Litigation: The restrictive covenant and proper formation for enforceability and protection

A restrictive covenant can be a valuable tool in ensuring that sensitive information is not turned against the company

Enforcing a restrictive covenant is perhaps the most straightforward example of how an emergency injunction may be necessary to guard against a potential injury. The purpose of a restrictive covenant is to prohibit another party from acting in a certain way. If they violate that covenant, then, in many cases, getting an injunction is the only practical way to prevent serious, and often irreparable, harm.

As a preliminary matter, a court will first examine whether the covenant was formed properly. The two determinations that it must make are whether the covenant was ancillary to the contract, and whether the covenant was supported by adequate consideration. For the first, a covenant, which is a naked restraint on competition, cannot, as a matter of law, be the sole or primary purpose of a contract. As for the second, as the covenant represents one party’s agreement to forego activity it could have otherwise lawfully done, it must be bargained for like any other enforceable contract. The courts have held that merely adding on a restrictive covenant to an employment agreement already in effect will not be enforceable. Exactly what constitutes adequate consideration will vary from jurisdiction to jurisdiction, however.

Once the court rules that the covenant was properly formed, it will next move on to determine whether or not the covenant meets the three-element test of enforceability. Those three elements are: 1) Does the covenant reasonably protect a legitimate business interest? 2) Is the covenant limited in scope? 3) Does the covenant violate the public interest?

The first element, whether or not there is a legitimate business interest that is being reasonably protected, will hinge on both the facts of the case and the case law of the jurisdiction. Merely wishing to prevent competition is not sufficient grounds for a restrictive covenant. More acceptable rationales are those such as protecting customer relationships, the goodwill of a party or company, the protection of trade secrets or confidential information, and cases where special, unique and extraordinary skills or training are involved. Depending on the state, there may also be rules regarding the enforceability of covenants for doctors, health-care associations and lawyers.

The next element examines whether the covenant is reasonably limited in scope. Both geographic and temporal limitations are considered. Whether these restrictions are reasonable will depend heavily on the facts of the case. For example, to use a case from Indiana, a covenant forbidding a dentist from operating in 43 counties will likely not be upheld if, prior to the covenant being signed, he only did business in three counties. In a case where a salesman has been regularly making contacts in every county in the state, however, a covenant enjoining him from making use of those contacts in any county may be upheld. In terms of time, a restrictive covenant that operates for an indefinite term is likely not to be upheld absent some compelling reason. How long a covenant can be, and still be considered reasonable, will likely depend on the type of business and the jurisdiction.

The final element that a court will look at is whether the covenant violates a public interest. Typically, the nature of the activity being enjoined will determine whether or not this element is met. For example, lawyers are considered to serve in the public interest, and ABA guidelines prohibit the use of restrictive covenants to prevent a lawyer from practicing. Conversely, a covenant restricting the activities of a salesman would likely have an easier fulfilling the public interest.

Having found the covenant valid, the likelihood of success on the merits and proof of irreparable harm (two of the four elements of a preliminary injunction) depends on the proof of its breach, the likely consequences to the employer for that breach, and whether they can be adequately compensated for with money. In balancing the laws, the court will focus on the effect of an injunction on the employee’s ability to earn a living in contract and the harm to the employer if an injunction is not granted.

A restrictive covenant can be a valuable tool in ensuring that sensitive information is not turned against the company that created it. Crafting and enforcing a restrictive covenant can be a complicated task, however, and is often best left to experienced commercial litigators.

Contributing Author

author image

Thomas Patterson

Thomas E. Patterson started the Patterson Law Firm in 2000. He has 32 years of experience preparing and trying lawsuits for businesses, professionals and entrepreneurs—often...

Bio and more articles

Join the Conversation

Advertisement. Closing in 15 seconds.