Labor: Restrictive Covenants and High-Level Executives

When it comes to restrictive covenants (non-competes, non-solicitation and non-disclosure agreements) for high-level executives, many companies think that "more is more." Because high-level executives make more money, have more responsibilities and are given greater access to trade secrets, confidential strategies and other proprietary corporate information, the typical corporate mindset is that executive restrictive covenants should have longer durations, cover more activities and have nationwide (and even global) geographic restrictions. The tactic of imposing such onerous restrictive covenants on high-level executives, however, may be bad for business and legally risky.

Up to 60 percent of high-performing employees plan to leave their organizations within the next year, recent research shows. With this expected talent drain, organizations need to have limited and enforceable restrictions in place to help deal with departing employees, but also to enhance their ability to recruit high-performing executives who are leaving their prior firms.

In Avco Co. v. Feldman, the employer Avco (a financial consulting subsidiary of Goldman-Sachs) obtained a preliminary injunction from a federal district court in New York enforcing a non-compete clause that stated he would provide Avco with 90 days notice prior to terminating his employment and that if he resigned prior to the end of the notice period, he would not work for a competitor anywhere in the United States for 90 days or for the unfinished portion of the notice period. Noting that Avco had offered to continue to pay Feldman his salary during the non-compete period, the court found that the 90-day limitation period was "well within what has been found to be a reasonable timeframe for a non-compete provision."

One of the reasons that cuts against using broad restrictive covenants with high-level executives is that the law varies from state-to-state. While one state may enforce a properly supported nationwide non-compete against a departed CEO or chief sales executive, others will not. Some states will allow courts to "blue pencil" or write overly-broad restrictive covenants, but others won't. Therefore, trying to tailor restrictions to the jurisdiction where the executive works may be futile if he or she has nationwide responsibilities.

Similarly, relying on choice-of-law provisions (designating a particular state's law to be applied by a court in the event of a dispute) can be problematic as most courts will refuse to enforce choice-of-law provisions if the law of the designated state conflicts with the law of the state where the enforceability of the restrictive covenant is located.

So what can organization do to prevent top executives from leaving and unfairly competing against them? Use the following techniques and strategies:

  • Garden Leave: Consider paying the executive for the time you would like him or her to refrain from competing. Courts favor these provisions, but they do not guarantee that the restrictive covenant will be enforced. It may be tempting to add a clause cutting off garden leave pay if the ex-employee finds another job or fails to conduct a diligent job search, but be aware that courts have found such attempts to "give with one hand and take back with the other" can undermine the enforceability of the restrictive covenant;
  • Forfeiture-for-Competition Provisions: Contractual provisions involving the employee forfeiting stock options and other deferred compensation by going to work for a competitor are akin to golden handcuff arrangements. They are viewed slightly more favorably by the courts than "regular" non-competes (which simply prohibit post-employment competition) because the ex-employee ostensively has the choice of taking the competitive new job and foregoing the compensation offered by the former employer or taking the money and sitting on the sidelines for designated time period.
  • Multiple Types of Restrictions: As noted above, employers should include in executive employment agreements separate provisions prohibiting designated competition, solicitation of customers and employees and the disclosure of trade secrets and protectable confidential information, as well as forfeiture-for-competition and advance notice of resignation provisions. The agreement should also contain a severability clause stating that each of these restrictions are independent of the others and that any invalid restriction can be severed from the rest, so that the fall of one does not lead to the fall of all post-employment restrictions. However, the severability clause must be carefully drafted and accompanied by a "blue pencil" provision, so that it does not preclude the modification of an overly broad restriction in states where courts are allowed to "blue pencil" or judicially modify overly broad covenants.
  • Trade Secrets, Confidential Information and Intellectual Property: The prior employer's need to protect trade secrets, confidential information and intellectual property (along with the desire to protect customer relationships) is at the heart of many disputes about the restrictive covenants of high-level executives. The multi-million dollar Barbie v. Bratz doll litigation (Mattel, Inc. v. MGA Entertainment), to name one recent example, arose out of the intellectual property provisions of a former Mattel employee's employment agreement and involved disputes about whether he had to assign to Mattel his "ideas" (as opposed to "inventions") that he allegedly developed on his own time without Mattel resources.

The bottom line is that employers must carefully think through the restrictive covenants of top executives and must follow through to make sure that, among other things, compensation and benefit plans used to provide the consideration for the restrictive covenants are aligned with the terms of the executives' employment agreement and that information that the employers do not want to be later used against them (customer information, marketing strategies, etc.) must be kept under lock and key, password-protected and secured against replication by external means.

Read Paul Starkman's previous column. Read Paul Starkman's next column.

Paul E. Starkman

Paul Starkman is one of the leaders of the labor and employment law practice group at Pedersen & Houpt.

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