State Laws Make Noncompetes A Challenge

Online Exclusive: Georgia's New Non-Compete Law Hits a Legal Roadblock

It's a corporate nightmare: A key executive leaves the company amidst embarrassing revelations, and a few weeks later turns up at a competitor.

Not surprisingly, the company strikes back, filing suit in an effort to protect its trade secrets and confidential information. Two weeks later, the parties settle, with the executive returning some of his severance compensation and agreeing not to disclose company secrets.

When the companies are big names in the tech world such as Hewlett-Packard and Oracle, and the executive in the spotlight is as well known as Mark Hurd, the saga is front-page news (see "C-Suite Scandal"). But the untold story is the challenges legal departments across the spectrum of size and industry face in protecting company secrets. Those challenges are growing in a very tight job market where employees are tempted to barter inside information in exchange for a job. The proliferation of portable devices that make it easy to download and walk away with confidential data has raised the stakes.

"In these difficult economic times, people are looking to land a new position or a more secure position, and in the process they do things that are extremely ill-advised," says Paul Peralta, a member at Moore & Van Allen and adjunct professor at the University of Notre Dame Law School. "The quantity of data that can walk out the door at any time [on a jump drive] is staggering. This type of misappropriation is a real problem."

California Complications

Writing contracts designed to protect secrets is complicated because different states view noncompetition provisions very differently.

For example, in California, legal experts predicted that the court would throw out HP's suit because California law prohibits agreements that restrain a person's livelihood. Therefore, the courts don't recognize noncompetition clauses or arguments that a former employee inevitably will reveal trade secrets (see "Inevitable Impediment" sidebar).

"California really is the major outlier," says Peralta. "At the other end of the spectrum, Florida has a comprehensive set of laws that are very employer-friendly and create the presumption of validity and reasonableness. And you have everything in between."

One key difference is that in many states, judges will modify, or "blue pencil," noncompete agreements they think are unreasonable without rejecting the agreement outright. For example, the court could add a geographical restriction, defining the area in which the employee is barred from competing, says Susan Guerette, a partner at Fisher & Phillips.

"But some jurisdictions will not do that," she adds. "Some will say if a contract is overbroad it is unenforceable. Some say certain things have to be in a contract--in Louisiana, for example, you have to list the parishes in which the person is barred from competing--and they will not add those in. So you really have to tailor your restrictions to meet the specifications of each state."

Venue Variations

Agreements should be based on the law of the state where the employee works, rather than where the company is based or incorporated, because courts may reject a contract based on the law of another state or one that requires an employee to defend an action far from home.

"Employers often try to use the law of their own state," says Melissa Calhoon Jones, counsel at Tydings & Rosenberg. "But they need to know that the court may not accept it. I recently saw a case where a Maryland employer had a Georgia employee sign a noncompete that had a Maryland choice of law provision but did not meet the requirements of Georgia law. The Georgia court would not enforce it because its defects would violate Georgia law."

Regardless of the state of venue, courts will only uphold noncompetes tailored to the employer's legitimate business interests. "It has to protect something of value--trade secrets, confidential information, customer good will--those are the three fundamentals," Peralta says.

Narrowing an agreement based on legitimate business needs is critical to surviving a court challenge. Courts look more favorably on limited agreements that prohibit soliciting the company's customers, stealing its employees or disclosing confidential information, without restricting the former employee's employment prospects.

"You might be able to protect your interests with a nonsolicitation of customers provision rather than a noncompete," Guerette says. "Otherwise the court could say this is invalid--you are trying to bar them from competing when your interest is in protecting your customers."

In determining whether the agreement is reasonable, the court will also consider the employee's position. A CEO might be restricted from competing in a broad geographic area, while a branch employee's agreement might be much narrower, she adds.

Timing is Everything

For best results, a noncompete agreement should be completed at the beginning of an employment relationship, or when an employee is promoted into a position in which he is privy to confidential information. In some states, introducing a noncompete after an employee is already working in the position will require tying it to some financial consideration, such as a bonus or enhanced benefits.

"I've also seen the worst-case scenario, where an employer realizes that a departing employee has no noncompete and negotiates to include it in a severance agreement, tied to financial rewards," Jones says.

She adds that whenever someone with a noncompete is leaving to join a rival company, the employer should remind the employee of his obligations under the agreement and let the other employer know as well. The hiring employer should inquire in advance about whether the prospective employee is bound by a contract.

"If there is a noncompete and the second employer hires the person anyway, he can have his own liability for interfering with a contract," Jones says.

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