Restrictive Covenants in the Time of Coronavirus

Ogletree, Deakins, Nash, Smoak & Stewart, P.C.
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Ogletree, Deakins, Nash, Smoak & Stewart, P.C.

The spread of the coronavirus disease 2019 (COVID-19) has led to changes regarding many legal issues. Despite the changes, companies still need to protect confidential information, goodwill, customer relationships, and competitive marketplace positions. The pandemic raises a variety of issues to consider for restrictive covenants. Employers may want to keep these challenges in mind and tread carefully.

Heightened Scrutiny and Logistical Challenges With Courts

Restrictive covenant claims and the usual requests for preliminary injunctive relief are likely to meet heightened judicial scrutiny during the pandemic. They also face logistical challenges because many state and federal courts are not holding in-person hearings.

The primary focus at the start of restrictive covenant cases concerns the question of immediate irreparable harm resulting from a defendant’s alleged breach of a covenant. Given the health and economic exigencies currently facing the nation, business dispute claims of emergencies may pale in comparison, at least in the eyes of deciding judges. With many businesses shut down or operating in limited fashion, courts may be more receptive to arguments that breaches cannot cause irreparable harm since little to no commerce is being conducted. Nevertheless, for plaintiffs, the focus remains on the irreparable harm from breaches relating to confidential information, goodwill, and customer relationships.

Obtaining injunctive relief in the present circumstances may be difficult when it comes to the equitable issues of the balance of hardships and impact on the public interest. Arguably, when jobs are scarce, stronger support may exist for allowing a laid-off or furloughed defendant to continue to work in a position in violation of a restrictive covenant. Counter-arguments against hardship to the defendant employee—namely, that the person could find another job in what was until recently a booming economy—could be less applicable now. The impact on the public interest component of injunctive relief for restrictive covenants often gets little attention. But if the case relates to healthcare, the public interest argument could be affected by the current strain on the medical system.

In 2013, a Connecticut district court refused to enforce a noncompete agreement against an employee who had not even been discharged, but had resigned his position in response to significant layoffs that had caused him to fear for his job security. The court cited several reasons for denying the employer’s attempt to enforce its noncompete agreement, including that under New Jersey law, doing so would cause the employee to suffer “undue hardship” because he was the sole breadwinner for his household, and that the agreement would prevent him from finding work in his field.

Several states, including Washington, Massachusetts, and Nevada, have enacted restrictive covenant statutes limiting or restricting the ability of employers to enforce noncompetition agreements against laid-off employees. A minority of states rely on common law principles to refuse to enforce noncompete agreements against employees discharged in other states.

Litigants also face logistical challenges in restrictive covenant cases and requests for preliminary injunctive relief. Many federal and state courts are no longer holding in-person hearings, leaving evidentiary hearings by phone or video as the only option. Courts and practitioners are already adapting.

In Biomin America, Inc. v. Lesaffre Yeast Corp., for example, a federal court in Kansas noted in a March 30, 2020, denial of a motion for a temporary restraining order for alleged breaches of restrictive covenants that the pandemic had led to difficulties for in-person court proceedings. “Given the unique difficulties posed at this time—such as the inability of out-of-state counsel and witnesses to travel to Kansas for a hearing—counsel agreed that an evidentiary hearing on the motion was neither feasible nor necessary,” the court stated. The Court thus resolves the motion on the papers and the evidence submitted by the parties.”

Moonlighting Employees

Many employers have policies or agreements limiting employees’ ability to engage in other employment. Employers may want to consider how and whether those policies apply to employees on temporary furlough and whether modifications are needed to ensure the employer’s confidential information, business, and customers are appropriately protected.

Selective Enforcement Arguments

Companies may elect not to enforce restrictive covenants in these turbulent times for a variety of reasons, such as cost, time, a lack of need given the scarcity of jobs, or worry about negative publicity. Regardless, there is a concern that future efforts to enforce the agreements could run up against selective enforcement arguments. In limited circumstances, such arguments have persuaded some courts. The rationales were:

  • The employer waived or relinquished its rights and interests in the enforceability of the restrictive covenant by failing to enforce them against others.
  • Under equitable estoppel principles, the employer led a departing employee to believe the restrictive covenant would not be enforced.
  • The reasonableness and necessity of the restrictions are in doubt if they are not enforced against others.

Some employers, short of enforcing all restrictive covenants, have used limited (and confidential) releases to allow work in specific positions with established duties for limited periods of time while still protecting their legitimate interests and obtaining reasonable (albeit different) restrictions against former employees.

In some jurisdictions (e.g., New York), restrictive covenants are not enforceable against employees who have been involuntarily discharged. In such situations, selective enforcement arguments have limited applicability.

The First Material Breach

A basic tenet of contract law is that a party may not claim the benefits of a contract after having been the first to breach it. Many courts have applied this doctrine to employment agreements containing restrictive covenants, finding that employers’ failures to abide by the material terms of contracts warrant invalidation of the restrictive covenants therein. Determining whether a breach is material will depend on the specific circumstances and contract at issue, but material breaches typically include meaningful changes to compensation or an employer’s failure to abide by a contract’s termination provisions. Employers considering altering certain terms and conditions of employment may want to review existing employment agreements beforehand.

Relying on the “prior breach doctrine,” at least one court has held that an interruption or substantial reduction in pay to an at-will employee could discharge an employee’s obligation under a restrictive covenant agreement. In Cytlmmune Sciences, Inc. v. Paciotti, the U.S. District Court for the District of Maryland in 2016 declined to grant a preliminary injunction as to a noncompetition agreement, noting that furloughs that caused an employee to forgo a substantial portion of his annual salary supported “the finding that the failure to pay his full salary was a material breach to the employment relationship.” The court acknowledged, however, that a salary modification would not necessarily constitute a material breach depending on the nature of the employment relationship, or where the parties agreed to the modification, whether explicitly or implicitly.

Narrowly Tailored Covenants and Enforceability

Restrictive covenants containing reasonable and narrowly tailored restrictions tend to be more enforceable—in a time of pandemic or otherwise. Limits for time, activity, and geographic restrictions, together with identified, legitimate protectable interests such as trade secrets, confidential information, goodwill, specialized training or techniques, and established customer relationships, loom larger as courts become more critical of noncompetes and other agreements. Restrictions that bar an employee from working in any position for a competitor—as opposed to the same or similar position the employee held—may be viewed unfavorably by courts. Geographic limitations specific to company, industry, employee, and position, as well as narrower time limits, are likely to be better received in many jurisdictions.

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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