IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities.  Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog article has been provided by Martin Kreshon III of North City Law (www.northcitylaw.com):

The Vital Role of Restrictive Covenants in Protecting Employer Interests

In today’s competitive business landscape, protecting sensitive information and maintaining a stable workforce are paramount to an organization’s success. Employers often invest significant resources in developing the things that grant them a cutting edge: customer/client lists and preferences, pricing methodologies, and vendor agreements, to name a few.

To safeguard these valuable assets, employers frequently utilize restrictive covenants agreements  to limit an employee’s actions during and after their employment. Critically, for these covenants to be enforceable, they must be supported by valid consideration, i.e., they should be signed at the beginning of the employment relationship or for some other form of consideration, like a bonus or extra PTO.

The foundation of a valid contract rests upon the principle of mutual consideration. Consideration represents the bargained-for exchange between the parties. In the context of employment agreements, the employer’s promise of employment and compensation serves as consideration for the employee’s promise to abide by the terms of the restrictive covenants. However, this exchange must occur simultaneously. If an employee is already employed and then asked to sign a restrictive covenant without receiving anything additional in return, the agreement is likely unenforceable due to a lack of consideration. The pre-existing employment relationship does not constitute new consideration for the restrictive covenant. Essentially, the employee is being asked to give up certain rights without receiving anything of value in exchange. This is why it is absolutely crucial for employers to implement restrictive covenants at the beginning of the employment relationship, ideally as a condition of employment. At this juncture, the offer of employment, including its associated compensation and benefits, serves as the necessary consideration for the employee’s agreement to the restrictions.

One of the most critical areas where restrictive covenants are essential is the protection of confidential information. In today’s information age, businesses rely heavily on trade secrets, proprietary formulas, customer lists, marketing strategies, and other confidential data to maintain a competitive edge. Employees, particularly those in key roles, often have access to this sensitive information. Without a properly executed restrictive covenant, an employee could potentially misappropriate this information for their own benefit or share it with a competitor, causing significant harm to the employer. A well-drafted restrictive covenants agreement can define what constitutes confidential information, restrict its disclosure to unauthorized parties, and outline the employee’s obligations regarding its protection, both during and after their employment. This can include stipulations about returning company property containing confidential information upon termination of employment.

Beyond protecting confidential information, restrictive covenants play a crucial role in safeguarding an employer’s relationships with its employees and clients. Employee solicitation, often referred to as “poaching,” can disrupt business operations and damage morale. Clients represent a significant investment for any company, and their loss can have substantial financial repercussions. Restrictive covenants can address these concerns by limiting an employee’s ability to solicit or recruit other employees to join a competitor or to solicit clients to move their business away from the employer. These restrictions can be particularly important for employees in sales, marketing, or other client-facing roles. A well-crafted restrictive covenants agreement can specify the duration of the restriction and the geographic scope, ensuring that the limitations are reasonable and enforceable. For instance, a covenant might restrict an employee from soliciting clients they directly worked with for a period of 18 months following their departure from the company.

While restrictive covenants are vital for protecting employer interests, they must be reasonable in scope and duration to be enforceable. Courts have scrutinized these agreements, and overly broad or restrictive covenants are often deemed invalid. The restrictions must be no greater than necessary to protect the employer’s legitimate business interests and should not unduly restrict the employee’s ability to earn a living. Factors considered by courts include the nature of the employee’s work, the geographic scope of the restrictions, the duration of the restrictions, and the potential harm to the employer if the restrictions are not enforced. It is crucial for employers to work with legal counsel to draft restrictive covenants that are tailored to their specific needs and comply with applicable state laws.

It is also extremely important that a restrictive covenants agreement contain appropriate attorneys’ fees language. Litigation is VERY expensive, and no employer initiating a lawsuit for theft of its trade secrets or confidential information  (e.g. calls, texts, and emails to all customers or clients asking if they’d like to come to the employee’s new venture at a reduced rate) wants to file. Though expensive, such terms allow the court to require the person committing the theft (and it is theft) to pay the employer’s attorneys’ fees, expenses that can get into the 5 figures pretty quickly.

In conclusion, restrictive covenants are an indispensable tool for employers seeking to protect their confidential information and maintain stable relationships with their employees and clients. They give employers an additional cause of action, breach of contract, against the rogue employee in addition to breaches of statutory and common law. However, the effectiveness of these agreements hinges on their implementation at the beginning of the employment relationship or after receipt of the employee of separate consideration. By proactively addressing these concerns through well-drafted and properly implemented restrictive covenants, employers can mitigate the risks associated with employee departures and safeguard their valuable business assets. This proactive approach is essential for long-term success in today’s competitive business environment.

If you have questions relating to the content of this article or legal issues associated with restrictive covenants, Martin Kreshon would welcome the opportunity to answer them.  Mr. Kreshon can be reached at (206) 929-0609 and martin@northcitylaw.com.

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, real estate, accounting, legal, and financial planning communities on subjects relevant to the purchase & sale of privately held companies and family-owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.