COVENANTS NOT TO COMPETE (There might be more to it than you think.)

The legal issues related to employee “non-competes” (also known as covenants not to compete or non-competition agreements) are often not well understood by employees subject to them, companies insisting upon them, or companies intending to hire persons subject to them.  That may well be especially true in the Commonwealth of Virginia where one frequently hears, “That agreement is so broad it will never be enforced and Virginia doesn’t ‘blue pencil’ these agreements, so no problema.”

True enough, Virginia courts generally do not enforce unduly broad or overreaching employee agreements not to compete because they are contrary to the public policy of the Commonwealth of Virginia.  Such agreements are “disfavored in the law” and are strictly construed by Virginia courts.  Why?  Because covenants not to compete are frequently coerced from employees in exchange for the “privilege” of working for the employer, never mind the employee is providing services to the employer and does not usually receive any separate consideration, or payment, for giving the non-compete.  Further, they are disfavored because they are restraints of trade that affect the employee’s ability to earn a livelihood, restrict others from obtaining the employee’s services, and deny the public the benefit of such services.

Employee non-competition agreements are enforceable in Virginia where the agreements (1) are narrowly drawn to protect the employer’s legitimate business interest, (2) are not unduly burdensome on the employee’s ability to earn a living, and (3) are not against public policy.   However, Virginia courts, unlike the courts of some states, will not rewrite, or “blue pencil,” them to make them enforceable.

Whether a non-competition agreement is unduly broad or is unduly restrictive of an employee’s ability to earn a living is fact based.  Generally, however, where the restricted geographic boundary, occupational limitation or time limitation extends beyond any legitimate employer interest, or where the agreement prevents all or substantially all employment in the employee’s field of endeavor within a reasonable geographic area, the non-competition agreement will generally not be enforced.

Nonetheless, where Virginia courts find covenants not to compete enforceable, they will use their injunctive power to keep employees and prospective employers from violating them.  Further, they will enforce liquidated damage provisions for breach of contract where the actual damages contemplated at the time of the agreement are uncertain and difficult to determine with exactness and where the amount fixed is not out of all proportion to the probable loss.  Finally, Virginia courts will enforce choice of law clauses where such clauses are not unconscionable.

General contract law also applies as to the enforceability of covenants not to compete.  Thus, covenants not to compete will not be enforced if the employer comes to court with “unclean hands.”  Generally, a party who commits a first breach of a contract is not entitled to enforce that contract.  The exception to this rule exists where the breach does not go to the root of the contract but only to a minor part of the consideration.  Where two or more agreements are entered into together, such as an employment agreement and a non-competition agreement, they may be viewed as one agreement.  A material breach of the combined agreement is a failure to do something that is so fundamental to the contract that the failure to perform that obligation defeats an essential purpose of the contract.

Thus, where an employer does not meet its obligations under the employee’s employment agreement, oral or written, and thus breaches the agreement, the agreement will not be enforced against the employee.  Further, in all matters of contract, the parties have a duty to act in good faith.  Thus, where an employer employs an at will employee and requires the non-compete in consideration of employment, and subsequently terminates the employee without cause soon thereafter, it is likely a non-compete agreement will not be enforced against the employee.  Further, where the employee is employed by a written employment agreement for one position and subsequently is given another, lesser, position of significantly reduced status or compensation, such changes may amount to constructive termination and be a breach of the combined agreement resulting in the unenforceability of a non-compete agreement against the employee.

Enforceability is not the end of the matter, however, either for the employee subject to the agreement, the company to which the duty not to compete is owed, or the prospective employer of such an employee.

First, as to the employee, questions arise as to whether the employee can be restrained (“enjoined”) from working for the prospective employer, whether the employee will be subject to damages for breach of the covenant not to compete, whether the employee will have breached his duty of loyalty to his employer, and whether the employee will be subject to claims of common law or statutory business conspiracy and, perhaps, trade secret act violations.

Second, as to the company to which the duty not to compete is owed, questions arise as to whether it will be able to enforce the non-competition agreement against the employee, whether it will be able to obtain an injunction against the employee or the prospective employer to prohibit the employee from being employed by the prospective employer, whether it will be able to obtain damages from the employee for breach of the agreement, whether the employer will have claims against the employee and the prospective employer for breach of the employee’s duty of loyalty or for aiding and abetting the breach, whether the employer will have claims against the employee and the prospective employer for common law or statutory business conspiracy, whether it will have causes of action against the prospective employer for tortuous interference with contract or business expectancy, and whether it may have claims against both the employee and the prospective employer for trade secret act violations.

Third, as to the prospective employer, questions arise as to whether the employer will be able to hire the employee, whether it will be able to retain the employee’s services once hired, and whether it will be subject to any liability for inducing the employee to become employed by it as a result of claims for tortuous interference with contract or business expectancy, aiding or abetting the prospective employee’s breach of his duty of loyalty, common law or statutory business conspiracy and/or trade secret violations.

The answers to all of these questions will depend upon the specific facts and circumstances, and, not inconsequentially, the law of the forum deemed to apply.  As an example of circumstances that might arise that are not atypical, suppose a Virginia corporation wishes to employ a person living in New Jersey who is employed by a corporation whose headquarters is in Ohio.  Suppose also that the employee is subject to a non-competition agreement that has a choice of law, jurisdiction, and venue clause that states that the agreement will be interpreted and enforced pursuant to Ohio law in Ohio courts.

The first question to be addressed is, “How did the covenant not to compete arise?”  Employee covenants not to compete generally arise in one of two ways:  1) solely as a result of employment; and 2) ancillary to another agreement, such as an agreement to purchase the prospective employee’s business.  Covenants not to compete that arise solely as a result of employment generally arise in two ways as well:  1) an agreement simply required in order to be employed; and 2) an agreement for which separate consideration is paid by the employer to the employee, other than the bare offer of employment.

In Virginia, as much as a matter of fact as a matter of law, covenants not to compete demanded solely as a condition of employment tend to be more “disfavored” by courts than covenants not to compete that were independently negotiated and compensated.  Covenants not to compete that arise from ancillary agreements, such as agreements to purchase businesses, tend to be less disfavored by Virginia courts than non-competes that are not related to ancillary agreements.

The reasons are obvious.  Where a prospective employee is required to enter into a non-competition agreement solely as a condition of employment, without any additional consideration, the employee is not really compensated for the agreement.  The employee is going to have to work in order to get paid.  However, where the employee bargains with the employer for the non-competition agreement, where the employee gets paid for the agreement or obtains some additional consideration, and where the agreement is not simply a condition of employment, the equities shift somewhat in favor of the employer to whom the duty is owed.  The employer gave up something other than the mere privilege to work and the employee obtained the additional benefit.  Similarly, where non-competition agreements are ancillary to other agreements, such as the sale of a business, the facts often suggest that the employee was compensated for the agreement in the form of part of the purchase price of the business.  In such a case, the equities shift further in the direction of the employer as it is considered bad form for a person to sell his business and then to recreate it down the street.

Another question that arises is, “Under the law of which state will the covenant not to compete be interpreted?”  The laws of Virginia, Ohio, and New Jersey each treat non-competition agreements differently, as do the laws of most states.  All states tend to disfavor such agreements, though to different degrees even while ostensibly using essentially the same criteria to evaluate such agreements.  Further, while courts in Virginia will not “blue pencil” non-competition agreements, some states, including Ohio, will.  Generally, Virginia courts will honor a choice of law, jurisdiction, and venue clause contained in a non-competition agreement where not unconscionable, though there are good arguments against this policy that some states have adopted.  Further, Virginia courts will generally honor the valid orders of foreign courts.  Otherwise, Virginia’s contract law as to choice of law generally applies.

Thus, in the foregoing example, the employer of an employee (also the prospective employee) could presumably go into Ohio courts and obtain an order enjoining the New Jersey employee from working for the Virginia employer, assuming that the Ohio court found the agreement enforceable, or chose to rewrite it so that it would be enforceable (something that Ohio courts are willing to do).

Additionally, the former employer may bring claims against the former employee for breach of contract, for breach of the employee’s duty of loyalty (assuming the employee planned his exit to the competing employer while employed or took other steps or actions on company time) or for common law and statutory conspiracy under Virginia’s business conspiracy statutes, Va. Code §§ 18.2-499 & 18.2-500.   Further, if the employee even copied any trade secrets of the former employer in anticipation of departing, the employee may be subject to both criminal and civil sanctions for violation of Virginia’s trade secret act.

What about the prospective employer?  The prospective employer’s circumstances are fraught with potential difficulty.  The former employer might seek an injunction against the prospective employer to prevent the prospective employer from hiring the employee.  Assuming the new employer has already hired the employee, so much the worse.  The hiring and training costs, of course, will be lost if an injunction issues, assuming the new employer chooses not to fight.  If the new employer chooses to fight, the new employer is faced with the legal costs and expenses as well.  Further, if the new employer “induced” the employee to leave the former employer in violation of the employee’s agreement with the former employer, the new employer may be subject to claims for tortuous interference with the employment or the former employer’s “expectancy,” and aiding and abetting the employee in his breach of his duty of loyalty.  Even worse, the new employer may be subject to claims pursuant to common law conspiracy or Virginia’s business conspiracy statutes.  Further, if the new employee brings with him or her any trade secrets of the former employer, both the new employee and the new employer may be liable for both criminal and civil sanctions for breach of Virginia’s trade secret laws, whether or not the trade secrets were ever used to further the new employer’s business.

While there is a fine line between fair competition for employees, it is clear that if an employer knows that an employee is subject to a non-competition agreement and nonetheless induces that employee to come to work for the employer in a competing business fairly within the terms of a valid non-competition agreement, the employer may well be subject to a claim by the former employer for damages.   A claim for damages under a theory of tortuous interference requires only:  1) the existence of a valid contractual relationship or business expectancy;  2) knowledge of the relationship or expectancy on the part of the interferor; 3) intentional interference inducing or causing a breach or termination of the relationship or expectancy; and 4) resultant damage to the party whose relationship or expectancy was disrupted.

As to a breach of an employee’s duty of loyalty, a duty owed by every employee to his employer, one who is entrusted with the business of another cannot use that business to benefit himself.  Thus, while employed, an employee may not use his employer’s business to further his own interests nor, in most circumstances, may he compete with his employer.  Further, he may not use anything of his employer’s to his own benefit and he may not solicit an employee for another enterprise.  Nor can one lawfully induce anyone else to take any such actions.  All such actions would constitute a breach of his “fiduciary” duty of loyalty to his employer.

Finally, a claim under Virginia’s business conspiracy statutes may be made against any two or more persons who undertake to willfully and maliciously injure another in his trade, business, or profession by any means whatsoever, or against any such persons who compel or induce another to do so.  Violation of the business conspiracy statute constitutes a Class 1 misdemeanor.  In addition, a civil action may be maintained against violators and treble damages and attorneys’ fees may be awarded.  Malicious does not mean malice in the usual sense, but rather means legal malice, a standard more closely related to “knowingly.”  Thus, it is clear that where an employer knowingly induces the employee of another company to breach his contract with his existing employer in a manner that the employer knows will injure the former employer in his trade or business may be liable for treble damages and attorneys’ fees to the former employer.

From the foregoing, it can be seen that there are many more issues related to non-competition agreements than the issue of enforceability.   Thus, employees with non-competition agreements and employers who seek to employ them are well advised to seek legal counsel as to the potential issues and ramifications that are fact specific to the employee and the prospective employer.

© Neal J. Robinson 2010.

This article is not to be considered or construed as legal advice.

Persons desiring legal advice in a matter should contact Tarley Robinson, PLC.

Filed under: Business Entity Formation, Acquisition, Sale and Merger, Business Planning and Strategies, State and Federal Litigation, TR: Neal J. Robinson, Uncategorized by jtadmin

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