Limitations and Best Practices for Using Non-Competition Agreements to Protect Company Trade Secrets
With the advent of the Defend Trade Secrets Act (“DTSA”) in 2016, the number of companies choosing to use trade secret law to protect and enforce their intellectual property has risen dramatically. Even a casual observer will recognize that many of the high-profile trade secret misappropriation lawsuits – from the Uber/Waymo lawsuit relating to self-driving car technology to the LG Chem/SK Innovation relating to lithium-ion batteries – involve allegations that the defendant hired away former employees of the plaintiff, and that in so doing, they took the company trade secrets and IP from one firm to the other.
There is a strong public policy concern in favor of allowing departing employees to leave freely and pursue new employment in their chosen field. This often stands in tension to trade secret policy and to trade secret claims. If trade secret plaintiffs were permitted to allege broad categories of technology or information as the particular trade secret, then this would effectively give former employers broad power to embroil employees in litigation and expensive discovery without fear of having the case dismissed early.
In some states, such as California, this public policy battle is codified into the elements of a trade secret action itself. See, e.g., Weco Supply Co. v. Sherwin-Williams Co., 2012 WL 1910078, at 6 (E.D. Cal. May 25, 2012) (stating that a plaintiff bringing a trade secret claim must show that “the public policy in favor of the protection of the complainant’s interest in maintaining the secret outweighs the interest of the employee in using his knowledge to support himself in other employment.”).
With this backdrop, it is crucial now more than ever that companies understand (1) the legal limits with respect to non-competition agreements, as well as the various legislative approaches by states that bear on in this important area, and (2) the best practices to increase a firm’s chance of successfully enforcing non-competition agreements to protect trade secrets.
Restrictive covenants of the kind found in non-competition agreements and employment agreements are a common device utilized by companies across a broad spectrum of industries to augment available tangible measures for protecting trade secrets and confidential information, such as access limitations and password barriers. As such, many employers require applicants or employees to sign agreements banning, or restricting, competitive activities for some specified time-period post-termination as a condition of employment or continued employment.
However, it is important to be judicious and reasonable in the use of these devices. Courts universally recognize that restrictive covenants are a restraint of trade and, as such, implicate public policy concerns. While the law governing enforceability of employment-related restrictive covenants varies dramatically from state-to-state, every jurisdiction calls for close scrutiny of non-competition agreements and imposes constraints, to some degree or another, on the extent an employer may go in preventing, or limiting, a departing employee’s activities in pursuit of a livelihood.
Some states, most notably California, have enacted legislation imposing an outright ban on non-competition covenants in virtually all contexts. See California Business & Professions Code §16600 (any non-compete provision between an employer and an employee – in other words, any contract that restrains a person from engaging in a profession, trade or business – will not be enforceable under California law). The lone exception in California allows for the imposition of reasonable restrictions on the seller of a business that are narrowly tailored to safeguard the acquired asset. Oklahoma has likewise outlawed non-competition covenants save those tethered to the sale of a business, even then the restriction must be confined to the carrying on of a similar business within a narrow specified geographic area. A virtually identical statute has been in effect in Montana for about a decade. Colorado’s statutory ban on non-competition covenants similarly includes an exception for the sale of a business but goes farther by also allowing for the imposition of restrictions serving to protect trade secrets as well as those limiting the post-termination activities of executive and management personnel and professional staff.
Traditionally, in the absence of a statutory ban or limitation, the scope of permissible restrictions on employee mobility via non-competition covenants have been established by judges applying common law principles on a case-by-case basis. While there are an array of state-by-state nuances to the law in this area, there are certain common threads transcending jurisdictional boundaries.
Non-Competition Agreements Should Be Supported By Adequate Consideration
First, as a matter of basic contract law, a non-competition agreement, like any contractual instrument, must be supported by adequate consideration. The consideration requirement has given rise to a singularly recurring and divisive issue: is an offer of continued at-will employment, of itself, adequate consideration for a non-competition agreement entered into in the course of an existing employment relationship?
More common law states answer this question in the affirmative than the negative, but the scorecard is hardly one-sided, with the law on the point in some jurisdictions, such as Connecticut, remaining cloudy to this day. To avoid the issue altogether, most employers require new hires to execute the company’s standard restrictive covenants documentation as part of the onboarding process (all agree that an offer of at-will employment is adequate consideration) or couple a mid-term non-competition agreement with a bonus, salary increase, or some other tangible benefit.
Non-Competition Agreements Must Be Reasonably Tailored in Scope
Second, virtually all states applying common law precepts insist that a non-competition covenant be narrowly tailored to protect a recognized legitimate business interest, such as trade secrets and confidential information, goodwill, and/or customer relationships. The employer’s interest in protecting the business is then balanced against the employee’s interest in pursuing a career and supporting his or her family. The requisite narrow tailoring would be embodied in durational and scope limitations. Although there are no hard and fast rules, or anything even close, assuming the restrictions are otherwise reasonable courts generally have no issue with a duration of one year or less.
As for scope, a non-competition covenant must be confined geographically to the area where the company does business or is actively pursuing business opportunities. With some types of businesses, it is relatively easy to define the geographical parameters; examples would be doctors and other medical professionals, tradespersons such as plumbers, electricians, and carpenters, and local retail shops, all invariably draw customers from a narrow geographic sphere that can be pinpointed with a fair degree of precision. But many companies now do business largely on the internet or widely across countries, continents or even the globe. For these companies, a geographic limitation would defeat the purpose of a non-competition covenant. Courts tend to recognize this reality and allow for unlimited or nearly unlimited restrictions in terms of geography where necessary to safeguard legitimate business interests. Geographic restrictions can also be effectively replaced by customer restrictions, this is an especially common approach with sales employees. Thus, with customer-facing personnel, it is usually most effective to prohibit solicitation of clients the employee serviced or pitched rather than imposing a geographic constraint. As for the duration of a customer non-solicitation covenant, a useful guidepost would be the minimum amount of time it would take for a replacement salesperson to develop customer relationships roughly on par with the relationships enjoyed by the departing employee, the legitimate business objective being to allow the company a fair opportunity to retain the business.
Keep the Public Interest In Mind As Appropriate
Third, the common law analysis factors in the public interest. More specifically, a court will consider and account for the effect enforcement of a restrictive covenant would have on the public at large. In almost all cases, this is a non-issue. As a practical matter, the public interest only comes into play where essential services are at stake. So, for example, the public interest would be an important consideration where a medical practice is seeking to enforce a non-competition covenant against a specialist in a rural area where access to specialized medical care might be dramatically compromised.
Legislative Approaches by the States
In an effort to provide clarity to an inherently grey area of the law, a number of states have codified some variation of the reasonableness test. Among the states taking this approach to dealing with restrictive covenants are Texas, Florida, Georgia and Oregon.
Many states have been more circumscribed and barred employers from imposing restrictions, or limited the types of permissible restrictions, on certain types of workers, most commonly doctors and other medical professionals (e.g., Alabama, Connecticut, Delaware, Maryland, Tennessee, and Texas) and broadcast employees (e.g., Arizona, Connecticut, Washington, D.C., Illinois, Maine and Washington).
Just this year, the Connecticut legislature blazed a new path by tucking into a nearly 600-page omnibus budget bill a one-paragraph law exempting homemakers and companions from restrictions on competition and patient solicitations.
Recently, several states, reacting to public outrage, have enacted laws protecting fast-food and other low wage workers from being shackled by non-competition covenants. A Maryland law that went into effect on October 1, 2019 offers a good illustration: the statute bars employers from requiring workers earning less than $15.00 per hour or $31,200.00 per year to sign a non-competition covenant. Similar protections based on earning level have been enacted in New Hampshire ($14.50/hour), Maine (less than 4X the current poverty level), Oregon (median income for a family of four), and Washington ($100,000.00 per year).
Freshly minted non-compete legislation in other states is of a far more comprehensive variety. Leading the way are Massachusetts and Washington. The Massachusetts law went into effect on October 1, 2018 and includes some novel provisions. Particularly noteworthy, the statute bans employers from requiring non-exempt employees to sign a non-competition agreement, bars enforcement of a non-competition agreement against an employee who was discharged without cause, limits the duration of an enforceable non-competition covenant to one year, and requires the inclusion of a garden leave clause providing for payment of at least 50% of the former employee’s highest salary during the preceding two years for the duration of the non-compete period. The law also erects a variety of procedural standards, such as the requirements that a non-competition agreement (i) be presented to a prospective employee at the time an offer is extended or at least ten days before employment begins, (ii) be signed by both parties, and (iii) contain language that serves to advise the employee to consult a lawyer before signing. Washington’s law goes into effect on January 1, 2020 and includes several interesting features (apart from the aforementioned ban on non-competes for employees earning less than $100,000.00 annually). Like Massachusetts, Washington requires advanced notice, specifically the non-competition agreement must be presented to a prospective employee before an offer is accepted. Washington’s statute codified the rule established by case law that continued at-will employment is not adequate consideration for a non-competition agreement. Furthermore, the Washington law establishes a presumption that restrictions exceeding 18 months are unreasonable and requires employers to continue paying base salary to a laid off employee for the entire period of time a non-compete is being enforced. Under the new law, a judicial or arbitral determination that a non-competition covenant is unenforceable as drafted (even if modified by a court or arbitrator) will trigger an award of actual damages or a statutory penalty of $5000.00, whichever is greater, plus reasonable attorneys’ fees, expenses, and costs. It bears noting that both the Massachusetts and Washington laws only regulate non-competition covenants, neither law serves to place any statutory limitations on non-solicitation or confidentiality covenants.
Cases Where Employers Successfully Enforced Non-Compete Covenants to Protect Trade Secret/Confidential Information
In those jurisdictions where non-competition covenants are not statutorily proscribed, it is generally accepted “that ‘confidential business information which does not rise to the level of a trade secret can be protected by a properly drawn covenant not to compete.’” Medtronic, Inc. v. Sherland. Generally, “[t]he existence of a nondisclosure covenant does not preclude a noncompetition covenant from also protecting an employer’s legitimate business interest in its confidential information.” In Sherland, the court enforced a non-competition covenant where the defendant/former employee “acquired confidential information throughout his career at Medtronic and … ‘had access to and significant knowledge about sales and marketing strategies used by Medtronic to train their sales force and such information would be useful to Medtronic’s competitors.’”
Another more recent illustration of a successful litigation initiative to enforce a non-competition covenant to safeguard confidential information is XPO Logistics, Inc. v. Northrop. The defendant in that case resigned from XPO to join a competitor but before leaving sent herself documents containing “confidential and proprietary information about XPO’s business, including its operations, business strategy, customers, and financial information.” Among the purloined documents was “a proprietary tool that XPO uses to internally communicate confidential operational and performance information, such as competitively sensitive information about the company’s incentive plan for employees” and “a proprietary management tool that is designed to identify and execute strategies and actions to drive improvements across all aspects of an LTL [less-than-truckload] facility’s business.” Emphasizing “the undisputed nationwide scope of XPO’s LTL network and Northrop’s knowledge of Confidential Information—including the proprietary materials she took from XPO—that can be used to compete against XPO anywhere in the country,” the court ruled that a six-month nationwide ban on competition was enforceable. Notably, the court issued an injunction barring Northrop from working for a competitor anywhere in the U.S., including the company she left XPO to join, even though she claimed to have wiped the proprietary information from her e-mail system, explaining that “her knowledge and prior utilization of these business tools applicable to any competing business in any competing area, combined with her apparent intention to reference them and access them post-employment, demonstrates the reasonableness of the nationwide scope under these facts.”
In another recent case where the protection of confidential information was at stake, a federal appeals court, in Tilden Recreational Vehicles, Inc. v. Belair, affirmed a district court’s order enforcing a non-competition covenant by way of a preliminary injunction where the defendant/former employee of BNRV, a company that sells recreational vehicles, “had access to pricing guidelines for deals, the value of a product to BNRV and general costing information.” The information available to the defendant included “the minimum amount of profit that BNRV has to make on a deal, the actual cost to BNRV and what BNRV paid for a vehicle.” Agreeing with BNRV’s contention that the company enjoyed “a protectable interest in Belair’s knowledge of confidential information to which he had access as part of his job,” the Court of Appeals explained that: “In the sales context, courts have held this kind of interest justifies enforcing a restrictive covenant when, because the employee’s new role relies on the same knowledge of ‘customers, products, technical details, and marketing strategies’ as did the former role, ‘it is virtually inconceivable that the employee would be able to avoid utilizing the confidential information.’”
CVS likewise recently procured an injunction to prevent a high-level executive from working for a direct competitor in violation of a non-competition covenant by convincing a federal district court that the 18-month covenant in question “is narrowly tailored to serve CVS’s legitimate interest in protecting its Confidential Information and is reasonable in duration and scope.” CVS Pharmacy, Inc. v. Lavin. At CVS, the defendant, Lavin, was primarily responsible for negotiating with retail pharmacies on behalf of CVS Caremark, a Pharmacy Benefits Manager, or PBM. PBM’s manage prescription benefits for clients, such as insurance companies, employers, unions, and governments, and negotiate with retail pharmacies and mail-order distributors to get the best deal for these clients and their subscribers. This gave rise to a protectable interest since, as the court observed, “[c]onfidentiality of pricing and relationships is an extremely high priority in this competitive business.” The court further noted that “Mr. Lavin also participated in weekly executive underwriting calls to discuss negotiations with CVS Caremark’s largest clients and prospective clients …” and was “involved in high-level strategic planning for CVS giving him advanced and complex knowledge of the company’s internal strategies for the future. He was ‘deeply involved in CVS Caremark’s strategy for the upcoming selling season, which necessarily includes pricing and other types of very sensitive information to be used for the next 12-18 months and, in most cases, up to 36 months.’” Beyond that, “[d]uring his employment with CVS, Mr. Lavin obtained ‘detailed knowledge of CVS Caremark’s current and future strategy for dealing with mail pharmacies in its retail networks including how CVS Caremark identifies whether such pharmacies should be deemed mail pharmacies, the terms and conditions under which they are permitted to participate in CVS Caremark’s network, the rates that are offered (versus the rates offered to retail pharmacies), and the rates charged to CVS Caremark’s clients for CVS Caremark’s own mail services.’ He was also intimately involved in ‘CVS Caremark’s strategy to differentiate its mail-based services from potential competitors.’” All of this led the district court to conclude that injunctive relief was warranted because the services Lavin was to perform at a competing company “are substantially like the services he provided for CVS Caremark… it is highly likely that [his] new employment will result in the disclosure of Confidential Information to CVS’s Competitor.”
These cases vividly illustrate the utility of non-competition covenants as a means of protecting confidential information and trade secrets from falling into the hands of, or being exploited for the benefit of, a competing enterprise when a valued employee moves on.
1 2018 WL 6729773, at * 5 (Minn. App. Dec. 24, 2018)
2 2019 WL 3543877 (W.D.N.C. Aug. 2, 2019).
3 __ F. App’x __, 2019 WL 4200263 (3d Cir. Sept. 5, 2019)
4 384 F. Supp. 3d 227, 236-37 (D.R.I. 2019).