This newsletter explores important considerations for companies and some uncommon approaches to protecting your company's competitive advantage, customers, confidential information and employees from unfair competition and poaching.

Decades of experience and knowledge of the uneven statutory and common law of the 50 states teaches that a company's defenses to unfair competition must include a coordinated system of protection to be effective.

Some states are friendly to efforts to protect competitive advantage, some are unforgiving and some are downright impossible. But whether you are in the best of states or the worst of states, there are some measures that every company should consider keeping in its arsenal to protect its company jewels.

IN-TERM CONTRACTS

By Mark Furlane, Joseph C. Faucher and David J. Woolf

The problems companies face in enforcing restrictive covenants are almost universally limited to postemployment restrictive covenants. In the case of critically important employees, a material competitive advantage can be maintained by creating in-term restrictions and responsibilities designed to provide the company with enforceable rights. This can be done by providing an employment termination notice period, which can be — but may not necessarily be — mutual. During this notice period, the employee can be contractually restricted from competing, prohibited from discussing with customers the employee's plans to compete and required to transition accounts. A multitude of other notice-period responsibilities can also be tied to the unique circumstances of the employee's role with the company. If, as usually occurs, the employee gives notice late on a Friday that he or she is leaving, the company is then in a position to sue on a breach of an in-term claim versus a post-employment restrictive covenant claim. The notice provision may to that extent take the employee out of the at-will ranks. Depending on the employee value/ possibility or harm, notice can go from days to months.

Too many restrictive covenants start at the time of termination of employment (e.g., "for a period of six (6) months after termination of employment, Employee agrees..."). Companies that limit their provisions this way are leaving a valuable contract right off the table. Every contractual restriction should include in-term applicability (e.g., "during Employee's employment and for a period of six (6) months after termination of employment..."). If the in-term language is not included, the employer is relegated to finding some common law or statutory theory to pursue claims of employee misappropriation and competition during employment, rather than the much cleaner breach of the in-term contract claim.

USING EXECUTIVE COMPENSATION AND SEVERANCE PLANS

By Mark Furlane and Joseph C. Faucher

"Bad Boy" and "claw back" clauses in executive compensation plans can be an important component of an employer's protection of its business from unfair competition. A "Bad Boy" clause offers an employee a benefit in exchange for an agreement to not compete or solicit after employment. The employee then chooses between competing or the benefit. If the employee competes, the unpaid benefit amount is forfeited. A "claw back" is the right of the company to go after monies paid if a violation occurs during the restriction period. In some states where post-employment restrictive covenants are severely restricted, such clauses may be enforced because of the employee's choice. If such clauses are part of an ERISA plan, even in states where post-employment restrictions are prohibited, the carrot of an executive compensation plan's "Bad Boy" and "claw back" clauses will be enforced. As an ERISA plan, such as a top-hat or severance plan, state law is preempted and the "Bad Boy" and "claw back" clauses will generally be enforced. In Marsh USA Inc. v. Cook, the Texas Supreme Court recently upheld a restrictive covenant in a stock option agreement case, noting that when the executive exercised the options he became an owner. The court found it enforceable, ruling: "[t]he stock options are reasonably related to the protection of this business goodwill. Thus, this covenant not to compete is ancillary to an otherwise enforceable agreement."

Employers will often seek to impose post employment restrictive covenants in separation agreements, which are, for the most part, untested under most state law. Even in states hospitable to restrictive covenants, the focus of an enforcement action — whether the covenant is ancillary to a valid employment agreement — will almost certainly be a state's threshold requirement. A company can improve the enforcement prospects by making the "Bad Boy" and "claw back" clauses part of an ERISA severance plan. While severance plans often have wider applicability at a company, it is possible to have a single person severance plan under ERISA. An ERISA plan can be drafted to give complete interpretive and decision-making discretion to the plan administrator, and courts must give deference to the determination. A company that does not take advantage of executive compensation arrangements to augment its arsenal of protections is leaving money on the table.

TOP RESTRICTIVE COVENANT AGREEMENT CONSIDERATIONS FOR EMPLOYERS

By Mark Furlane and David J. Woolf

There are numerous important considerations companies should focus on to create an enforceable array of protections of their competitive advantage, not only contractually but also under state and federal common and statutory law. In this and in subsequent client communications, we will focus on the most important considerations.

Recognizing and addressing the potential barriers to enforcement

Overbroad Restrictions. Regardless of which state law applies, overbroad restrictions will not be enforced.

Geographic restrictions – Restrictions that limit former employees' rights to compete within certain geographic areas will not likely be enforced if they cover an area where the employer does not operate or are otherwise deemed to be overly broad.

Temporal restrictions – Restrictions that purport to limit employees' rights to compete for an especially long period of time are not as likely to be enforced.

Restrictions on how "competition" is defined – The more broadly that a restrictive covenant defines what it means to be "competing," particularly where the employer goes beyond its core business, the less likely it is to be enforced.

Remember: Pigs get fat, hogs get slaughtered. The employer must demonstrate that the restriction is reasonably necessary to protect a legitimate employer interest, which most often includes (i) access/exposure to confidential information, (ii) possession/access to customer goodwill and relationships (sometimes only long-standing ones) and/or (iii) the restricted employee's participation in extensive training programs.

Lack of Valid Consideration. Courts routinely strike restrictive covenants where not entered into at the inception of employment, unless supported by additional valuable consideration. The cleanest and easiest approach is to have the agreements signed at the inception of employment. After employment starts, continued at-will employment may be enough to support the restrictive covenant in some states, but is inadequate in other states. If the restrictive covenant is not entered into at the inception of the employment relationship, it may be supported by a raise, promotion or other meaningful new benefits.

State Law and Forum. In drafting the agreements, companies often have flexibility in choosing what state law and forum will apply for the agreement. State laws vary dramatically across the country, including the scope of restrictive covenant permitted, whether the court will modify overly broad agreements, and how certain professions (e.g., doctors and lawyers) are treated. Where multiple states have significant contact with the employment relationship, employers should pay attention to the most restrictive state's choice of law requirements. Consider exclusive venue and jurisdiction provisions. They can often help the company avoid unfriendly jurisdictions (e.g., California).

Anticipating Employee Defenses. Depending on the applicable state law and the reason for termination, a court may refuse to enforce a restrictive covenant agreement if an employee is discharged without cause. Employers should explore angles to maximize enforceability even where employment is terminated, including the possibility of some type of severance if the restriction is important enough to the employer. Employers should also separate restrictive covenants from other contract and employment terms to avoid a possible claim by the employee that the contract is unenforceable because of a material breach by employer (e.g., failure to pay promised compensation or severance). This may require separating out the consideration driving the restrictions (e.g., access to confidential information and customers, rather than compensation and severance).

Severability or Savings Clauses. This is state specific. Many states will allow modification of an overly broad restriction, and the likelihood of enforcement can be enhanced by the agreement itself providing for "blue penciling" or "equitable modification." But the employer must know the state law that applies. Some states will strike an entire agreement if any part of it is unenforceable. In some states, the court may refuse to blue pencil and save the agreement without such a clause. Indeed, in some states, the very existence of such a clause can render the agreement invalid.

Beyond a Non-Compete. A company should consider the extent to which its agreement should include confidentiality, employee non-solicitation and customer, supplier and distributor non-solicitation provisions. Courts examine such restrictions closely to ascertain if they are reasonably related to protecting a legitimate company interest, often under the same standard applicable to noncompetition provisions. Make sure non-solicitation of employees, agents, suppliers and customers is broad enough to cover what is enforceable in your state. Simply providing "will not solicit" has too many holes —it does not take much to consider a defense of "they called me first." Instead, take up the slack: "you will not solicit, communicate with about future employment or terminating employment, hire, etc." And, equally as important, find out what protectable interest and factual underpinnings are required to support the restriction you are including in states with significant contacts with employment relationships and restrictions. Finally, do not over reach. Protecting legitimate interests you really care about is better than an agreement getting struck down because it restricted conduct that cannot be shown to be a legitimate protectable interest.

Measures a company can take to enhance its protections.

There are many things an employer can do, including:

  1. When an employee leaves, conduct an exit interview and make sure all property is returned, including all thumb drives and other storage devices. Get the laptop and copy the hard drives and all company information stored at the employee's home and on third party servers over which employee has access or control and block access to the network. All of these obligations can be included in the restrictive covenant agreement.
  2. Find out why the employee left and where he or she is working next, if possible. Truthful and complete answers to written exit interview questions can be made part of the employment contract.
  3. Include in the restrictive covenant agreement a clause requiring the employee to provide a copy of the agreement to his new employer and another giving the old employer the express authority to do so. This helps avoid a claim that the employer is tortiously interfering with the employee's prospective economic advantage or contract with the new employer.

THE COMPUTER FRAUD AND ABUSE ACT — A NEW ARROW IN YOUR QUIVER

By Mark Furlane and Kenneth K. Dort

In recent months, the courts have been putting new teeth into the Computer Fraud and Abuse Act. And with a little attention to detail, a company can make this law's provisions a major arrow in the company's quiver of competitive advantage protections.

The act provides civil and criminal penalties when an employee "knowingly and with intent to defraud, accesses a protected computer without authorization, or exceeds authorized access, and by means of such conduct furthers the intended fraud and obtains anything of value." There have been several recent criminal prosecutions under the act that have withstood appeals, and the act has been used successfully in civil proceedings as well. Take, for example, the recent Ninth U.S. Circuit Court of Appeals case of United States vs. Nosal, which reversed the dismissal of several counts of a criminal indictment and remanded for trial of allegations that Nosal, a former Korn/Ferry executive, enlisted other Korn/Ferry employees to obtain and transfer to Nosal trade secrets and other proprietary information by using their user accounts to access the Korn/Ferry computer system. This case, however, makes clear that if a company wants to make use of the act, it should implement a computer use policy that will put its employees on notice that there are clear and conspicuous restrictions on the employees' access both to the system in general and to certain databases. The policy should clearly delineate authorized from unauthorized use, including the information's return upon termination of employment, and make clear to the employees that unauthorized use may result in civil and/or criminal prosecutions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.