Labor: Avoiding antitrust concerns in employee restrictive covenants

Covenants may be problematic if they damage labor markets by restricting large categories of employees

Employers devote substantial resources, in terms of both time and money, to develop proprietary products and services and to train employees. The primary tool employers use to protect their legitimate interests from competitor intrusion has been the employee restrictive covenant. 

Employee restrictive covenants are generally two-party agreements between the employer and employee that govern the post-employment conduct of the departing worker. The enforceability of employer-employee restrictive covenants is generally governed by state noncompetition law, which asks a court to weigh the legitimate interests of the employer, the degree of impairment on the departing employee and the state’s interest in the free flow of labor. Restrictive covenants that violate state noncompetition laws are void and unenforceable, although in some states, courts are permitted to strike objectionable provisions or rewrite an offending restriction to render it enforceable.    

In the past several years, however, there has been an uptick in the use of employee restrictive covenants between employers. Employer-employer restrictive covenants are restrictions, agreed upon by employers, which seek to restrict the conduct of large categories of employees. These types of restrictive covenants may raise antitrust concerns and, as such, may attract scrutiny under the antitrust laws. This article examines the interplay between the antitrust laws and employee restrictive covenants.

Employer-employee restrictive covenants

Employer-employee restrictive covenants are quite common and generally take three forms:

  1. Non-competition covenants, which restrict employees from directly working for competitors of the former employer.
  2. Non-solicitation covenants, which restrict employees from contacting the current employees and/or customers of the former employer
  3. Non-disclosure covenants, which restrict employees from disclosing the former employer's proprietary information

Enforceability of employer-employee restrictive covenants has historically been determined by the state law where the restraint is imposed. State laws on these types of restrictive covenants vary considerably. In general, in those states that permit employer-employee restrictive covenants, the state law focuses on five considerations:

  1. The state's public policy to protect the mobility of its labor force
  2. The legitimacy of the former employer's business interests
  3. Consideration given and received for the restriction
  4. The precise restrictions placed upon the departing employee
  5. Whether the restrictions go no further than necessary to protect the employer's legitimate business interests in terms of the duration of the restriction, the breadth of the geography involved and the scope of the restricted activities post-employment (compared to the employee’s activities during employment)

Although the remedies also vary state by state, generally if the restrictions violate the state law, then the court will either void the restriction altogether (rendering it enforceable) or modify the language in some fashion to make the restriction partially enforceable.

Employer-employer restrictive covenants

In the recent past, there has been an increase in the use of employee restrictive covenants between employers. Employer-employer restrictive covenants sprang from the traditional employer-employee context and have evolved over time. However, unlike their employer-employee equivalents, these types of covenants may raise antitrust concerns for the following reasons:

  • The covenant has no legitimate competitive basis other than to restrict the free movement of employees in a particular commercial market
  • The employers may be direct competitors of one another in a particular commercial market
  • The employers may have significant, if not dominant, market shares in a particular commercial market
  • The restricted employees may not have consented to the covenant
  • The restricted employees may not have been given consideration for the covenant
  • The employees affected by the covenant may occupy a large percentage of a particular labor sector
  • The restricted employees may include employees who had no contact whatsoever with the counterparty employer

As such, employer-employer restrictive covenants may pose a risk of injury to competitive labor markets. Because of this, antitrust laws, rather than state noncompetition laws, may be used to challenge their lawfulness.

Unlike state noncompetition laws, in assessing the competitive impact under the antitrust laws, courts are not concerned with the legitimate business interests of the employers; rather, the focus of the antitrust laws is to determine whether a particular restraint is “unreasonable” within a particular commercial market. To determine whether the restrictive covenant is unreasonable, courts consider the relationship of the parties, the parties’ level of dominance within the market, the nature and history of the restraint, the precise market involved and the degree of commercial impairment to that market. On balance, those restraints that, in practice, produce more competitive harm than good are deemed “unreasonable.”

While unreasonable restraints are void and unenforceable, the antitrust laws also permit recovery of pre- and post-judgment interest, injunctive relief, treble damages, attorneys’ fees and costs-of-suit reimbursement. In addition, while a remote possibility in this context, certain types of antitrust violations between direct competitors may lead to criminal penalties, including significant fines and imprisonment.

When considering the use of employer-employer restrictive covenants, employers should be mindful of: 

  • The competitive relationship between the employers;
  • The commercial markets the covenant affects
  • The relative market share of each employer in the relevant commercial market;
  • The nature and purpose of the covenant
  • The duration of the restriction
  • The number of employees the covenant impacts and the basis for restricting each of them
  • The restricted employees’ overall percentage in the labor sector impacted by the restriction
  • The notice, consent and consideration afforded to the affected employees

 Conclusion

Because employer-employer restrictive covenants may raise antitrust concerns, particularly if they are entered into by direct competitors, employers should carefully consider the risks associated with their use. Assuming the necessity of such restrictive covenants, employers should be careful when crafting their terms to avoid unnecessary antitrust exposure.

Contributing Author

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Todd Seelman

Todd R. Seelman is a managing partner for the Denver office of Lewis Brisbois Bisgaard & Smith LLP and is the chair of the firm's...

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