Non-Compete, Non-Solicitation, and other Restrictive Employment Covenants

A restriction is a limitation. A covenant is a promise. A restric­tive covenant is a promise to limit activities, usually found in an employment agreement. Often, an employer will attempt to impose limitations on his employees’ post-employment activi­ties by the use of restrictive covenants.

The law does not favor restrictive covenants in employment relationships. A restrictive covenant generally will be strictly construed against the employer. One reason restrictive covenants are construed against the employer is because the employee is typically at a bargain­ing disadvantage. Unequal bargaining power may be a factor to consider when examining the hardship on the departing employee.

There are two often-used types of restrictive covenants in employment agreements:

1. covenants not to compete, and
2. non-solicitation covenants

Below, we will look at the law concerning each type of covenant.

Covenant Not to Compete

A covenant not to compete restricts an employee’s ability to work after his current employment is terminated. Typically, it will prohibit the employee from working in the same trade or industry for a period of time after the termination of his employment, within a specified geographic area. For example, a covenant may state, “John shall not sell widgets for a period of five years after the termination of his employment by Arizona Widget Company within the state of Arizona.” Both the term and the geographic scope of the covenant must be reasonable. However, many restrictive covenants are too broad to be valid (such as the covenant in the preceding example, for instance).

Under Arizona law, a covenant not to compete in an employment agreement is “valid and enforceable by injunc­tion when the restraint does not exceed that reasonably neces­sary to protect the employer’s business, is not unreasonably restrictive of the rights of the employee, does not contravene public policy, and is reasonable as to time and space.” A restrictive covenant is reasonable and enforceable when it protects some legitimate interest of the employer beyond the mere interest in protecting itself from competition. The legiti­mate purpose of post-employment restraints is to prevent competitive use of information or relationships which pertain peculiarly to the employer and which the employee acquired in the course of employment.

What is reasonable will turn on a very fact-intensive inquiry and will depend on duration, geographic area and the activity prohibited. Each case hinges on its own particular facts. A restriction is unreasonable and will not be enforced if (a) the restraint is greater than necessary to protect the employer’s legitimate interest, or (b) that interest is out­weighed by the hardship to the employee and the likely injury to the public. No exact formula can be used when balancing these competing interests.

The burden is on the employer to demonstrate that the restraint is no greater than necessary to protect the employer’s legitimate interest, and that such interest is not outweighed by the hardship to the employee. The court in one case found that a three-year covenant was unreasonable and that any provision over six months was unnecessary to protect the employer’s interests.

In another case, a restrictive covenant was held to be unen­forceable by the court because its statewide scope was overly broad and unreasonably restricted the right of the employee to work in his chosen occupation. Again, the restriction cannot be greater than necessary to protect the employer’s legitimate interests. Each case is decided on its own facts.

Non-Solicitation Covenant

The second type of restrictive covenant is the non-solicita­tion, or “anti-piracy” covenant. Unlike the covenant not to compete, it does not restrict the employee’s subsequent employment. The non-solicitation covenant restricts the employee’s ability to solicit his employer’s customers after the termination of his employment. A typical non-solicita­tion covenant might read: “For a period of two years after Employee’s termination with Arizona Widget Company, the Employee agrees that he/she will not solicit or contact for the purpose of establishing a business relationship any of Arizona Widget Company’s customers as they exist on the date of Employee’s termination.” For the reasons discussed below, the two-year period in the preceding example probably is too long to be enforceable.

The non-solicitation provision in Arizona Widget Com­pany’s fictional employment agreement is an “anti-piracy” covenant. This type of covenant is designed to prevent former employees from using information learned during their employment to divert or “steal” customers from the former employer. An anti-piracy agreement is ordinarily not deemed unreasonable or oppressive, unless it is so restrictive in its scope that it becomes unenforceable. An anti-piracy agree­ment is only enforceable as long as it is no broader than neces­sary to protect the employer’s legitimate business interest.

What is reasonable depends on the whole subject matter of the agreement, including the purpose to be accomplished by the restriction and the totality of the circumstances which show the intention of the parties. In the leading Arizona case on the subject, the anti-piracy covenant was held to be unrea­sonable because it subjected the former employee to a penalty for customers who transferred to the employee’s new employer, even if the employee did not solicit the customer.

The burden is on the employer to prove the extent of its protectable interest. The employer’s interest in its customer base, however, is balanced with the employee’s right to the customers. Where the employee took an active role and brought customers with him to the job, courts are more reluc­tant to enforce restrictive covenants.

In addition to proving that the anti-piracy covenant is rea­sonable, the employer must prove that the former employee actually “solicited” customers. Merely informing customers of a change of employer, without more, does not constitute solic­itation. Neither does the willingness to discuss business upon invitation of another party. The law will not prohibit a former employee from receiving business initiated by the customers of his former employer, even if the former employee would be pro­hibited from soliciting such business.

Legal Tip

If a restrictive covenant is unfair under the circumstances of the case, or if it imposes an extreme hardship on the departed employee, then the restrictive covenant probably is invalid.