Duty of Loyalty: Postemployment and Noncompete Agreements

Many companies have their employees sign contracts that include covenants not to compete or covenants not to disclose information about their former employers should the employees leave their jobs or be terminated from their employment.

Downsizings in the high-tech industry have brought back the issue of noncompete and confidentiality agreements. When employees are recruited by upstart firms and lured with stock options, it is often difficult for them to imagine a time when the company would need to downsize or would no longer exist. As a result, most of them signed fairly restrictive covenants not to compete.

In dealing with these covenants, courts are striking a balance between the employees' right to work and an employer's right to protect the trade secrets, training, and so forth that the former employee has and then transfers to another company or to himself or herself for purposes of starting a business.

Requirements for Noncompete Agreements

The Need for Protection

The laws on noncompete agreements vary from state to state, with California and a handful of states being the most protective of employees. However, across all states, courts are clear in their positions that there must first be an underlying need or reason for the noncompete agreementthat is, the employee must have had access to trade secrets or be starting his or her own business in competition with the principal/employer.

Reasonableness in Scope

The covenant must also be reasonable in geographic scope and time. These factors depend on the economic base and the nature of the business. For example, a noncompete in a high-tech employee's contract could be geographically global but must be shorter in duration because technology changes so rapidly. A noncompete for a collection agency could not be global but might be longer in duration because the nature of that business is one of relationships.

Valid Formation

Noncompete agreements are also subject to the basics of contract law (see Chapters 11 and 12). There must be consideration and there cannot be duress. For example, one dot-com company agreed to give its employees stock options if they would sign a noncompete agreement. Amazon.com offered downsized employees an additional 10 weeks' pay plus $500, in addition to the normal severance package, if they would sign a three-page "separation agreement and general release" in which they promised not to sue Amazon over the layoff or disparage it in any way. Amazon, as a long-standing practice, has had employees sign a confidentiality agreement at the beginning of their employment that restricts their use of information and systems knowledge they gained while working at Amazon.

Some states provide protection for employees who refuse to sign noncompete agreements, punishing employers with punitive damages in wrongful termination cases brought by employees terminated following their refusals to sign.

Other Theories for Noncompete Enforcement

Because covenants to compete have been so difficult to enforce, businesses and courts have developed alternative theories to stop agents from competing with their former employers. One theory is called the doctrine of inevitable disclosure, which applies in situations in which the departing employing will be working in a situation in which disclosure of the previous employer's competitive information will necessarily be disclosed. For example, an executive in energy drinks (All Sport) at PepsiCo who left PepsiCo to work for Quaker Oats was not restrained from working for Quaker Oats but had to spend a few years working on something other than its energy drinks (Gatorade) so that Pepsi's product plans would not be disclosed. [PepsiCo, Inc. v Redmond, 54 F.3d 1262 (7th Cir. 1995)] Another example involved a Thomas English Muffins executive who knew the "Nooks and Crannies" secret to the muffins leaving for another employer. He could work for the bakery but not on English muffins. [Bimbo Bakeries USA, Inc. v Botticella, 613 F.3d 102 (3rd Cir. 2010)]

Some employers have employees sign nonsolicitation clauses. The employees can leave and work for a competitor, but they promise not to recruit other employees from the firm if they leave. These clauses are different from noncompete clauses because they do not prohibit work and are more easily enforced.

There are also some statutory protections . For example, most states have trade secrets protections that prevent former employees from disclosing what the employer has identified as a trade secret through limited use by employees and by requiring passwords for access.

Some employers have begun to use the tort of tortious interference with contracts as a means of preventing former employees from working for competitors or beginning their own competing businesses. In those states in which noncompete clauses are unenforceable, the tort avenue has been used as a means of enjoining the former employee's business activities. For example, in TruGreen Companies, LLC v Mower Brothers, Inc., 199 P.3d 929 (Utah 2008), the Utah Supreme Court held that a company whose former employer had gone to work for a competing company and recruited other employees to join him was liable for tortious interference and allowed recovery of lost profits.

Garon Foods, Inc. v Montieth (Case 16.3) provides the answer for the opening consider and involves several issues related to former employees competing with their former employers.

QUESTIONS:

After doing the reading, please explain:

1. What is necessary for a noncompete agreement to be enforceable; and
2. If you think that noncompete agreements are generally a good, or bad, idea and why.

• In answering the 2nd question, please find a case or news article involving a dispute over a noncompete agreement and use it to support your position and provide a citation for it.