Non-Competes Are Not for Everyone

March 24th, 2017

If properly drafted and used, restrictive covenants (non-competition agreements) can be terrific and enforceable tools.  However, recent government scrutiny of their use and impact on employee mobility and wages make it clear that their use should be limited to key employee and executive personnel and/or those with significant client and marketplace relationships.

The intent behind a non-compete is to provide protection for a limited period of time against the transfer of an employer’s relationships and or know-how to a competitor.   Non-Competes only have value if they are treated (1) as special agreements involving limited groups of employees; (2) carefully tailored to the circumstances of a given employment relationship,  industry, and job duties; and (3) found to be worthy by the courts.  If they are devalued by being issued to every employee in a company regardless of the material nature of the employee’s position, they may slightly improve employee retention, their use may come under scrutiny, their effect diluted, and their enforcement difficult to achieve.

As discussed in an earlier HNRK Blog post, when deciding the seminal case of Reed, Roberts Assoc. v. Strauman, 40 N.Y.2d 303, 307-08 (N.Y. 1976), the New York Court of Appeals made it clear that restrictive covenants “will only be subject to specific enforcement to the extent that they are reasonable in time and area, necessary to protect the employer’s legitimate interests, not harmful to the general public and not unreasonably burdensome to the employee.” Id. Legitimate interests of the employer, according to the Reed, Roberts court, would include the protection of trade secrets or confidential information, or preventing competition when “an employee’s services are unique or extraordinary.”  Id. at 308. This ruling and judicial policy statement strongly suggests that a company should use great discretion when requiring execution of a restrictive covenant as a condition of employment and make sure that the employee, officer, or director are engaged in activities that to preclude unfair competition, deserve shielding from a competitor.

Federal and local governments have grown increasingly sensitive to the misuse of restrictive covenants.    In May 2016, the White House released a report on the use of non-competes and their potential misuse by employers and the negative effects it may have on the economy by limiting wages and employee mobility. (“Non-Compete Agreements: Analysis of the Usage, Potential Issues, and State Responses.” See October 2016 Blog entry.)

Similarly, New York State Attorney General Eric Schneiderman, has called out employers for abuse of non-competes, which in some settings, have become so ubiquitous that even fast-food companies are requiring line workers to sign them.  Tracking New York law, Schneiderman states that, “Unless an individual has highly unique skills or access to trade secrets, non-compete clauses have no place in a worker’s employment contract.” He continues, “Unscrupulous non-compete agreements not only threaten workers seeking to change jobs, they also serve as a veiled threat … Workers … should be able to change jobs and advance their careers without fear of being sued by their prior employer.”

In what was a first, the NYAG used the power of his office to challenging non-compete agreements between companies and their employees.  The NYAG settled two investigations brought pursuant to Section 63(12) of the New York Executive Law, which authorizes the NYAG to investigate and redress “unconscionable contractual provisions.” In June 15, 2016, the NYAG announced a settlement with Law360, a prominent legal news outlet, restricting its use of non-compete agreements with members of its editorial staff.  Before the settlement, the publisher required all of its editorial employees to sign agreements preventing them from working for a “direct competitor” for one year after leaving Law360. Given that Law360 is a national publication, the contract effectively prevented employees at all levels of seniority from taking another job.  Under the settlement agreement, Law360 will no longer include non-compete provisions in its agreements with most editorial staff members, and it will alert former employees who left the publisher in the past year that their non-compete provisions will not be enforced.

A second settlement was with Jimmy John’s Gourmet Sandwiches (“Jimmy John’s”).  In a classic case of overreach,  Jimmy John’s franchisees based in New York will cease requiring its sandwich makers to sign non-compete provisions in connection with their employment and will void all such agreements currently in effect.  Jimmy John’s also will cease including sample non-compete agreements in the hiring packets that it sends to franchisees, and it will alert franchisees that the NYAG believes that such clauses are unlawful.

Significantly the NYAG has not challenged the employment agreements between senior, technical, sales, or other personnel who were more likely to have access to confidential information and trade secrets or whose relationships with clients and vendors are significant.

In sum, non-competes and other forms of restrictive covenants, including non-solicitation and no raiding provisions, are in fact alive and well and enforced by New York State and Federal courts.  They are an essential tool against unfair competition and the protection of key relationships.  But, they should be used sparingly and only for certain classes of employees who have knowledge of material information which could be used by a competitors to unfairly enter the market, operate at a lower cost, on a faster schedule and thus to unfairly compete.