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Guarding Business Goodwill With Non-Compete Agreements


By: 
Date: April 7 2003

What if your devices, processes, data, etc. do not rise to the level of trade secret status because, e.g., they have insufficient economic value, the information is widely known, easily ascertainable, or -- most commonly (as discussed in Part 2) -- your methods to maintain secrecy fall short of legal requirements? Your business still has potential tools to protect forms of goodwill other than trade secrets.

As discussed in Part 1, goodwill can exist in trade secrets, patents, copyrights, and trademarks/trade names. But it also exists in factors such as reputation, location, course of dealing, customers, and the expectation of continuing relationships with a significant percentage of them. Businesses concerned with transfers of knowledge in the trade secret disputes previously discussed are, of course, really concerned with the ultimate damage of transfers of customers. Obviously, a high-powered salesperson can wreak havoc on his former employer´s business.

Employer efforts to preserve goodwill often focus on the factor of continuing customer relationships. "Non-compete agreements" are the legal tools employed. Other terms used interchangeably for these types of agreements are "restrictive covenants", "covenants not to compete", "non-competition agreements," and "non-competes." Whatever their label, the use of such agreements has been increasing markedly in recent years.

Unlike some other states, Maryland does not have a statute governing the enforceability of covenants not to compete. It is left to state courts to decide the limits upon enforceability of such covenants. These agreements are scrutinized -- and sometimes very strictly so -- by courts under common law principles that take into account the countervailing interest of not imposing unreasonable restrictions on someone´s ability to earn a livelihood in the industry/profession of his choice. The employee´s interest is likely to be more protected because of the great disparity in typical bargaining power. Employers often are anxious to make sure their key business producers do not fall into the clutches of the competition. However, they must craft any such contemplated agreements with an eye toward the current trends of court rulings. They may not be enforceable depending upon the court´s view of their reasonableness in terms of duration, geographic scope, their extension to existing or prospective customers, and impact on the employee´s ability to earn a livelihood.

In weighing reasonableness, Maryland courts have stated that the following factors (in addition to the previously-discussed need to protect trade secrets) are to be considered in deciding whether to enforce non-competes:

 

  • First, whether the employee is a skilled employee whose services are unique. If the employee takes to his new employer nothing more than training and experience provided by the prior employer, there is no protectable interest. Where the business involves a nonunique product or service, and information such as customers´ names and addresses are readily available by way of canvassing, cold-calling, and telephone or professional journals, there may be no protectable interest. This line of reasoning is particularly true in industries where customers are major industrial concerns or are somewhat transient and cancel or transfer their business commonly and future business depends on constant periodic renewals.
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  • Second, whether there is unfair solicitation or exploitation of contacts, or there is a "close relationship" or "personal contact" between the employee and the customer, as stated by federal courts in 2 of my cases from the mid-1990s. The factor of unfair solicitation of customers has been applied in cases involving route salespersons or non public customer lists, where the salesperson became familiar with such customers due to the employer´s exposure. Where business success is perceived as more attributable to substantial personal interactions of employees with customers than to the unique or superior quality of its business product, the employer´s interest in protecting the diversion of the business to a former employee will be deemed more deserving of protection. Accordingly, the Maryland Court of Appeals has upheld a covenant against a former employee of an insurance brokerage firm. Non-compete agreements may tend to be more enforceable in service industries than in goods-producing industries where products may be merchandised more on the basis of price, quality and advertising efforts, and the salesperson´s efforts are of secondary impact.
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  • Third, whether enforcement would pose an unfair hardship on the employee or would disregard the public interest. A former employee´s unemployment because of a covenant suggests undue hardship. To reduce this risk, employers might consider a covenant providing for the payment of a portion of the employee´s salary for the duration of the noncompetition period. In one case, paying half the salary was ruled not to impose an undue hardship.
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In considering whether duration and geographic restrictions are unreasonable hardships, the Maryland Court of Appeals long ago stated there is no "yardstick as to what protection of the business is reasonably necessary, no quantifiable measurement of what constitutes undue hardship on the employee, and no precise scales to weigh the public interest." Tuttle v. Riggs-Warfield-Roloson, 251 Md. 45 (1968). As some barometer, one year restrictions have been upheld repeatedly, if other restrictions passed muster. Practitioners in this area of the law are ill-served by boilerplate contract language applied to every situation.

As to what state´s law applies in a litigation over a covenant not to compete, the general rule in Maryland is that the construction and validity of such a contract is governed by the place the contract is made. Other states, however, may have different rules and an agreement enforceable in Maryland, for example, might not be in California courts.

It is also noteworthy that Maryland courts often "blue pencil" restrictions found to be overbroad. That is, the multiple promises or restrictions in such agreements are considered severable; if one portion is overbroad, it will be struck and the balance of the agreement enforced. In contrast, some states do not apply the "blue pencil" rule, under the rationale that an overbroad restriction so taints the entire document as to make it unenforceable.

In sum, the risk in using non-competes varies, depending on the nature of the pre- and post-termination activity. Employers may be better off using more specific and less restrictive agreements. For example, if the former employee solicits his former employer´s customers, particularly those customers he personally dealt with during the prior employment, the noncompetition restriction has a better chance of being enforceable. An agreement which prohibits solicitations of any of the employer´s clients is less likely to be upheld as reasonable than is one which prohibits the employee only from soliciting clients with whom the employee had contact while employed by the employer. The highest degree of court scrutiny will be imposed on an agreement prohibiting an employee from engaging in any type of activity with the competing employer. The Virginia Supreme Court just recently (in April 2002) ruled a non-compete prohibiting a former salesperson for an office furniture company from working in any capacity for a competitor was overbroad and unenforceable.

In short, "non-solicitation" agreements are more likely to be enforceable than "non-compete" agreements. Another permutation is the "no-raiding" or "anti-piracy" agreement, prohibiting employers from hiring away other employees of their employer.

As the foregoing suggests, there are no "bright line" tests in this area of the law. The limitations on enforceability are very fact-specific, applied on a case-by-case basis, and subjected to increased scrutiny. The new Virginia Supreme Court case is likely to be used as a defense in multiple non-compete cases. The gray areas in the law should not rule out considering the non-compete agreement for your toolbox of potential devices to preserve certain forms of your business goodwill.

 


About The Author

Pat Pilachowski graduated from Johns Hopkins University and received his law degree, with honor, from the University of Maryland. He joined the Shawe & Rosenthal firm in 1977. Pat has represented employers in a wide range of labor relations matters, such as contract negotiations and litigation involving executive employment contracts with non-competition, confidential business information and/or trade secret provisions, as well as union contract, EEO, Wage and Hour, NLRB and OSHA matters.



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