Before Adopting a Restrictive Covenant Program, Check For Fundamentals?

A relatively recent Connecticut Superior Court decision holding certain non-compete and non-solicitation covenants unenforceable illustrates the need for businesses to focus on fundamentals in creating and litigating these provisions.  It also illustrates that in some instances, old axioms in this area don’t always apply.

The old axiom here is that courts are more inclined to uphold these covenants in the sale of a business context than in the employment setting.  The rationale is that business sales generally include the purchase of the business’ good will and its customer relationships, and having been paid for those relationships, the principals shouldn’t be able to take them away, at least not for a fairly lengthy period.  Creative Dimensions was a business sale case.  The covenants the seller’s principals agreed to were in employment agreements that were part of the business sale transaction.  Nevertheless, the court refused to apply the more liberal business sale standard in evaluating the covenants for enforceability.

The court found that the reason the buyer bought the business was to secure the principal’s skills and expertise, not to acquire other assets, including the business’ good will.  This reality persuaded the court that it would be inappropriate to treat the case as a business sale case.  The court was also influenced by the fact that the original employment agreements were for three year terms, the three years had expired, and while the defendants were given new agreements, they were for at-will employment with much less guaranteed compensation.  The take away?  Variations in facts can render reliance on old maxims dangerous.

The fundamental principle the court applied in declaring the covenants unenforceable is that restrictive covenants ancillary to employment agreements are only enforceable if they protect legitimate employer interests.  Before there is any need to address the reasonableness of the particular restraints (scope and duration), a plaintiff seeking to enforce a covenant must show that these interests are present in his business and that the defendant is in a position to threaten them using, as an old Supreme Court colorfully phrased it, the “weapons” the plaintiff placed in the defendant’s hands.

There are only two such judicially recognized employer interests – customer relationships and trade secrets/confidential business information.  In Creative Dimensions, the court concluded that there was no confidential business information in the plaintiff’s business and that the defendants were not in a position to threaten the plaintiff’s customer relationships when they left and joined a competing business.  Among the bad facts for the plaintiff was that it had restrictive covenants only with the defendants and not with any other employees, including its salesmen — many of whom had left over the years and joined competitors.  The plaintiff simply demonstrated a lack of concern with the diversion of his customers and therefor did not warrant judicial protection.

The take away here?  Be sure to check for the presence of these fundamentals before adopting a restrictive covenant program.  If they aren’t there, your covenants are likely worthless.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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