Article - Covenants Not To Compete - A History Lesson And Nine Tips Arising From It

You get the job of reviewing and updating your company’s employment contract form, which includes "covenant not to compete" language. You cover everything in detail. You retain the language forbidding the disclosure of trade secrets and other confidential information. You know that it is important to limit the geographic scope and duration of your covenant, so you limit yours to one year and the Eastern United States. You include the boilerplate admission that your company has no sufficient remedy at law if the covenant is breached, and which states expressly that the only way you can be protected is with injunctive relief, believing it will help you to get that injunction if you need it. You also include language making it clear that you would not have the made the decision to hire the employees in the first place if they had not agreed to be bound by the covenant. Your revisions are approved.

One of the first people to accept employment on the new terms is a high-level executive, who reports directly to the CEO. She resigns unexpectedly after fifteen short months, just long enough to learn almost literally everything about your business. Your main competitor announces that they have hired her, effective immediately, to do exactly what she was doing for your Company. She’ll be working for them a few blocks down the street.

You call outside counsel immediately. You fax your covenant with instructions to get an immediate injunction to stop her from spilling her guts regarding everything she knows about your business to your competitor. You also want, and expect, the court to stop her from helping them compete with you.

You like your outside counsel. He’s gotten good results in other matters. You trust him. He pulls together the pleadings and brief, rushes into court. The court schedules a quick hearing. The judge takes a 15-minute break and announces his decision, denying your request for preliminary injunctive relief.

Is the judge nuts? Can’t he read? How could this have happened? How in the world are you going to explain this to top management?

One explanation – an explanation that few people know about – is rooted in history; a lot of history over a very long period of time. If you saw a sign on a restaurant that said “Celebrating Our 100^th Year,” you might think they had been doing something right. And if you walk into court asking a judge to enforce a restrictive covenant, the following should give you some idea of what you are up against. Plain and simple, the courts do not like restraints on trade, and they have not liked them since nearly the birth of our legal system.

Take Judge Macclesfield from a decision published in 1711: Covenants not to compete are subject to “great abuses” by employers, who are “perpetually labouring for exclusive advantage in trade, and to reduce it to as few hands as possible.”¹ Seventh Century employers were not just abusive, according to the judge, but often deceptive as well, in an effort to “bond” (i.e., enslave) their employees.”² In case there was any doubt in your mind about how he felt, Judge Macclesfield concluded as follows: As to “all restraints of trade, where nothing more appears, the law presumes them bad.”³

Of course, as a good English judge, steeped in the common law, Judge Macclesfield needed to find “precedent” for his view that restrictive covenants are “vexatious.” Incredibly, it was there to be found. A hundred years earlier, an English court had refused to enforce a covenant in the Case of Tailors of Ipswich, 77 Eng. Rep. 1218 (K. B. 1614).

The judges who were concerned that there be plenty of tailors around some 400 years ago were not making law either. Two hundred years before that, an English court held in The Dyer’s Case in 1414, some six hundred years ago, that it was then “old and settled law” that covenants not to practice one’s trade are against the common good.⁴

These old precedents have stuck. In an article published in the Harvard Law Review in 1960, the author stated that: “There is very little in the modern approach to the problem [of restraints of trade] for which a basis cannot be found in Macclesfield’s opinion.”⁵ And the courts’ disdain for covenants continues to be expressed in the same language. In a relatively recent decision in New York, the court found that “the effect of these provisions is to indenture the employee.”⁶

What you can do (and a little of what you should not do) in light of this history

What can you do in the face of this 600+ years of judicial antagonism? Here are several tips, all grounded in the case law:

(1) Don’t make the language of your covenant sound like it has been evolving over the last 700 years.

Here is some language from a covenant that I was recently asked to review, defining what it was that the employee was restricted from revealing:

All ideas, potential marketing and sales relationships, inventions, copyrightable expression, research, plans for products or services, business development strategies, marketing plans, computer software (including, without limitation, source code), computer programs, original works of authorship, characters, know-how, trade secrets, information, data, developments, discoveries, improvements, modifications, technology, algorithms and designs, whether or not subject to patent or copyright protection, made, conceived, expressed, developed, or actually or constructively reduced to practice by the employee solely or jointly with others during the terms of his employment with _____________, which refer to, are suggested by, or result from any work which the Employee may do during his employment, or from any information obtained from ________ or any affiliate of ____________, such that said information is obtained in the performance of duties related to employment at _____________.⁷

Lawyers look to covenants drafted by their predecessors. They don’t take anything out, whether they understand it or not, because it is safer to leave everything in. What they do, however, is add things, so that covenants that might have sounded reasonable 200 years ago are now a hodgepodge. Who, for example, remembers what an algorithm is, let alone gains access to confidential algorithms at work?

Many decisions in this area of the law turn on how the covenant “feels,” although a judge will not often say as much. When covenants are included as part of a larger document, setting forth terms and conditions of employment, the judge will not limit her review to the covenant language alone.⁸ Therefore, if you include your covenant in a hiring package that includes provisions reminding employees that they are “at will” and describing all the rights they do not have as a consequence of their lowly status, and that includes language permitting you to change the terms and conditions of employment any time you want, with or without notice, you must understand that these provisions, which might help to protect you in other contexts, will hurt you if you are in the context of trying to enforce the covenant, because they suggest that you have overreached by trying to “indenture,” rather than employ, the individual in question.

The days of enforceable multi-year covenants are effectively over, particularly in the kinds of industries that have arisen in the information age. A recent decision from the New York State courts tells us that a covenant restricting an employee from working for a competitor for twelve months is “too long” in the Internet business.⁹

And, when you really sit back and think about it, does it make sense too push so hard at the edges of this envelope? Are you really going to follow the activities of a former employee for several years, making certain that s/he doesn’t get a job in your industry that is, or might be, a competitor of yours? Will that former employee really be in a position to hurt you with insider information 18 months after she’s resigned? Or, as a practical matter, isn’t the real issue the immediate fallout from an unexpected resignation and reemployment that violates the covenant? In my experience, the initial panic (and consequent willingness to take on substantial legal fees) subsides once an employer learns that it can thrive, or at least survive, without the former employee.

We have come a long way from Judge Macclesfield’s concern that bakers in a village outside of London should not be able to corner the market. Geographic limitations are still one of the two key areas looked at by the courts, however, as they attempt to assess whether a covenant is reasonable. While it is possible for a former employee to compete from anywhere in the internet age, and until that legal framework is changed by the courts, you simply must assess whether it is worth restricting a former employee from working for a competitor in New Delhi, when a world-wide scope is almost certainly going to push the judge in the direction of finding that your covenant is too broad.

(5) Shred all boilerplate covenants from form books or the internet that you intend to require all, or almost all, new employees sign.

You are mistaken if you think that it is cost-effective to go the Internet, download some covenant language from a human resources website, and ask new hires (or existing employees as well for that matter) to sign the same version, no matter how well crafted.

The courts try to balance the legitimate need of the employer to protect its business and the legitimate, and obvious need, of the employee to make a living in the trade of his or her choice.¹⁰ If your covenant is way too broad, the courts won’t enforce it at all. If it is “only” too broad, the courts may be willing to blue-pencil your version, and enforce one or more aspects of the covenant.

One way for a court to assess whether the covenant is too broad is to look at whether the employer tailored its covenants to the particular circumstances involved. That being said, if all employees in the plant, from the account clerks to the vice president for research, are required to sign an equally restrictive covenant, it will make it more difficult for the employer to enforce the covenant as against the vice president for research, because the employer’s overreaching becomes evidence that it did not approach its legitimate need to protect itself from illegitimate competition in a reasonable way.

Your chances of getting the covenant enforced are substantially enhanced if the former employee dirtied his hands on his way out your door. It is not enough, however, if he is venal enough to attempt to recruit from your employees before he leaves, or shameless enough to rifle through your files to find and copy your trade secrets, or adept enough to copy the entire memory of the company’s computers onto a disc or two. He must also be stupid enough to get caught.

This makes it critical that you act decisively. If you get a reliable tip that an employee is engaging in such conduct, it is an opportunity that must not be lost to shut down access to your company’s computers and demand that he turn over his laptop the moment he is terminated for breaching his fiduciary duty to you. It is incredible what you will often find, from new business plans (often cut and pasted from your business plans), to customer lists, to e-mail that you might not be that proud of.

(7) If you expect a court to think it’s confidential, have some evidence that you thought so too.

Courts look beyond the documentary trail in their efforts to figure out whether information that a former employee has taken is really all that confidential. One thing they look at is how you treated the information that you are now claiming would devastate your business if a competitor was to find out about it before the employee with the information quit. Was it marked “confidential?” Were copies floating all over the place? When meetings were held and documents distributed, was there any discussion about their confidentiality? Were copies collected at the end of the meeting? All of these little pieces of information help to tell the true story, and you must be alert to them as you conduct your business on a day-to-day basis.

There is no statutory provision in New York governing covenants, but there is such language in many states, so beware, particularly, if you are hiring employees who have worked elsewhere and might be covered by a competitor’s covenant. Some of these state statutes are quite precise about what will, and will not, be enforceable.

(9) Don’t treat the judge like she’s stupid, by hiding your restrictive covenant under the guise of something else.

“But your Honor, neither ‘restrictive’ nor ‘covenant’ even appear in the document.” Of course, when a lawyer says “But your Honor,” you already know you’re in trouble. But beyond that, the courts have historically hated indirect restrictions almost with a greater passion than direct restrictions. Take “training agreements,” for example, which require an employee to pay back the costs of her training if she leaves your employment too soon to your liking and takes “her” training with her. Yes, someone who takes the training and runs is irritating. No, you cannot punish her for it.

This is not to say that training agreements are per se unlawful, but you must beware of such decisions as Heartland Securities Corp. v. Gerstenblatt, et al., 2000 WL 303274 (S.D.N.Y.), in which the court found that “refund of training costs provisions are designed to chill people from changing jobs, and thus, function as restrictive covenants,” and found that enforcing the training agreements at issue in that case would have been tantamount to “indentured servitude,” precisely the kind of label applied to covenants by Judge Macclesfield some 400 years earlier.

Employee mobility is an exploding phenomenon that shows no sign of abating. In this context, it is critical for employers to pare down their expectations about the extent to which they will be able to keep former employees from moving to competitors. Don’t despair. It is still possible to craft a covenant not to compete that is enforceable. But, note that efforts to slow employee mobility have traveled a rough road for 600 years, and it is getting even rougher.

¹Mitchell v. Reynolds, 24 Eng. Rep. 347 (Q. B. 1711).

²Id.

³I am a practitioner, not a legal scholar. Credit for the historical finds that appear in this article goes entirely to Dan Messeloff, whose article, entitled Giving the Green Light to Silicon Alley Employees: No-Compete Agreements Between Internet Companies and Employees Under New York Law, appeared in the Spring, 2001 edition of the Fordham Intellectual Property, Media and Entertainment Law Journal. I came across this wonderful article while preparing for a speech at a program sponsored by the City Bar Association of the City of New York, and it helped me to understand in a new way what I have been up against as a practitioner looking to help clients in this area of the law. The purpose of this article is to bring Mr. Messeloff’s findings, and the perspective they bring, to the attention of an audience unlikely to be reading law reviews, and to add my own thoughts and experiences as a practitioner in this area. For those interested enough to pursue it, I recommend a full reading of his article.

⁴Y. B. Mich. 2 Hen. 5, pl. 26 (1414).

⁵Harlan M. Blake, Employee Agreements Not to Compete, 73 Harv. L. Rev. 625, 626 (1960).

⁶Earthweb v. Schlack, 71 F. Supp.2d 299, 311 (S.D.N.Y. 1999).

⁷That wasn’t all. Another section provided that: “The Employee will not disclose or use, at any time either during or after the term of employment, except at the request of __________, or an affiliate of ____________, any “Confidential Information (as herein defined). “Confidential Information” shall mean all propriety information, technical data, trade secrets, and know-how, including, without limitation, research, product plans, customer lists, markets, software, developments, inventions, discoveries, processes, formulas, algorithms, technology, designs, drawings, marketing and other plans, business strategies and financial data and information, including but not limited to Inventions, whether or not marked as “Confidential.” “Confidential Information” shall also mean information received by ____________ from customers of ___________ or other third parties subject ot a duty to keep confidential.”

⁸See, e.g., Earthweb v. Schlack, 71 F. Supp.2d 299 (1999).

⁹Doubleclick v. Henderson, 1997 WL 731413 (N.Y. Sup.).

¹⁰See, e.g., Earthweb v. Schlack, supra, 71 F. Supp. At 312.