S UPERHEROES OR C REATURES F ROM THE B LACK L AGOON ? R ESTRICTIVE C - - PDF document

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SUPERHEROES OR CREATURES FROM THE BLACK LAGOON? RESTRICTIVE COVENANTS

Jennifer Divine, Joseph Vance I. ENFORCEABILITY OF NONCOMPETITION AGREEMENTS. With certain employees, particularly those with significant access to confidential information or important clients or customers, an employer may want to limit the competitive activities that employees can undertake after leaving employment and either branching out on their own or going to work for another employer in the same industry. Employers may require agreement to a noncompete and/or other restrictive covenants as a condition of employment or advancement in certain fields. Common provisions include agreements not to solicit or perform work for the former employer's customers for a certain period of time, as well as agreements not to compete within a certain market or geographic area for a particular amount of time after departing from the former employer. While some states, such as California, refuse to allow noncompetition agreements except in very limited circumstances, noncompetes and other restrictive covenants are usually valid and enforceable in Oregon and Washington, as long as they meet the standards for enforcement set out by the legislature and the courts in each state. A. Differences between Oregon / Washington law. Noncompete agreements in Oregon are governed by a statute, ORS 653.295. Under the terms of the statute, noncompete agreements entered into after January 1, 2008, are voidable unless they comply with the following provisions:

• The employer must present the noncompete to a prospective employee as part
• f a "written employment offer" at least two weeks in advance of starting

employment or the noncompete must be entered into with an existing employee as part of a "bona fide advancement" in compensation and job duties.

• The employee must be an exempt employee under state wage-and-hour law.
• The employer must have a "protectable interest."
• The employee's annual gross salary must exceed "the median family income

for a four person family" as determined by the United States Census Bureau for the most recent year available at the time of the employee's termination (currently over $70,000). In addition to satisfying the requirements of the statute, the restrictions must also comply with common-law requirements related to contracts that restrain trade. Under Oregon common law, to be enforceable, a restrictive covenant:

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(1) must be partial or restricted in its operation in respect either to time or place; (2) must be on some good consideration; and (3) must be reasonable, that is, it should afford only a fair protection to the interests of the party in whose favor it is made, and must not be so large in its operation as to interfere with the interests of the public. Unlike Oregon, Washington does not have a statute that governs noncompete

• agreements. In Washington, it is well established that covenants not to compete upon

termination of employment are enforceable if they are "reasonable." Whether a covenant is reasonable involves a consideration of three factors: (1) whether restraint is necessary for the protection of the business or goodwill of the employer, (2) whether it imposes upon the employee any greater restraint than is reasonably necessary to secure the employer's business or goodwill, and (3) whether the degree of injury to the public is such loss of the service and skill

• f the employee as to warrant non-enforcement of the covenant.

B. What is adequate consideration? 1. Oregon Under Oregon statutory law, a new employee must receive two weeks' advance written notice of the noncompete agreement. For existing employees, a noncompete agreement is enforceable only if it is in conjunction with a "bona fide advancement of the employee with the employer." A "bona fide advancement" requires more than a raise in salary, an improved benefit package, or some other form of additional compensation or consideration. It must also include an actual change in the employee's job status or duties performed. In addition, the change in job status or responsibilities must justify the imposition of a noncompetition

• restriction. The legislative intent of that provision indicates that the focus was upon the

employee's job duties, not on the consideration otherwise proffered by the employer. The change of duties or status must support imposition of the noncompete agreement. 2. Washington The general rule in Washington is that for a new employee, consideration exists if the employee enters into a noncompete agreement when the employee is first hired. For an existing employee, continued at-will employment does not provide sufficient independent consideration to support a noncompete agreement. Independent consideration requires new promises or obligations previously not required of the parties. Independent consideration may include increased wages, a promotion, a bonus, a fixed term of employment, or access to protected information. In addition, for employees who are given the opportunity to become shareholders or purchase stock in a company, the mutual promises of shareholders will be considered adequate consideration for a noncompete agreement among the shareholders even if the actual noncompetition restriction is contained in employment agreements entered into during employment.

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C. Identifying protectable interests. In both Oregon and Washington, in order for a noncompete agreement to be enforceable, the employer must show that it has a legitimate interest entitled to protection. The rule in Oregon and Washington, as well as most other jurisdictions, is that skills and industry knowledge acquired while working for the employer are not a "protectable interest" that justify enforcement of a noncompete agreement. Courts have described the need for a protectable interest this way: The essential purpose of the post-employment restraint . . . is not to prevent the competitive use of the unique personal qualities of the employee—either during

• r after the employment—but to prevent competitive use, for a time, of

information or relationships which pertain peculiarly to the employer and which the employee acquired in the course of the employment. In short, if the purpose of a restriction is merely to prevent a talented and experienced employee from going to work for a competitor, the restriction will not be enforced. But if, by virtue of the employee's employment with the employer, the employee has acquired information or relationships (i.e., confidential information regarding the employer's operations, marketing strategies, specific information relating to customers) that would enable the employee to compete unfairly (by virtue of the information acquired during the employee's employment) with the employer, then that creates a legitimate interest entitled to protection. Accordingly, in any analysis of a noncompete agreement, it is critical to be able to identify and articulate the legitimate interest entitled to protection. Oregon: In 2008, ORS 653.295 was amended to add a definition of "protectable interest" as follows: [A]n employer has a protectable interest when the employee: . . . Has access to trade secrets, as that term is defined in ORS 646.461; [or] . . . Has access to competitively sensitive confidential business or professional information that otherwise would not qualify as a trade secret, including product development plans, product launch plans, marketing strategy, or sales plans[.]1 D. Reasonableness of time / scope / geographic restrictions. In both Oregon and Washington, time, scope, and geographic restrictions must be "reasonable." Oregon courts have stated that to be "reasonable," the restriction "should afford

• nly a fair protection to the interests of the party in whose favor it is made, and must not be so

large in its operation as to interfere with the interests of the public." Similarly, Washington

1 The definition also includes a provision related to on-air talent by an employer in the business of broadcasting.

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courts have stated that in determining whether a time, scope, or geographic restriction is reasonable, the court will evaluate whether they are reasonably necessary and calculated to protect the legitimate interests of the employer without imposing undue hardship on the employee's ability to earn a living. A determination of "reasonableness" is judged from the standpoint of the time and place when and where the contract is executed, and from the general nature of the business

• involved. It is a very fact-specific inquiry. It boils down to whether the restriction is necessary

for protecting the protectable interests of the employer. What is acceptable in time, scope, or geography will vary greatly from case to case depending on the employer's business and its interest entitled to protection and what restrictions are necessary to protect those interests. In both Oregon and Washington, if the restrictions in the covenant not to compete are unenforceable because they are overbroad, the courts are permitted to modify the covenant to narrow the restrictions in order to make the covenant enforceable. Some Oregon courts have refused to do so, however, reasoning that employers drafting noncompete agreements might be encouraged to overreach if they knew that the worst that could happen was that the court would strike the most egregious provision. They have concluded that the better approach is to void unreasonable agreements. Oregon: Under ORS 653.295, any noncompete agreements entered into after 2008 with a restrictive term of more than two years are voidable and will not be enforced by an Oregon court. The statute was amended in 2015, and agreements entered into after January 1, 2016, must be limited to 18 months in order to be enforceable. E. Public-policy considerations. Courts in both Oregon and Washington will refuse to enforce restrictive covenants that are so broad as to interfere with the public interest or cause harm to the public. An example is noncompete agreements for physicians. Some states consider restrictive covenants for physicians to be void as against public policy altogether or otherwise severely limit them by statute. While that is not the case in either Oregon or Washington, courts here will scrutinize such restrictive covenants carefully to ensure that enforcement will not create a risk of harm to the public by limiting access to necessary services or prevent patients from seeing a doctor of their choice. Restrictive covenants in other industries involving critical or hard-to-find public services will face similar scrutiny. F. Nature of employee's termination. Some states may refuse to enforce restrictive covenants against employees who are involuntarily dismissed, particularly if the terminations were without cause. Examples include Montana, where the state supreme court has held that an employer lacks a legitimate interest in enforcing a noncompete agreement against an employee whom it has chosen to dismiss, and New York, where some courts have similarly refused to enforce restrictive covenants against employees who were either terminated involuntarily or terminated without

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• cause. While neither Oregon nor Washington2 will refuse to enforce noncompete agreements

solely on that basis, the manner of the termination of employment may still be considered by the court as a factor in determining whether the covenant is a reasonable restriction necessary to protect the employer's interests. Employers should ensure that any restrictive covenants are specifically drafted to apply regardless of whether the employee is terminated with or without cause or resigns

• voluntarily. Employers should also be extremely cautious in drafting those provisions,

particularly when adding language to a preexisting agreement or in negotiating changes or modifications to agreement language with an employee, since those changes could have unintended consequences. Because restrictive covenants are agreements in restraint of trade, they will be strictly interpreted in accordance with their terms, and any ambiguities will be decided in favor of the least restriction possible. If the contract language can be interpreted as applying only in cases of just-cause terminations, the noncompete cannot be enforced against an employee who is terminated without cause or even one who resigns voluntarily, even if the employer intended the restrictive covenant to apply to all departing employees regardless of the reason for the separation. II. DISTINGUISHING BETWEEN TRUE NONCOMPETES AND OTHER RESTRICTIVE-COVENANT PROVISIONS. It is important to recognize and distinguish between the various types of restrictive

• covenants. Although sometimes the term "noncompete agreement" is used to refer to both

noncompetition and nonsolicitation agreements, there are significant distinctions between the two. A noncompetition agreement generally refers to an agreement that prevents an employee from competing with the employer in providing products, processes, or services that are similar to the employer's products, processes, or services. On the other hand, a nonsolicitation agreement does not prevent an employee from working for a competitor. Instead, a nonsolicitation agreement restricts the employee from soliciting the employer's customers (which customers depends on the terms of the agreement; in some cases the employee is prevented from soliciting all customers, and in other cases the employee is restricted just from soliciting customers formerly serviced by the employee). In addition to a restriction on actual solicitation (usually considered taking the initiative to contact the potential customer in pursuit of work or bidding on a job), there are agreements that go further and prevent employees from performing work or transacting business with former customers, no matter who makes the initial contact. For instance, an agreement that restricts only "solicitation" would prevent the employee from calling on customers and asking for their business. Yet such an agreement would not preclude the customer from contacting the former employee and asking the employee to provide the product or service. If the employer

2 There is a specific statutory exception in Washington applicable only to the broadcasting industry, prohibiting

enforcement of noncompetition agreements against employees who are dismissed without just cause or laid off by the employer. RCW 49.44.190.

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wants to prevent the former employee from accepting that work altogether, the agreement must clearly specify that, either by drafting the nonsolicitation provision more broadly or by including a separate "no-work" provision preventing the employee from performing work or transacting business with former customers or clients. As well as client nonsolicitation provisions, employers may also want to include employee nonsolicitation provisions preventing a departing employee from soliciting other employees to leave and join the new enterprise or from hiring employees of the former employer at all for a certain time. Agreements containing any of these nonsolicitation provisions (including "no-work" provisions restricting transactions with former customers) are restraints on trade that are governed by the same common-law principles related to reasonableness discussed above that apply to noncompete agreements. Generally, nonsolicitation provisions are looked on more favorably by courts than noncompete agreements because they are less restrictive in that they do not preclude the employee from engaging in a profession, but simply restrict the employee from calling on and/or doing work for the employer's customers. Oregon: Before 2008, nonsolicitation agreements were also governed by ORS 653.295. The 2008 amendment to ORS 653.295, however, specifically provides that the new restrictions on ORS 653.295 do not apply to a "covenant not to solicit employees of the employer or solicit or transact business with customers of the employer." Notwithstanding the express exclusion contained in the 2008 amendment, some courts have construed that provision very narrowly. For instance, a federal district court judge in Portland in 2011 analyzed an agreement that contained a restriction that an employee "may not directly or indirectly solicit, divert, or appropriate any past, present, or prospective customer of plaintiff for two years following their termination." The court found that this language extended beyond a restriction "not to solicit or transact business with plaintiff's customers" because it also prevented defendant from engaging in activities that would indirectly divert prospective customers away from the employer. Naegeli Reporting Corp. v. Petersen, No. 3:11-1138-HA (D. Or. Dec. 5, 2011). The court found that the overall effect was to prevent the employee from competing with the employer and therefore was subject to the restrictions of ORS 653.295. III. STEPS TO TAKE WHEN AN EMPLOYEE LEAVES FOR A COMPETITOR. Noncompetition litigation is on the rise. In August 2013, the Wall Street Journal reported that the number of published U.S. court decisions involving noncompete agreements had risen 61 percent since 2002. The increase in litigation corresponds with the increased usage

• f noncompete agreements among lower-level staffers and with employees' greater mobility and

access to sensitive information. When faced with an employee leaving for a competitor, consider taking the steps below. A. Exit interview. Before the employee departs, it is important to conduct an exit interview. The exit interview provides an opportunity to review the terms of the noncompetition agreement with the employee. Doing so reminds the employee of the employee's ongoing obligations to the

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employer and that the employer takes these obligations seriously. The employers should also ask the departing employee to verify that he or she is not keeping any company property or documents that contain confidential or proprietary business information. Particular attention should be paid to the departing employee's laptop computer and workstation. The employer should assess the need to preserve and/or immediately review e-mails and other information stored electronically for evidence showing that the departing employee has breached or intends to breach a noncompete. An exit interview also provides an opportunity for the employer to gather information to assess the threat posed by the departing employee. The departing employee should be questioned about future plans so that the employer can learn whether the employee intends to work for a competitor and what activities the departing employee will perform for the new employer, or whether the departing employee intends to start a venture that might compete with the former employer. If the departing employee denies going to work for a competitor and then does so, the employee's misrepresentation may well be held against him or her if litigation ensues. B. Cease-and-desist letter. If the employer learns that a former employee is breaching or about to breach a noncompete agreement, the first step in enforcing the noncompete is normally to engage legal counsel to send a cease-and-desist letter to the employee. In some situations it is also appropriate to send a separate demand letter to the former employee's new employer, setting forth the facts and arguments as to why the new employer's engagement of the former employee will unlawfully interfere with the noncompete agreement. The letter to the new employer must be considered carefully because there is a risk of liability of interfering with the employee's contractual relationship with the new employer if it is subsequently determined that the noncompete was not violated. In many cases, a cease-and-desist letter is sufficient to cause the employee to decide to abide by the terms of the noncompete. Notwithstanding what is discussed in the exit interview, some employees do not think the employer is really serious about enforcing the agreement or are under the mistaken belief that noncompetes are unenforceable. Often, receiving a demand letter from the employer's attorney is enough to convince the employee that the employee needs to abide by the terms of the agreement. At the very least, a cease-and-desist letter will often lead to discussions that result in some sort of resolution by settlement. C. Filing suit. If the situation does not resolve by sending a cease-and-desist letter, the employer must assess whether it will file a lawsuit to enforce the noncompete. The decision to file suit must be carefully examined. A major consideration for most employers is the expense of

• litigation. Typically, suits to enforce a noncompete include seeking a preliminary injunction that
• rders the former employee to stop work for a competitor and/or calling on certain customers.

The expedited nature of the relief being sought means that significant legal fees and costs are incurred in a short time. It is often the equivalent of what would normally be 8 to 12 months of litigation compressed into just a few weeks.

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Another factor to consider is the uncertainty of litigation. In fact, it seems that the

• nly thing that is certain is that the litigation will be expensive. There is a certain level of

uncertainty in all litigation, but the nature of noncompete litigation makes it particularly difficult to predict. Since there are no bright-line rules as to what restrictions will be considered "reasonable," no one knows for sure whether a certain restriction will be enforced in a particular case until a judge actually rules. Yet another consideration is the impact that the litigation will have on customers. Often, customers are important witnesses in the litigation. Not surprisingly, many customers are wary of being dragged into a legal dispute and do not appreciate being called as witnesses or subpoenaed to produce documents. Consequently, many employers prefer not to involve customers in the legal proceedings. Notwithstanding the costs and uncertainty, as well as the potential impact on customers, employers must also consider the impact of not pursuing litigation. In certain situations, the former employee's breach of a restrictive covenant can have a significant impact

• n the company that outweighs any of the other considerations. In addition, not enforcing a

noncompete, particularly if there is a pattern of not enforcing the agreements, sends a message to current employees and competitors that the employer does not take the noncompete agreement seriously and, when push comes to shove, will not take the steps necessary to enforce it. Obviously, given all the factors in play, whether or not to pursue litigation is not an easy decision. It must be carefully considered in light of all the considerations discussed above. IV. BEWARE OF JURISDICTIONAL ISSUES. Employers with multistate operations or companies seeking to hire employees coming in from another state need to be aware of the jurisdictional issues that may affect enforcement of noncompetes and other restrictive covenants. As should be clear from the discussion above, interpretation of restrictive covenants is a state-law issue, and enforcement of different covenants may vary depending on the choice of law that applies to the agreement and the venue where the issue is heard. When the noncompete agreement does not specify the choice of law or venue, the result may depend on an expensive and resource-draining "race to the courthouse," in which each party maneuvers to have the dispute heard in the forum perceived as most favorable to the party's preferred outcome. A former employee, perhaps supported by a new employer, may file a declaratory judgment action in California or another state where noncompetes are disfavored, arguing that enforcement of the restrictive covenant would violate public policy in that state. The former employer, on the other hand, may seek to obtain a temporary restraining order or preliminary injunction against the former employee in the home state, assuming that the law there would support enforcement of the restrictive covenant. While such forum-shopping may never be completely avoided, employers can maintain as much control of the process as possible by thinking through potential jurisdictional issues at the front end and including well-drafted choice-of-law and forum-selection clauses in any noncompete or other restrictive-covenant agreement.

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Employers seeking to apply the state law where their main business operations are located or where the company is headquartered should include that specific choice-of-law provision in the noncompete agreement. Courts in another state will usually honor the contracting parties' choice as to the law to be applied. But employers should be aware that a court may refuse to uphold a contractual choice-of-law provision if it is deemed offensive to the public policy of the state in which the court sits. A California court, for example, may refuse to enforce a noncompete agreement with a Washington or Oregon choice-of-law provision in a contract involving California employees. Even a court sitting in the state of the contractual choice of law may refuse to apply that law in situations with minimal connections to the chosen state while another state has a materially greater interest in the matter. In a recent case in Delaware, for instance, the court refused to apply a Delaware choice-of-law provision, even for a company incorporated in Delaware, because the noncompete agreement at issue was negotiated and entered into in California and was limited almost exclusively to California employees and markets. Regardless of the choice-of-law issue, employers seeking the most control over the enforcement process should include a specific, exclusive forum-selection clause as well as choice-of-law provision in their restrictive-covenant agreements. A mandatory forum-selection clause is generally binding on the contracting parties unless the party seeking to avoid enforcement meets the heavy burden of showing that enforcement would be unreasonable, unfair, or unjust. Mere inconvenience is not enough; rather, the party must show that the contracting forum is so gravely difficult and inconvenient that he or she would for all practical purposes be deprived of the party's day in court if the forum-selection clause were upheld. Even courts in California will generally uphold a well-drafted forum selection clause for another state such as Washington, rejecting arguments that sending a case to a jurisdiction that enforces restrictive covenants would violate California's strong public policy against noncompetes. California courts have reasoned that the forum-selection issue is distinct from the choice of law to be applied and that litigants in Washington are free to argue that California law should govern the dispute before the Washington court. As a practical matter, however, controlling the forum often means controlling the law to be applied, because the court hearing the dispute has a natural tendency to apply the law of the home state with which it is most familiar. In any situation involving multiple states and the potential application of different state laws and venues, the employer should carefully analyze the language of the agreements with respect to choice-of-law and forum-selection issues, preferably with assistance of counsel, to determine the strength of the parties' relative positions on jurisdictional issues. There is no

• ne-size-fits-all strategy; each side must weigh both the economic and strategic costs and

benefits of winning or losing the race to the courthouse compared to pursuing other nonlitigation enforcement strategies first. V. DON'T RELY SOLELY ON NONCOMPETES; KEEP CONFIDENTIAL INFORMATION PROTECTED. Given the difficulties and expense of litigation, an employer should not rely solely

• n enforcement of restrictive covenants to protect confidential information. The cost-benefit

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analysis of litigation may make sense only for the most critical competitive material, while the transfer of any confidential information to a competitor may harm an employer's business, regardless of whether it justifies taking legal enforcement action against the employee departing with that information. Employers should not overlook the many practical steps they can take to protect confidential information and prevent its disclosure, whether the information is a secret manufacturing ingredient or process, or important customer lists and contact information for key decision-makers for those customers. An employer's confidential-information policies should be carefully drafted to apply to the specifics of the employer's business and workplace, and front-line managers and supervisors should be trained to understand and apply the confidentiality policies. All managers should be able to identify what information the company considers confidential and know what the company policy is with respect to protection of that information. Managers should be required to comply with the written policy and take appropriate steps to protect confidential information. Access to confidential information should be strictly limited to those with a need to know and use the information in performance of their work. Confidential documents should be marked confidential and maintained in secure locations physically and electronically. Company servers and e-mail systems should be equipped with secure ways to restrict and limit access to employees who need the confidential information. Employers should take efforts to keep confidential information off mobile devices that might be lost or stolen, or at least carefully restrict what information is allowed to be stored on the devices. Appropriate levels of security should be reviewed and required for mobile devices and programs with clear steps that can be taken to wipe a device if it is lost or stolen. Third-party visitors should be prohibited from entering physical workplaces containing confidential materials or production processes, or be carefully screened and have their access restricted and monitored at all times during the visit. Prototypes or other physical materials that are proprietary or confidential should be secured, rather than being left out in the

• pen.

Confidential customer lists and customer contacts should be protected and

• secured. Computer records on customers should be maintained on secured password-protected

files, and there should be appropriate restrictions on access to company databases and contact

• lists. Employers should be cautious about allowing employees to keep customer information on

their own personal devices and should have clear and technologically feasible procedures in place to retrieve that information and wipe it off a device when an employee departs. Even if an employer is not able to completely prevent confidential information from being disclosed outside the company, the more steps that have been taken to protect the information, the stronger the company's position will be in any subsequent litigation to enforce the employer's confidentiality agreements or prove harm from an employee's breach of a noncompete or other restrictive covenant.

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