NONCOMPETE AGREEMENTS AREN’T ENFORCEABLE, ARE THEY?

We encounter this scenario a lot: a company executive preparing contracts for key employees, or considering whether to enforce a restrictive covenant against a former employee, will sigh with resignation and say, “What’s the point? Courts won’t enforce a noncompete anyway, right?”  Or an individual, who is considering resigning from her current position and taking a new job with a competitor, asks, “I don’t need to worry, do I?  I mean, these agreements aren’t enforceable anyway, right?”

General Rules

The good news – or the bad news, depending on your perspective – is that post-employment noncompetition and nonsolicitation covenants (“restrictive covenants”) are indeed enforceable, if they meet the standards of the particular state’s law that applies to the situation. While courts frequently comment that restrictive covenants are “disfavored in the law” because they operate to restrain trade, in general – and this concept does vary from state to state – restrictive covenants will be enforced by the courts if they:

(a)        are supported by consideration (i.e., the employee receives value in exchange for agreeing to the restriction on his post-employment activities); and

(b)        reasonably protect legitimate interests of the employer.

In determining whether a restrictive covenant is “reasonable,” courts in Connecticut will consider:

(1)        the temporal scope of the restriction (i.e., the length of time it remains in effect);

(2)        the geographic scope of the restriction (i.e., the area it covers);

(3)        the fairness of the protection the employer receives (i.e., whether the employer is being protected against more than “mere competition”).  Often this relates to whether the employee has acquired trade secrets or other confidential information (e.g., customer lists) from the employer that it is reasonable to prevent the employee from exploiting;

(4)        the extent of the restraint on the employee (i.e., whether the employee will be prevented from earning a living); and

(5)        the extent to which the restriction interferes with the public interest.

As one might expect, the application of these standards to any particular case depends very much on the specific facts and circumstances of the case. Connecticut also has statutory rules that apply to certain classes of Connecticut workers, including doctors, lawyers, security guards, media personalities and home care aides.

While the standards for enforcement of restrictive covenants in other states are not precisely the same as in Connecticut, in many states they are somewhat similar. But there are a couple of interesting wrinkles in our neighboring states of Massachusetts and New York.

Massachusetts

Massachusetts has enacted statutory restrictions on post-employment noncompetition agreements which, among other things, generally limit them to twelve months’ duration and require “garden leave” payments of at least one-half the employee’s base salary during the time the restriction is in force. The law prohibits noncompetition agreements altogether for certain groups of (generally low-earning) employees.  It does not apply to nonsolicitation agreements and does not apply to noncompetition provisions in employment separation agreements provided that the employee has at least seven days to rescind the agreement after signing.

A question that often arises in connection with restrictive covenants is whether an employer who terminates an employee’s employment without “cause” may nonetheless enforce restrictive covenants contained in an agreement with the employee. There have been cases in some states holding that restrictive covenants may not be enforced where the employee has been discharged without cause, and the Massachusetts statute includes a provision of this type.  (In Connecticut, however, the law is clear that a restrictive covenant that is otherwise valid and enforceable will be enforced regardless of whether the employee was terminated without cause.)

New York’s Employee Choice Doctrine 

In New York, restrictive covenants contained in employment agreements are generally measured against a reasonableness standard similar to Connecticut’s. Covenants voluntarily entered into will be enforced if they are:

(1)        reasonable in time and area;

(2)        necessary to protect the employer’s legitimate interests;

(3)        not harmful to the general public; and

(4)        not unreasonably burdensome to the employee.

In New York, as in Connecticut, an employer’s “legitimate interests” often include the protection of confidential information and trade secrets.

The New York courts have also developed a rule known as the “employee choice doctrine,” applicable to restrictive covenants contained in employee benefits or compensation arrangements such as stock option or severance pay plans which include “forfeiture for competition” provisions under which the employee forfeits (or must return) the benefit if s/he breaches the covenant. Under the employee choice doctrine, these provisions will be enforced against a voluntarily departing employee without regard to their reasonableness; the court will not even inquire whether the covenant is reasonable.

The logic here is that the employee has a choice: honor the covenant and receive the benefit, or breach the covenant and forfeit the benefit.  In these circumstances the covenant is not imposed as a condition of employment; it is a condition for receiving something extra, something that is usually of significant value and offered only to higher-level employees, and something that the employee can choose to forego if some new opportunity is sufficiently attractive.

There have been cases in New York construing the “employee choice doctrine” which have held that when an employee is involuntarily terminated without cause, a restrictive covenant in a compensation or benefit arrangement will not be enforced, regardless of its reasonableness.  There have also been cases taking a slightly more employer-favorable view, holding that where the employee is discharged without cause, the employee choice doctrine will not apply; that is, the court will treat the forfeiture for competition provision as though it were part of an employment agreement rather than a benefit plan, and will examine the restrictive covenant to determine whether it is reasonable.

Finally, there has been at least one New York case holding that in general, restrictive covenants in employment agreements will not be enforced where the employee has been terminated without cause (taking this rule beyond the employee benefits plan context).  But that case, which was not decided by New York’s highest court, is, so far, an outlier.  Therefore, it currently remains the general rule in New York that restrictive covenants in employment agreements (i.e., outside the context of the “employee choice doctrine”) will be enforced if they are “reasonable,” even when the employee has been terminated without cause.

The Takeaway

If there are any clear lessons to be drawn from the above, they are:

(1)        restrictive covenants in employment agreements and employee benefit arrangements will be enforced in appropriate circumstances, but

(2)        Enforcement of noncompetes can be complicated.  The standards and rules vary from state to state.  Sometimes statutes create exceptions, and sometimes exceptions are developed through caselaw.

Anyone faced with an issue involving enforcement of a restrictive covenant should consult knowledgeable legal counsel.