Covenants Not To Compete: An Ounce of Prevention vs. a Pound of Cure
In today’s business climate, it’s critical for companies to save money and maintain a competitive advantage. Sometimes, you can take simple and relatively inexpensive precautions that achieve both objectives. A covenant not to compete (CNC) is a time-tested measure that helps you protect important business interests. Here’s a noncomprehensive informational guide designed to help you consider whether you want to use CNCs in your business.
A Kentucky example
A CNC is an agreement between an employer and an employee that can be used to guard against a situation in which an employee, after obtaining skills, knowledge, and business connections, decides to leave the company, take a chunk of business with him, and set up shop in direct competition with his former employer. While noncompetes may not be appropriate for every employee, you may want to consider them for employees who would pose a significant competitive risk because of the training and information they’ve received.
A CNC can be placed in an employment agreement. Thus, for minimal up-front expense, noncompetes can protect your company from a potentially devastating future hazard. A recent Kentucky Court of Appeals case provides a tidy example of the benefits of CNCs.
A carpet-cleaning company, New Life Cleaners, asked Chad Tuttle, who had worked there for several years, to enter into a CNC. He reluctantly signed the agreement, which provided that he wouldn’t contact, contract with, or provide carpet-cleaning services to any New Life client for 24 months following the last day of his employment with the company.
About 16 months later, Tuttle quit New Life and started a competing business.
Not long after he began the new business and within the CNC’s 24-month restrictive period, an important longtime client approached New Life and requested carpet-cleaning services, but specifically asked that Tuttle do the work. When the client was informed that he no longer worked for New Life, it sought him out on its own and hired him to perform the work.
New Life filed suit against Tuttle, alleging that he had breached the CNC by providing carpet-cleaning services to one of its clients within the 24-month restrictive period. The Kentucky Court of Appeals ruled that Tuttle had breached the CNC, even though the client had approached him, and ordered that the agreement be enforced. As the court’s decision illustrates, in Kentucky, a CNC has the power to prevent a former employee from siphoning off your clients even if they seek him out for services. New Life Cleaners v. Tuttle, 2009 WL 2408337 (Ky. App., August 7, 2009).
Limits of a CNC
CNCs, although useful, aren’t all-powerful, and Kentucky courts have curtailed the kind of restrictions you can place on an employee’s postemployment business activities. When considering whether noncompetes are good for your business, you should be aware of their limits. Kentucky courts won’t enforce a CNC unless it’s reasonable in scope and purpose.
Generally, a CNC must have a time limit, such as a reasonable number of months or years following the termination of employment. In addition, courts tend to favor CNCs that are limited in geographic scope — that is, there’s a limit placed on the geographic area in which the former employee’s competition with your company can be prohibited. Courts tend to look favorably on CNCs that have time and geographic limits. Nonetheless, Kentucky courts will look at the circumstances of each case to determine whether a noncompete is reasonable in scope and purpose.
A court will consider whether the purpose of the CNC is to fairly protect legitimate business interests like goodwill, client lists, confidential business information, or the time and money you’ve spent training an employee. A well-drafted and duly executed CNC is enforceable whether the worker’s employment ends voluntarily or involuntarily.
When an employer offers an employee continuing employment in exchange for a CNC, a court will determine the agreement’s enforceability by looking at whether the employee worked for an appreciable length of time following the CNC’s execution and whether he voluntarily resigned or was fired. A court is less likely to enforce a CNC if the employee is terminated shortly after it is executed.
Remedies for breach
In deciding whether CNCs might be good for your business, you may also want to consider the broad range of remedies enforced by Kentucky courts in upholding them. For example, in a 1984 case, an employer hired an employee to perform accounting services and had him sign a CNC that prohibited him from practicing accounting within 50 miles of Fayette County for five years after he left the company and from representing anyone who was a client of the company at the time of his departure.
After the former employee breached the CNC, the employer filed suit and was immediately granted a restraining order against him. The judgment later entered in favor of the employer included an order requiring the former employee to abide by the terms of the CNC. When he continued to violate the noncompete (and thereby the court’s order), the court held him in contempt and ordered him to pay more than $65,000 in damages to the employer.
In this case, the CNC provided solid legal ground for (1) an immediate restraining order against a former employee, (2) an enforceable court order that prohibited him from breaching the terms of the CNC, and (3) an avenue for pursuing and obtaining monetary damages for his breach of the agreement. White v. Sullivan.
Should I have my employees sign a CNC?
In deciding whether a CNC is appropriate for your employees, remember that Kentucky courts will recognize noncompetes that are signed as part of an initial offer of employment or (generally) as part of an offer of continuing employment. You should also consider some of the following questions:
- Do you have employees whose skills and knowledge could be useful to one of your competitors?
- How critical is “goodwill” to your business?
- How much time and money do you spend training employees only to have them go to work for a competitor?
- How much access do your employees have to your confidential business information?
- How much access do your employees have to your client lists and marketing strategies?
- In which specific markets or counties do you do business?
CNCs, though not complicated, still must be drafted correctly. When drawing up a noncompete, you must strictly observe the normal formalities of contract formation. Also, be careful not to try to get too much out of a CNC because Kentucky courts won’t permit you to use a noncompete to unduly restrict a former employee’s business activities. Courts will enforce CNCs only to the extent required to protect your legitimate business interests.
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Copyright 2009 M. Lee Smith Publishers LLC
KENTUCKY EMPLOYMENT LAW LETTER does not attempt to offer solutions to individual problems but rather to provide information about current developments in Kentucky employment law. Questions about individual problems should be addressed to the employment law attorney of your choice.