July 1, 2008
By:
Ready, Set, Sell Your Business – It’s a Process
Businesses of all shapes and sizes often rely on restrictive covenants contained in employment agreements to ensure that their proprietary and confidential information is not misappropriated by a departing employee. A common restrictive covenant prohibits the departing employee from soliciting the employer’s customers for a period of time following termination of the employment relationship. This type of restrictive covenant is known as a non-solicitation agreement. A non-solicitation agreement can effectively protect a customer base from a departing employee if it is properly drafted and routinely audited.
A recent case handled by Di Monte & Lizak, provides a valuable lesson in connection with non-solicitation agreements. In 1975, Company A hired Employee B. At that time, Company A required Employee B to execute a non-solicitation agreement. In 1983, Company A, realizing that the non- solicitation agreement executed in 1975 was overly broad, required Employee B to execute a second agreement. Employee B executed the revised non-solicitation agreement and continued his employment with Company A until 1999. Between 1983 and 1999, Company A did not revise or modify its non- solicitation agreement.
The non-solicitation agreement utilized by Company A between 1983 and 1999 stated that the employee could not, for a period of three years following the termination of his employment, “solicit customers” of Company A. Although the rights and obligations of the parties may seem clear and well- defined, a lawyer experienced in drafting and litigating non-solicitation agreements would immediately question whether a court would enforce the agreement against the departing employee.
Unfortunately for Company A, and many other employers, the case law involving non-solicitation agreements has changed significantly since 1983. Therefore, a non- solicitation agreement that was enforceable when drafted in 1983 may be difficult to enforce today.
The text of Company A’s non-solicitation agreement raises two issues which are common in litigation regarding non-solicitation agreements. First, because it prohibits Employee B from soliciting customers for a period of three years, its duration could be unduly burdensome to the employee; that is, the court could find that the covenant effectively puts the employee out of work for three years. When the duration of a covenant is challenged, a court may consider the nature of the employer’s business and the employee’s role in the company in determining the reasonableness of the restraint. As a general rule, the shorter the duration of the restriction, the more likely the court will be to enforce the restriction.
Company A’s non-solicitation agreement also was susceptible to a challenge because it failed to define the term “customer.” Is the term intended to include past customers, entities that Company A is soliciting, and/or only entities Company A was servicing on Employee B’s last day of work?
When Company A filed a lawsuit to prevent Employee B from soliciting its customers, Employee B brought these issues to the court’s attention. The court ultimately ruled the non-solicitation agreement was unenforceable as a matter of law. The court found the agreement was too vague to be enforced because it did not define “customer.” The court also questioned whether the duration of the restriction was too long to be enforceable. In the end, Company A was unable to rely on its non-solicitation agreement to prevent Employee B from soliciting its customers.
Company A’s misfortune should teach all businesses that the case law surrounding restrictive covenants is dynamic and constantly evolving. To be effective, a non- solicitation agreement, as is true with other restrictive covenants, should be routinely reviewed by an attorney. We recommend employers audit their employment contracts at least every five years.