What are Protective Covenants Agreements?
A protective covenants agreement is a legally binding contract between an employer and employee, which restricts the employee in various ways. The employee is usually a shareholder or a director of the company. It aims to protect the legitimate business interest of the employer. A protective covenants agreement can restrict: An employee cannot look up customers on the company’s customer database and set up his or her own business. An employee cannot take customers with them. An employee cannot use the trade secrets in his or her future business. A protective covenants agreement is usually restrictive, but it does not have to be so . The employer could put in clauses which would require the employee to perform certain actions for the employer, but for which he or she could be compensated. For example, a post termination compensatory payment could be an inducement to sign the agreement.
Agreements that are tailored and use appropriate language will be upheld by the courts. However, courts can be reluctant to find in favour of employers if all the remedies listed above are included in one contract. If that is the case, there could be a real danger that the line between protecting the legitimate business interest and placing a restraint on the employee’s professional freedom becomes blurred. Employers must ensure that their agreements are drawn up with the relevant constraints in mind.
Types of Protective Covenants
There are several different types of protective covenants. These can include non-compete agreements, non-solicitation agreements, confidentiality agreements and indefinite agreements.
Generally, a setting with a non-compete agreement, the restraint on competition afforded to a company will be more than if it merely entered into a non-solicitation agreement or confidentiality agreement with its employee.
Non-Compete Agreements
A non-compete agreement restricts a party from competing with another party in some manner. Typically a non-compete agreement will limit the type of competition, the duration of the restraint and the geographic area of the restraint. A non-compete agreement must be tailored against the inevitable harm to a business that results when a skilled, valuable employee separates from the company. Thus, the non-compete must provide protection for the specific employer’s interests and protect against what the employer reasonably believes that its employee might do.
Non-solicitation Agreement
A non-solicitation agreement prevents a separate party from trying to convince employees to leave a company or clients/customers to stop doing business with a company and to begin doing such activity with a separate business. A non-solicitation clause often accompanies a non-compete agreement and can, over time, become more important than a non-compete provision, which cannot be forever enforced.
Confidentiality Agreements
A confidentiality agreement is a promise by an employee to not disclose any knowledge or information learned while working for the separate party. Or, it can prevent the disclosure of information regarding a process or formula that the working party wants to keep confidential and protected from the general public. This agreement can be enforced during the course of an employment or business relationship, and can also be enforced post-employment. In Indiana, unless the agreement has a specified duration, it will be presumed to not apply indefinitely.
Indefinite Agreements
An indefinite agreement is simply an agreement with no specific duration. In Indiana, the law considers an indefinite agreement to last for five (5) years.
Enforceability of Protective Covenants
The legal enforceability of protective covenants can vary from state to state, with some having relatively relaxed restrictions and others placing significant limitations on their efficacy. This can pose challenges for employers who operate across state lines and who seek uniformity in their agreements with their employees and independent contractors. In California, for example, all non-compete clauses are void unless there is a dissolution of a partnership under California law. There are, however exceptions to this rule, such as in the event of a sale of business, in which case certain provisions may be necessary to protect the value of a company.
Generally speaking, courts will determine whether or not an agreement between companies and their employees or subcontractors is unenforceable depending on jurisdiction. Some states still have a bright line definition of what constitutes a trade secret, while others places the final determination in the hands of a jury or fact finder.
There is also significant discrepancies between states regarding what remedies are available for the breach of a contract. Some states may leave remedies for breach of a contract entirely to the parties involved, while others may only permit injunctive relief or monetary compensation. Factors such as how much notice an employee must provide prior to leaving, the amount of damages that are easily measurable, and whether or not an injunction is likely to be obtained are also considered.
Some courts also consider whether or not non-compete clauses between contractors and companies are appropriate and reasonable if they are written to apply beyond the individual state, such as in the case of cross-border disputes.
Advantages of Protective Covenants
There are several benefits to protective covenants for both employers and employees. We first discuss employers, followed by a look at some of the benefits to employees. Employers are at significant risk of unfair competition from former employees. While it is not uncommon for a former employee to maintain a relationship with his/her clients after leaving a company, there can be a fine line between a former employee properly maintaining previously-established relationships and improperly soliciting former clients or taking unfair advantage of the employer’s investment in the employee’s training and development. Turnover in employees can also be costly to an employer. Training new employees and correcting mistakes made by former employees is an expense employer’s are forced to incur, sometimes repeatedly, if the employee leaves the employer and takes the employer’s confidential information, client information, and/or cheap talent with them. Protective covenant agreements allow employers to protect their relationships with current and former clients, and to protect confidential information obtained through the hiring, training and development processes. They can also extend the development of employees whose skills are then available to employers and their clients.
Employees may benefit from a protective covenant agreement primarily in the context of unfair competition. It is a natural function of an employee’s employment that the employee makes contacts within her employer’s business environment, which we will refer to as "clients." Employees often seek to maintain those connections after separation from the employer. For example, a sales employee, such as a real estate agent, may work with a client for weeks or months prior to buying or leasing property. The employee then may seek to maintain that relationship after separation from the employer; particularly in high transaction fields like real estate, insurance, and financial services, the employee may seek to maintain contact with the client for years. In those situations, the employee is likely to be competing with the former employer unless the employee has a contractual right to maintain the relationship.
How to Draft Protective Covenants
Best practices suggest that protective covenants should be drafted as simply as possible, with clear, meaningful descriptions of the prohibited conduct and in a fashion that still gives adequate notice of what conduct is covered by the restrictive covenant. With respect to time, these provisions should be tailored to the particular situation and not merely copied from precedent. However, it should be noted that the courts rarely enforce a restrictive covenant of more than five years; therefore , when the time period exceeds five years, it must be clearly necessary for the benefit of the employer and protect the legitimate business interests of the employer. With regard to geographic limitations, these restrictions must also be tailored to the individual circumstances and not routinely copied from precedent. As a general rule, however, the geographic limitation can be no broader than the area in which the employee was principally based.
Recent Developments and Cases
In the last few years, we have seen a marked increase in the use of protective covenants, with more employers and clients interested in this type of agreement. Economists suggest that the shift in the economy and the growth of competitors in the valley has spurred this increased interest in protective covenants because these types of restrictive covenants tend to be tailored to a geographic area.
In 2015, Blake, Cassels & Graydon LLP published a summary of the state of the law on restrictive covenants in various Canadian provinces. Recent case law in Ontario and Alberta has endorsed the use of protective covenants. Most cases have emphasized the need for carefully crafted provisions, or the risk of being denied an injunction should those provisions be overly broad. However, cases in Quebec continue to decline to enforce post-employment provisions against employees.
In Cowling v. Lee, 2014 BCSC 49 (CanLII), the British Columbia Supreme Court enforced a protective covenant that the employer agreed to release because the court reversed its earlier determination that the employer was not released from the covenant. The parties had released the defendant company from the covenant if the defendant individual agent resigned, got terminated, or left voluntarily, but forgot to also include a release by the defendant company if the employee agent resigned, got fired, or left voluntarily. The plaintiff company sought to enforce the protective covenant against the individual employee even though it subsequently released the company which led the court to determine that it was a factual error by the parties and ordered to correct the contract to include the release of the individual.
The trend of increasing success in East Coast Canadian courts should be noted by West Coast employers. In Baig decision, the New Brunswick Court of Appeals set aside an injunction that restrained a former employee from soliciting clients based on the harshness of the enforcement of the restrictive covenant. The courts have required that the employer take steps to reiterate the employee’s responsibilities in the presence of independent counsel after termination. Employers should take steps to ensure that any and all restrictive covenants in an employment agreement are highlighted and explained to an employee. An Alberta court determined that although the employee could not be expected to abandon their entire reputation and network of contacts, the clause was reasonable and would not cause undue hardship to the employee if enforced. The Alberta Court of Appeal subsequently confirmed that other factors which may be taken into account and weighed in the balance included the costs to the plaintiff of the breach, the loss expenses the defendant will incur if the injunction is granted, along with the public interest in the enforcement or non-enforcement of the covenant.
Resolving Disputes from Protective Covenants
Disputes involving protective restrictions often stem from a disagreement with regard to the enforceability of such restrictions. However, the need for Courts to impose and determine the scope of restrictions over land is usually only required when the objecting party desires to change the use of the land and to insist on the development of a restriction-free environment.
It is not unusual for developers to seek to advance claims seeking permission to proceed upon the basis that existing restrictions have ceased to have effect either by virtue of changes to the character which that part of the land has in contemporary terms, or upon the basis that the restrictions have been rendered obsolete by a decision made unilaterally by their neighbours to change their land and the manner in which it is used.
It is, however, very rare indeed for a Court to find that protective restrictions are unenforceable where the intention of a developer to build is capable of being met by constructing the building and use for which the land was originally restricted, or a variation of that design. A refusal to relax the restrictions is much more likely to occur where the Court concludes that the builder is seeking a substantial change of use, or to make alterations of such dimension and type as to destroy the value of the original design and make it of no practical use .
A number of strategies may be used by parties to eliminate the costs of court proceedings and to obtain early certainty on the issue as to whether or not a building scheme may soon be constructed. Some of these include obtaining a pre litigation opinion from counsel, informal negotiations to obtain written consent, and adjudications by the Land and Environment Court to determine the scope of the restrictions.
Consent may be rather important to any developer asserting that the claim of another land owner with whom they share a restrictive covenant has been relinquished. The Court will be very reluctant to determine that a restrictive covenant has been destroyed, varied or extinguished if at any time prior to the commencement of their proceedings the party seeking to remove the restrictions informed other owners of the easements or restrictions that they would construct or use their land in a manner contrary to the restrictive covenant. As such, the party who wishes to build contrary to any restrictive covenant should seek a formal release from that restrictive covenant from other owners.
