Restrictive Covenants as a Device to Protect Trade Secrets

• Pages: 85-119

CHAPTER 4

Restrictive

Covenants as a

Device to Protect

Trade Secrets

Even when access to a company’s trade secrets is tightly restricted,

those trade secrets must necessarily be entrusted to some employ-

ees, and nondisclosure agreements do not always provide the pro-

tection required. The need for additional protection against the

disclosure of sensitive information may also arise when a business

is sold. In addition to confidentiality agreements, contract-based

mechanisms for protecting confidential and trade secret infor-

mation include noncompetition agreements (or “covenants not to

compete”), nonsolicitation agreements, and “no-hire” or employee

nonsolicitation agreements. These agreements are sometimes

refer red to coll ectively as “restrictive covenants.”

Nonsolicitation agreements restrict former employees or the

sellers of a business1 from contacting the business’s customers,

while “no-hire” or employee nonsolicitation agreements restrict

the hiring away of a company’s employees. Noncompetition agree-

ments more broadly prohibit former employees or owners from

competing with the business; this typically includes accepting

employment with a competitor. Each of these may play a vital role

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in a company’s enforcement of its trade secrets. In addition to serv-

ing as necessary evidence of the company’s efforts to protect its

trade secrets,2 they provide a superior avenue to prompt judicial

intervention when a former employee or the seller of a business

attempts to use a business’s trade secrets or confidential informa-

tion to his or her advantage.

Like trade secrets, these agreements are governed by state law.

Unlike trade secrets, with respect to which the Uniform Trade

Secrets Act (UTSA) has imposed some uniformity,3 no unifying

principle has emerged in the field of restrictive covenants and a

50-state survey displays remarkable variety in how receptive a

jurisdiction is to such agreements and in the rules governing their

creation, interpretation, and enforcement.4 A national survey is

beyond the scope of this chapter, which focuses on the law of five

jurisdictions whose disparate approaches highlight this diversity.

• New York. An influential jurisdiction with a common law

approach to trade secrets, New York also continues to

embrace a traditional common law approach to restric-

tive covenants. Judicial determinations of the validity of

employee noncompetition agreements are governed by

what the New York Court of Appeals has termed a “pre-

vailing standard of reasonableness.”

• Illinois. While Illinois has embraced the UTSA, the enforce-

ment of restrictive covenants is subject to a highly fact-

specific common law inquiry. While generally inhospitable

to restraints on competition, Illinois courts will examine

the “totality of the circumstances” to determine if an

employer’s protectable interest is being advanced without

unreasonable limitations on competition.

• Tex as . Although Texas courts have historically been hos-

tile to covenants not to compete, with recent case law, the

pendulum is swinging toward a more employer-friendly

approach. In 1993, the Texas legislature enacted a statu-

tory regime intended to provide the business community a

greater degree of certainty regarding the enforceability of

covenants not to compete, and in 2011, the Texas Supreme

Court issued a decision that appears to simplify Texas’s

previously complicated case law on enforceability.

• Florida. Responding to an increasingly mobile work force

and fierce competition for customers, the Florida legislature

codified its law of restrictive covenants in 1996 to provide

Restrictive Covenants as a Device to Protect Trade Secrets

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a comprehensive statutory mechanism for the enforcement

of restrictive covenants. Instead of forcing employers to

predict what a reviewing court might someday consider

a “reasonable” restriction, the statute provides “safe har-

bors” in the form of restrictions that are presumed to be

reasonable.

• California. Subject to a handful of legislative and judicial

exceptions, restrictive covenants are void in California as

unlawful restraints of trade. A recent decision of the Cali-

fornia Supreme Court reaffirmed the state’s public policy

favoring freedom of competition and employee mobility,

sparking debate about the future of the one broad excep-

tion that California courts historically have embraced:

enforcement of restrictive covenants where necessary to

prevent trade secret misappropriation.

Despite this variety in approaches, a common set of issues

underlies almost every state’s treatment of restrictive covenants,

dictating whether and to what extent they will be enforced:

1. Does the restriction protect a legitimate business interest?

2. Are geographic and temporal restrictions reasonable?

3. Is the covenant supported by adequate consideration?

4. Does the covenant impose an undue burden on the party

bound?

5. Is the restriction in the public interest?

PRACTICE TIP

Whether you are drafting a restrictive covenant or deciding

wheth er to hi re an empl oyee who is bound by one, make sure

to focus on the law of the jurisdiction or jurisdictions (there

may be more than one!) that may be asked to enforce the

agreement.

I. A Restrictive Covenant Must Protect

a Legitimate Business Interest

Because restrictive covenants restrain trade, they are looked upon

with disfavor. In those states that will enforce a covenant not to