to employee departures, because sometimes a company’s most valuable information and secrets can literally walk out the door with a former employee.
So, when a client calls me to talk about an employee whom we know or suspect is leaving to go to a competitor, one of my very first recommendations is that we take a very close look at what that employee has recently been up to on company computers, email, devices, printers, and servers. You would be surprised how often that review turns up something important. And I can tell you that our next step—ranging from a cease-and-desist letter to an emergency request for a court order—is much stronger when we can point to evidence of wrongdoing by the employee on the way out. In fact, it actually happened several times that we’ve been able to develop evidence of bad behavior that’s so compelling that the competitor decides to drop the whole thing by not hiring the individual after all.
Dan Murphy: Greg, another agreement we often see in connection with non-competition agreements (as well as non-disclosure agreements) are employee non-solicitation agreements. Are the considerations for employers in crafting and enforcing employee non-solicits the same or are they different from what we see with non-competes?
Greg Demers: Well, courts tend to view employee non-solicits through a similar lens as non-competes—which is to say that the analysis also focuses on whether that non-solicit is reasonably tailored to a legitimate business interest. Now, one challenge that employers face is that no matter how broadly you draft an employee non-solicit, the former employee can usually argue that it was their colleague who reached out to them about a job (not the other way around), and absent some smoking gun text messages, for example (which usually aren’t available until after the litigation begins), that can be hard to disprove. The more protective approach is to include a no-hire clause—assuming it’s enforceable in the relevant jurisdiction—because it removes the element of who solicited whom.
Now, another important consideration in the employee non-solicit context is the potential antitrust risk, and this has become increasingly important the last few years. The Department of Justice has demonstrated a renewed interest in what’s described as a “no-poach agreement,” and has adopted a very broad view, in particular, in the last two years or so. The latest guidance makes clear that there is antitrust risk if there’s no formal agreement in place, and even if the companies are not industry competitors—because they could still compete for talent in the workplace. So, companies do need to tread lightly when entering into any kind of business-to-business no-poach agreement, which generally only passes muster when it’s ancillary to a business transaction, or incorporated into a settlement agreement in a fairly narrowly defined way.
Dan Murphy: That’s really interesting, Greg. Are there other drafting issues that you’ve seen crop up recently, Doug?
Doug Brayley: I’d say choice-of-law provisions require special attention when it comes to restrictive covenants. There’s a trend toward state laws that invalidate choice-of-law provisions for employment-related restrictive covenant agreements. And even in the absence of a specific state statute, it often is not quite so simple as saying that Delaware law applies and moving on.
Dan Murphy: Speaking of strategic considerations, do either of you see any developments on the horizon that employers should be wary of in the next few years?
Greg Demers: Well, I can say at the federal level, President Biden issued an Executive Order just last year encouraging the Chair of the Federal Trade Commission to consider crafting new rules to curtail the unfair use of non-competes, so companies do need to keep a close watch on those developments. I don’t think we’ll see anything that renders non-competes unenforceable across the board, but we may well see greater protections for low-wage workers, in particular.
At the state level, of course, there’s a lot of variability, but one item to watch is how courts treat remote employees and partially remote employees just given the massive shift in the workforce during the pandemic. This can become particularly important for choice-of-law issues, because an employee who spends a majority of his or her time working remotely in a state that takes a narrow view of non-competes could potentially take refuge in that more favorable forum in the event of a non-compete dispute.
Dan Murphy: Well it will certainly be interesting to see where all this goes. Unfortunately, that’s all the time we have for today. Doug, Greg, I want to thank you for sharing these insights. For our listeners, please visit www.ropesgray.com for additional news and commentary about other important employment litigation developments as they arise. You can also subscribe and listen to the series wherever you regularly listen to podcasts, including on Apple, Google and Spotify. If you’d like to learn more about any of the topics we discussed today, or if we can help you to navigate this complex and rapidly developing area of the law in a more tailored way, please do not hesitate to contact us. Thanks again for listening.