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Using Non-Compete Agreements to Protect Confidential Information

Winter 2005Cole Schotz DocketAttorney: Jamie P. Clare

Employers in all industries can face the departure of key employees who possess highly confidential customer information or trade secrets.  If unchecked, the use of such information could devastate a company by providing a competitor or start-up venture with a distinct and unfair advantage.  The misuse of a company’s valuable inside information can lead to the diversion of customers and business opportunities, the dissemination of proprietary information or the loss of accumulated goodwill.  With or without a non-compete agreement, employers faced with this situation may seek to immediately restrain the former employee and his current employer.

Procedurally, a preliminary injunction obtained before a trial on the merits is an extraordinary, equitable remedy that is granted only in limited circumstances.  A court must be convinced that all four of the following factors are present before granting preliminary injunctive relief to a plaintiff seeking restraints:  (1) the plaintiff will suffer irreparable harm if the injunction is not granted; (2) the plaintiff will likely succeed on the merits of its legal claims; (3) the harm to the plaintiff if no injunctive relief is granted outweighs the hardship the defendant will suffer if the injunction is granted; and (4) the public interest will not be injured.

The state of the law regarding non-compete agreements is fairly well-settled.  Thirty-five years ago, the New Jersey Supreme Court rejected a per se rule invalidating non-compete agreements in employment contracts, and adopted a three-part test to determine whether a non-compete agreement is reasonable under the circumstances (and therefore enforceable).  At the same time, the Court embraced the so-called “blue pencil” approach to non-compete agreements, allowing courts to strike overly broad or unreasonable terms, and to modify, where appropriate, the application of restrictions concerning geographic area, period of enforceability and scope of activity.

An employee’s covenant not to compete will generally be found to be reasonable when it simply protects the legitimate interests of the employer, imposes no undue hardship on the employee and is not injurious to the public.  Our courts have held that legitimate, protectable interests of an employer include client/customer relationships, trade secrets and confidential business information.  For an employer to have a reasonably protectable interest in customer relationships under a restrictive covenant, there must be evidence that the employer's customers represent a significant investment of the employer’s time, effort and money that is worthy of protection.  Courts will not enforce a restrictive agreement merely to aid the employer in extinguishing competition and may find no legitimate interest in protecting customer relationships an employee develops through his or her own effort and expense and brings to an employer, or when customer identities are a matter of common knowledge in the industry.

A restrictive covenant is considered injurious to the public when it is broader than necessary and interferes with the public’s right to choose a professional.  Restrictive covenants among physicians are not per se unreasonable, but can be found to have a negative effect on the public interest if, for example, enforcement results in a shortage of physicians in an area, or imposes a hardship on patients who desire or need to maintain their relationship with a departing physician.  Similarly, restrictive covenants among accountants are not per se invalid.

The validity and enforceability of non-compete agreements also rest in part upon the existence of good and valuable consideration – something given in return for the restrictive covenant.  An initial offer of employment constitutes sufficient consideration, as does continued employment.  If termination occurs very shortly after execution of a non-compete agreement, however, consideration may be found to be lacking.

An employee can prepare to compete with his employer before leaving.  While still employed, however, an employee has a duty of undivided loyalty to his employer.  This means that he cannot compete with his current employer, and may not solicit the employer’s customers for his post-employment venture before leaving.

Finally, it should be noted that restrictive covenants agreed to in connection with the sale of a business are, in general, freely enforceable.  This is so because participants in the sale and purchase of a business normally have more equal bargaining power.  Courts recognize that in addition to inventory, customer lists, and other physical components of the sale of a business, buyers are purchasing the goodwill established by the business.  Courts, however, will still look for a protectable interest in such agreements to ensure that the principal thrust of the covenant is not its anti-competitive effect.  Likewise, courts may expressly decline to “blue-pencil” an agreement if they find the buyer no longer has a protectable interest in the goodwill of its seller.  What is a “reasonable” restriction in such agreements depends on the circumstances of each case, including the identities, experience and respective size of the parties to the agreement, the nature of the business sold, the length of time it should reasonably take for the buyer to make the seller’s goodwill its own, and the price paid as consideration for the non-compete agreement.

More and more often employers are finding themselves contending with non-compete agreements, whether in requiring them as part of the employment relationship or purchase of a business, enforcing them against departing employees or sellers, or responding to the enforcement efforts of others.  Carefully drafted restrictive covenants that can be demonstrated to protect legitimate interests of a business will be enforced by the courts.  Covenants that overreach with an aim solely to stifle competition will not.  Even without a restrictive covenant in place, however, employers can assert claims against parties that breach their duty of loyalty, misappropriate confidential information or corporate opportunities, wrongfully interfere with contracts or prospective economic advantage, or otherwise unfairly compete.  Employers should be attuned to these issues so they can take the appropriate action before, during and after employment or a transaction to protect their valuable interests.

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