RESTRICTIVE COVENANTS IN EMPLOYMENT AGREEMENTS
By: Daniel P. Simpson
With ever increasing frequency employers are demanding and employees are signing agreements that limit the employment and other business options available to the employee after termination of employment. Those portions of the employment contract are commonly known as restrictive covenants.
The discussion below generally comports with New York and New Jersey law, but each state has varying legal standards that apply. For instance, California has a broad statute prohibiting restrictive covenants in all but a very limited number of cases.
Typically, restrictive covenants include restrictions on the employee’s right to work for competitors and to solicit customers of the employer. An example of a restrictive covenant is as follows:
For a period of two years after the termination of employment for any reason, employee agrees that he shall not work in or have any interest in any business which is competitive to that of employer, and employee will not contact, solicit, or accept any business from any customer of employer.
Because these covenants are enforceable only to the extent that they are reasonable under the circumstances, their enforceability can never be determined in the abstract but rather only in the context of the particular facts and circumstances of the employer and employee in question.
A covenant must pass three tests in order to be enforceable.
- It must protect a legitimate interest of the employer
- It may not impose any undue hardship on the employee
- It must not impair the public interest
Then, even if the covenant is found enforceable, it may be limited in its application by its geographical area, its period of enforceability, and its scope of activity.
The Legitimate Interest Test
An employer’s interest in stifling competition is not a legitimate interest in this context. Conversely, if an employee was handed a large number of customers when he started working for his employer, and the employer had developed these customers over many years, the employer would have a legitimate interest in maintaining these customer relationships and preventing the employee from interfering with them. An employer’s legitimate interest is increased dramatically in the context of a business acquisition where the employee was previously a principal of the seller.
The Undue Hardship Test
All restrictive covenants impose some hardship on the employee. The determination of whether or not the hardship is undue is whether it is too harsh a burden on the employee given the legitimate interest of the employer. For example, if an employee came to the job with many years of experience in the industry and many contacts in the industry and worked on customers given to him by the employer as well as customers he developed on his own, a court would be reluctant to foreclose him from working in the industry.
As one court said, “What [the employee] brought to his employer, he should be able to take away.” Stated differently, a tradesman who brings tools to his employer may on separation leave with them. Similarly, a scientist who has entered into an employment relationship with a head full of scientific data, some of which he used for the benefit of his employer, may then use it for the benefit of another. As another court said, “Princeton is not to have the exclusive right to Einstein’s services just because he is Einstein.”
The Public Interest Test
The public interest is implicated in some employer/employee relationships. A good example is that of physicians, where there is a strong public interest in providing medical care generally and in ensuring patient’s access to their physicians. Thus, it is unlikely that a court would ever enjoin a physician from giving services to a patient. However, a court will enjoin a physician from opening an office within a certain distance of his former employer for a certain period of time. The distance would not prevent the patient from reaching him at his new office but would still give some measure of protection to the employer. In Bergen County, New Jersey, we have seen two- to five-mile restrictions for two years and more upheld by the courts in this context.
The Scope of the Restrictions
After analyzing all of the relevant factors in a given case, courts will often rewrite or “blue pencil” restrictive covenants so that what remains is reasonable under the three-part test set forth above. A prohibition on competition in a large industry might be reduced to a portion of the industry or a prohibition on competition might be eliminated, but a ban on solicitation might remain. A proscribed geographical area or the time period of the restriction might be reduced.
Restrictive covenants are multiplying in employer/employee relationships. Post-employment restrictive covenants are always vital to the employee and often important to the employer. They should be carefully considered by both sides in every case. Through careful drafting, one can eliminate a significant portion of the uncertainty that comes with judicial intervention.
This publication is intended for general information purposes only and does not constitute legal advice. The reader should consult legal counsel to determine how the law may apply to specific situations.