Articles Posted in Damages

Covenants not to compete, or noncompete agreemenoncompetents, can play a key role in helping a business entity protect its confidential information,  prevent unfair competition and the raiding of its workforce.  A poorly drafted agreement, however, can leave the business exposed to claims that the covenants are not enforceable, which in turn can lead to unnecessary litigation. Below are a number of common components that make up a well-drafted non-competition agreement.

Define the Parties

The parties should always be identified as one of the first terms in the agreement. The drafting attorney should make sure that all corporate entities which have an interest in the protections afforded by the agreement are included. This is especially important where there are parent, subsidiary or affiliated companies.

Use of Recitals

The introductory section of the agreement should focus on the protective purposes and justifications for the restrictions in the agreement. This serves to bolster the notion that prevention of unfair competition is the key purpose of the agreement. It is important to be aware, however, that in many states, such recitals are distinguished from the body of the agreement.

Describe the Job Duties

The agreement should identify the particular position that the employee is going to be employed in.   This helps to establish that the agreement is ancillary to a contract of employment and part of a particular employment position. It is not necessary to identify the specific job title (since that may change over time), but rather the nature of the position so that it is clear why a restrictive covenant is needed.

Consideration

If the noncompete agreement is executed in conjunction with an offer of employment, most states, including Delaware, will find sufficient consideration in the offer of employment itself.   Both the offer letter and the noncompete agreement should state that the offer of employment is conditioned on the execution of the noncompete agreement and that the employee would not be employed, but for the employee’s willingness to comply with the noncompete terms. For current employees, the issue of consideration can be more complicated, since some states require additional consideration other than the right to keep one’s job.

Termination

The wording of the contract should make clear the distinction between the termination of the parties’ obligations under the agreement, and a termination of the employment relationship. Typically, an employer will want to ensure that restrictive covenants such as nondisclosure, nonsolicitation, and noncompete obligations run for a period of time following the termination of employment.

Scope of Restrictions

This is probably the most important part of the agreement and requires careful drafting. Restrictions may include limitations on the employee’s ability to work or compete, solicit employees or clients, and what information can be disclosed. To obtain enforcement of restrictions on a former employee’s ability to work, most courts generally engage in a balancing test to determine whether the restrictions are reasonable and equitable. Therefore, it is imperative that the drafter considers the nature of the business and the type of employee when determining what constitutes reasonable limitations. In addition, the duration and any geographic limitations must be considered as part of the analysis. Finally, consideration should be given to the venue and choice of law (see below) when drafting the restrictions to ensure they will be enforced.

Tolling Provision

A tolling provision generally extends the time limitation of the restriction for the length of time in which the employee has found to have been in breach. When an employee breaches a covenant not to compete, generally the period of breach runs concurrently with the period of restriction in the agreement. Often, the period of restriction can be as short as six months or a year, and it can take that long, or longer, for a lawsuit to result in a ruling. Therefore, without a tolling provision, the employer can lose the benefit of its bargain because the time period may have expired by the time the lawsuit goes to trial.

Remedies for Breach

There are various remedies which can be provided for breach, including injunctive relief, claw-back provisions, stop-payment provisions, and balloon payment or condition precedent.

Injunctive relief is the most common enforcement mechanism for post-employment restrictions. Most states, including Delaware, require some showing of irreparable harm in order to obtain injunctive relief, but the standards vary from state to state. It is advisable to include a provision stipulating that irreparable harm will result from the breach of the restrictive covenant.

The drafting attorney also should consider a one-sided provision allowing for the recovery of attorneys’ fees for a breach of a noncompete agreement. This provision can help deter a former employee’s breach of the agreement and create helpful leverage in settling a dispute.   These types of clauses have been upheld in many jurisdictions, including Delaware.   However, it is important to be aware of the applicable state law on this issue before including a one-sided attorneys’ fee recovery provision.

Choice of Law

Choice of law provisions are essential for noncompete agreements, because variations in state law can have significant impact on the enforceability of the agreement. Some states’ laws are more favorable than others to an employer seeking to enforce a noncompete.   Moreover, the applicable law is not always easy to determine in noncompete cases. Depending on the particular state’s conflict of laws rules and facts of each case, law governing a contract could be at the place of performance, or at the place the contract is entered into. Determining the place of performance, for example, for a sales person who works out of her home, but who markets to a global territory, is not a simple task. Similarly, in the modern digital age, the place the contract is “entered into” can be less than self-evident. Therefore, a choice of law provision is critical to ascertaining the enforceability and limiting defense costs if the agreement is later challenged.

A choice of law provision will generally be enforced, as long as there is some material connection between the selected law and the parties and purpose of the contract. If the parties agree to a Delaware choice of law provision in their contract, Delaware law will presume a material relationship exists, as long as the parties are subject to the jurisdiction of Delaware’s court, and may be served with legal process.  A recent case from the Delaware Court of Chancery, however, noted exceptions to this rule in a case involving an employee living in California.

Choice of Venue

A choice of venue or forum selection clause establishes the site of any lawsuit regarding the agreement. The inclusion of such a clause is recommended for several reasons. First, there is a natural deference of courts to follow their own state’s laws. Therefore, if the agreement includes a choice of (presumably favorable) law, then it is advisable to have the lawsuit in the court most likely to apply that law. Second, the inclusion of such a clause can also increase leverage of the party seeking to enforce it by reducing or increasing the cost of litigation for one party or another, based on travel distance. Most states will enforce forum selection clauses unless there are highly extraordinary circumstances that would make enforcement unreasonable or unfair.

Other Provisions

The standard closing contract clauses, including survival, modification/waiver, integration, etc., are generally recommended for noncompete agreements. However, there are some traps for the unwary, of which the drafter should be aware. For example, integration clauses can be problematic if the agreement is one where other agreements (e.g., separation agreements) are meant to survive. A standard integration clause could arguably void all other agreements entirely. Where separate and important agreements exist (e.g., invention assignments, confidentiality obligations), the best practice is to carve these agreements out as an exception to the integration clause.

For more tips on drafting, see my earlier post on non-solicitation agreements.

Employers frequently confront the problem of theft or misappropriation of trade secrets and confidential, proprietary information by departing employees. While employers have an arsenal of legal weapons at their disposal to protect their most valuable business assets, it is critical that they take proactive steps to protect against the disclosure of important business information and prevent unfair competition. From a practical standpoint, failure to implement basic security measures makes it easier for an unethical employee or competitor to misappropriate confidential business information. From a legal perspective, absent efforts to preserve the secrecy of such information and avoid unfair competition, a court is unlikely to respond favorably to an employer request for relief.youngconaway

Trade Secret Protection

Delaware, like most states, has enacted the “Uniform Trade Secrets Act” providing employers with legal protection for trade secret information even in the absence of contractual agreements with employees. While many people may believe that “trade secret” status is only afforded to scientific data such as the formula for Coke, in reality, trade secret protection is available for a much broader array of information. The statutory definition for a trade secret is “information” that “derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means, by other persons who can obtain economic value from its disclosure or use.” To be protected by the statute, the information must be “the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”

Trade secret protection is available to business information other than scientific data such as formulas and chemical compounds. The Uniform Trade Secrets Act specifically extends protection to a “compilation,” “program,” “method,” “technique,” or “process” that has independent economic value to a company arising from its secrecy.

Customer lists may be subject to trade secret protection if the employer expended substantial resources and time in developing information that is not generally known to the public or competitors. Further, even if the customer list itself is not trade secret, information the employer compiled as part of its marketing efforts may be protected. For example, the courts have found that a “rankings report” kept by company sales representatives concerning the amount of sales to clients and ranking the company’s customers by sales volume is sensitive financial information that may be subject to trade secret protection. Likewise, while an idea such as linking a savings program to an affinity group may not be a trade secret, the means by which such a program is implemented may be.

Even if business information does not meet the definition of a “trade secret,” it still may be confidential, proprietary information subject to other legal protections.

Computer Fraud Act

Employers have a potentially powerful weapon to combat improper access and misappropriation of electronic data and information stored on a computer. We are all familiar with cases in which an unethical employee downloads company electronic information to a thumb drive for later use and/or sends such information via email to his or her personal computer in preparation for leaving employment and competing with their employer. The federal Computer Fraud and Abuse Act (“CFAA”) may be used to hold employees liable both civilly and criminally for such misconduct. Although the CFAA was originally passed to target computer “hackers”, not disloyal employees, some courts have applied the statute to employee misconduct. The CFAA also has criminal provisions. For example, former news anchor, Larry Mendete, plead guilty under the CFAA to intentionally accessing the private email account of his former co-anchor, Alycia Lane.

Delaware has a state counterpart to the CFAA.  The Misuse of Computer System Information Statute, 11 Del. C. § 935 et seq., makes it a crime to knowingly access a computer system without authorization. The statute prohibits not only the unauthorized copy and disclosure of electronic data, but the knowing deletion of data from a computer system.  The statute also has a civil component to this law which allows an aggrieved party to bring an action in the Delaware Court of Chancery for injunctive relief, restitution, treble damages, and attorneys’ fees.  For more information see our earlier blog post on this statute.

Common Law Claims

There are many other legal claims that the company may assert to protect its business assets if an employee improperly uses or discloses its confidential, proprietary, or trade secret information. Employees who are given access to such information may be treated as fiduciaries with a duty of loyalty to protect it from disclosure during their employment. A competitor who knowingly participates in improper disclosure may be charged with “aiding or abetting” a breach of fiduciary duty or illegally participating in a civil conspiracy. In addition, a competitor who unfairly competes through the acquisition and intended use of such information may be sued for tortious inference with contract or business relations.

Contractual Protections

Aside from statutory and common law protections, there are contractual safeguards available to help employers stop the inappropriate disclosure of the business information and prevent unfair competition. At a minimum, all employers should consider requiring key employees who have access to confidential, proprietary, and trade secret information to sign Confidentiality and Non-Disclosure Agreements. A company may legally require employees who have access to confidential, proprietary information to sign such an agreement. If drafted properly, such agreements have “teeth” when enforcement action is necessary. Confidentiality agreements may provide not only for emergency injunctive relief, but also for an award of damages from the improper disclosure of company information. Importantly, in appropriate circumstances, Delaware courts will enforce a provision in a confidentiality agreement providing that an individual who violates its terms is subject to paying the company’s attorneys’ fees and costs in bringing enforcement action.

For certain classes of employees, employers should consider broader contractual protections beyond a simple confidentiality agreement. Employees in sales and marketing or high-level management positions may be in a position to seriously damage the company’s business if they leave to work for a competitor. A non-competition agreement or restrictive covenant is valid and enforceable in Delaware so long as the agreement is not overly broad and is necessary to protect the company’s legitimate economic interests.

Delaware courts will generally enforce a non-competition agreement that is reasonable in geographic and temporal scope. The non-competition agreement must contain a geographic restriction tied to the areas where the company does business and where the employee works to establish that the Company has a legitimate business interest in restricting competition in those locations. Delaware courts, like most courts throughout the United States, also require that the restriction against competition have a reasonable time limit. Typically, a Delaware court will find a two-year restriction to be reasonable.

Since enforcement of a non-competition agreement prohibits an employee from working in a specified field in competition with his or her former employer, courts are careful to balance the equities. The court will consider the employer’s reasonable business needs versus the impact of the enforcement of such agreements on an individual’s ability to earn a livelihood. Upon a showing of a need for such relief, however, courts will enforce non-competition agreements and may even issue an order prohibiting a former employee from working for a competitor.

An alternative to a non-competition agreement is a “non-solicitation” agreement. Non-solicitation agreements are narrower than non-competition agreements. A non-solicitation agreement restricts a former employee from soliciting a company’s clients or customers. Like a non-competition agreement, a non-solicitation agreement must include a reasonable time limit. Instead of a geographic limitation, however, a non-solicitation agreement may restrict an employee from solicitation or business dealings with certain customers such as those with whom the employee had direct contact or about whom the employee received confidential information. Non-solicitation clauses may also include potential customers or prospects. Of course, as with other contractual provisions, careful drafting is necessary to ensure the enforceability of such contractual restraints.

In appropriate cases, employers may include confidentiality, non-competition, and non-solicitation clauses in the same agreement. As a rule of thumb, the need for such protections and the likelihood of successful enforcement increases with the amount of access an employee has to valuable business information and his or her level in the organization. In addition, employee misconduct, such as misappropriation of a customer list or other sensitive information, increases the likelihood that a court will award relief to the employer.

Posted by Barry M. Willoughby

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