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Legal Clinic

Drafting Effective Confidential Agreements

Agreements that limit the ability of a former employee to find work because of access to proprietary information may be challenged in court. Restrictive covenants and noncompete agreements must balance the interests of the organization and the former employee.

Monday, July 2, 2012
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Question: We are drafting confidentiality and noncompete agreements for our new company. Any tips for what these types of agreements should include to best protect the company and make sure they are enforceable if challenged in court?

Answer: The fundamental trick to drafting a good confidentiality or noncompete agreement (which are types of "restrictive covenants") is to balance the competing interests of protection and enforceability.

Courts will generally only find restrictive covenants enforceable if they are reasonable.

The more a restrictive covenant restricts an employee's freedom -- and thus the more protective it is of an employer's interests -- the more likely a court is to find the restrictive covenant to be unreasonable and unenforceable.

However, if a restrictive covenant is not protective enough of an employer's interests, it may be enforceable, but it will not be effective in meeting the business goals the restrictive covenant was drafted to accomplish.

You should keep in mind that there is no perfect restrictive covenant. Inherent in any attempt at balancing competing interests is uncertainty.

Even the most well thought out and planned restrictive covenants will be subject to the experiences and prejudices of the judge who hears the dispute and the law of the state in which the covenant is sought to be enforced.

This may or may not be good news for a company's lawyers, but it is certainly bad for the business side of the company, which often thrives on predictability.

Generally, courts will look at three factors to determine reasonableness and thus enforceability: (1) the protectable interests of the employer; (2) the burden of the covenant on the employee in terms of time, geographic area and restriction on the employee's ability to pursue his occupation; and (3) any resulting harm to the public interest (although this last factor rarely plays a role in the determination). Health Consultants Group, LLC v. Dailey, No. 04 Civ. 4586, 2004 U.S. Dist. LEXIS 27318, at *15 (S.D.N.Y. Aug. 24, 2004).

Courts will only find a restrictive covenant reasonable if the protectable interest of the employer is for a legitimate business purpose.

An interest in trade secrets and confidential information is certainly a legitimate business purpose, see, e.g., Statco Wireless v. Sw. Bell Wireless, 95 S.W.3d 13 (Ark. Ct. App. 2003), so confidentiality agreements satisfy the first factor of the reasonableness test.

In addition, there are measures the company can take after the confidentiality agreement is signed to improve the chances of enforceability.

Courts are more likely to uphold a restrictive covenant if the protectable interest of the employer is high. So, if the company can show that it spends a great deal of effort to keep certain information and trade secrets confidential, a court may be more likely to find the confidentiality agreement enforceable. Agency, Inc. v. Grove, 839 N.E.2d 606, 617-18 (Ill. App. Ct. 2005). 

When drafting a confidentiality agreement, the provision at a minimum should set forth the scope of the protected information, identify the multitude of forms which the information may take (e.g. documents, computer data, etc.), prohibit unauthorized use and disclosure of the material, and include a requirement that employees return the covered material upon termination of employment.

It is important that the agreement cover all confidential information the company would like to protect because the absence of a certain piece of information from the explicitly drafted agreement could give rise to the impression that the company meant to exclude that information from protection.

Noncompete agreements are a trickier area and are generally more strictly reviewed than confidentiality agreements.

Courts view noncompete agreements with disfavor because they inhibit competition and more severely impair an employee's ability to work. In many cases, the trade secrets and confidential information to which the employee is privy will play a role in the judging the reasonableness of the non-compete agreement. Estee Lauder Cos. v. Batra, 430 F. Supp. 2d 158, 180 (S.D.N.Y. 2006).

When drafting a noncompete agreement, it is important to keep in mind that a court will ultimately judge the duration and geographical scope of the employee's restrictions in looking at the reasonableness of the agreement.

It is impossible to give an area and time period that will be automatically enforceable, but the drafter of the agreement should keep in mind that the agreement should be limited to what is reasonably necessary to protect the employer's interest -- not necessarily what the employer wants -- and draft accordingly.

Because noncompete agreements can be so tricky to draft and hard to enforce, it is worth mentioning two alternative options that have been rising in prominence in recent years.

One option is to agree to pay the departing employee a sum of money for the noncompete period after the employee's separation from the company. Courts will still judge these agreements based on their reasonableness, but courts may be more likely to uphold the agreement because the fact that an employee is receiving compensation while restricted will reduce the burden on the employee. See, e.g., Natsource LLC v. Paribello, 151 F. Supp. 2d 465 (S.D.N.Y. 2001).

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Another option that is similar to the paid noncompete is the "garden leave" restriction. This restriction allows the company to terminate an employee's (often, an executive) active-duty status and relegate them "to the garden" on paid leave for a fixed period of time.

The advantage of this type of provision is that the employee remains an employee and thus is subject to the ongoing obligations of an employee while also remaining out of the job market.

However, because these types of provisions are so new, there is some question as to the scope of their enforceability. Compare Bear Stearns & Co. v. Sharon, 550 F. Supp. 2d 174 (D. Mass. 2008) (refusing to grant injunctive relief to require an employee to serve out the "garden leave" period, but leaving open the possibility of damages for breach of contract) with Ayco Co. L.P. v. Feldman, No. 1:10-CV-1213, 2010 U.S. Dist. LEXIS 112872 (N.D.N.Y. Oct. 14, 2010) (court issued a temporary restraining order to enforce a 90-day advance notice provision).

While the law in most states is rooted in the common-law principles of reasonableness and has developed over time through judicial decisions, many states have enacted statutes governing the enforceability of confidentiality agreements, noncompete agreements and other restrictive covenants.

Certain states, such as California and North Dakota, have enacted statutes that have blanket prohibitions against noncompete agreements with very limited exceptions.

On the other hand, Georgia has expanded the enforceability of confidentiality and noncompete agreements and has done so in its Constitution.

Still others, such as Colorado, have explicitly stated the situations in which its courts will find restrictive covenants enforceable.

Because there is so much variation between the common law and state statutes, and among the states themselves, close consultation with legal counsel to understand the law of the state in which you are is paramount in drafting an effective and enforceable restrictive covenant.

Keisha-Ann G. Gray is senior counsel in the Labor & Employment Law Department of Proskauer in New York and co-chair of the Department's Employment Litigation and Arbitration Practice Group.

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