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Restrictive Covenants May Not Be As Restrictive As Your Firm Leads You To Believe
estrictive covenants. Every rep has heard of them. Many reps have agreed to them. But do they "stand up in court", as they say? There are numerous issues surrounding the use and enforceability of restrictive agreements. Let's overview the more pertinent issues.
What is a restrictive covenant? It is an agreement, normally in writing, as part of a rep's employment agreement or training agreement. It has two components. First, a non-disclosure agreement, relating to trade secrets or other confidential information. Second, a non-solicitation agreement, relating to soliciting customers for a limited period of time and within a specified geographical area. Typically, the period of time ranges from 90 days to 1 year after termination, and the geographic restriction is from 10 miles to 100 miles of the rep's former branch office or any branch existing at the time of termination.
Are customer lists protected as trade secrets? Not necessarily. In fact, courts and arbitration panels scrutinize two critical questions. First, how was the customer list obtained? Second, what steps did the firm take to protect the confidentiality of the customer lists while the rep still was employed at the firm? To determine how the customer list was obtained, one examines such issues as: 1) did the firm give the customers to the broker upon hire; 2) did the broker bring the customers with him to the firm from a prior firm; and 3) did the broker develop the customers on his own at the firm? If the last scenario applies, one needs to consider, what types of assistance (financial, administrative, etc.) the firm provided to assist the broker in that effort.
Clearly, reps have the most success in voiding covenants not to compete either when the firms did not take sufficient steps to safeguard their "secret" customer lists or when reps have brought the customers to the firm from a prior firm. Otherwise, courts and arbitrators view restrictive agreements on a case-by-case basis. Further, there appears to be a real effort by courts and arbitrators to reach a "fair" or "equitable" result, always cognizant of the "reasonableness" of each party's actions.
In what other situations are reps likely to win? While there are no certain results in any litigation or arbitration process, there are two situations highly favorable to the rep. First, when the firm discharges the rep in violation of the parties' employment agreement, the law normally will excuse the promises that the rep made in his employment agreement - including the rep's covenant not to compete. The second situation is when the firm does not have the rep sign the covenant not to compete upon hire but, instead, after employment commences. The rationale for this is a legal term called "consideration". Applied here, it means that, since the rep already was employed when he was presented with and signed the covenant not to compete, the rep received nothing of value in return for relinquishing something of value (his covenant not to compete). By comparison, had the rep not been employed as of the date that he signed the covenant not to compete, the consideration that he received was that the firm hired him.
What happens with covenants that are deemed unreasonable in part but not unreasonable as a whole? This can happen, and courts and arbitrators approach this scenario in one of three ways. First, some strike the entire covenant - akin to "one bad apple spoils the whole bunch". Another approach is to enforce only what is deemed to be reasonable, and ignore the restrictions deemed to be unreasonable. Finally, the third approach is to "blue pencil" the covenant not to compete. In this approach, the courts or arbitrators modify the unreasonable portion to their liking, and enforce the modified covenant not to compete in its entirety.
Reps should note that states vary in their approaches to resolving covenants not to compete and should, as a result, consult competent legal counsel.
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Sponsored by James J. Eccleston, an attorney representing stockbrokers, financial planners and
investors nationwide in arbitration, litigation and regulatory matters, and a shareholder with the law firm
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P.C.(www.snsfe-law.com). This Web site contains material
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