April 16, 2024

What a Covenant Can — and Can’t — Restrict

As you probably know, my practice focuses primarily on intellectual property law. Nonetheless, many of the cases I handle tend to cross over into other legal areas, and, for whatever reason, lately I’ve handled a bunch of matters related to restrictive covenants and trade secrets. It’s an area of law I’ve dealt with before, but this sudden uptick of cases at one time is definitely out of the ordinary. Maybe it is something in the water — or maybe it has to do with the Federal Trade Commission’s proposal to ban non-compete agreements, along with the New York State legislature passing a bill banning them (Governor Hochul vetoed it.) It’s hard to say. But it is an interesting, and, if you’re a business owner, important subject.

So let’s talk about restrictive covenants, trade secrets, how they relate to each other, and the enforceability of restrictive covenants because, based on my recent experience, there’s a good deal of misunderstanding — even among lawyers — about what restrictive covenants can and can’t do, what trade secrets actually are, and the enforceability of restrictive covenants.

A note about terminology: Media coverage of the FTC’s proposed ban or relevant state legislation focuses on “non-competes” — agreements where an employee agrees not to compete against his or her employer after leaving employment. In my view, non-competes are just one type of restrictive covenant — the umbrella term I’m using here. This term encompasses not just “non-competes,” but also agreements barring a former employee from soliciting his or her former employer’s customers, vendors, or employees. 

Ok, let’s get down to business: Are restrictive covenants enforceable? The short (and very lawyerly) answer is: it depends. Under existing law, restrictive covenants are enforceable to the extent that they are necessary to protect the former employer’s legitimate interest(s), don’t impose an undue hardship on the employee, and aren’t harmful to the public. 

These are key points. In New York (where I’m based), courts look at a couple of things (there are some variations between states) to determine if a restrictive covenant meets these criteria. For example, is the covenant for a reasonable time period and is it limited to a reasonable area? One that limits a former employee’s ability to work for companies that directly compete with the former employer for six months may well be reasonable. One that bars a former employee from working anywhere in the world for 50 years, though? Probably not.  

In determining whether a restrictive covenant is reasonable, courts also look at whether it’s necessary to protect an employer’s interest. Usually this means that courts want to see that there are trade secrets, confidential information, and relationships an employee developed through his or her employment that need to be protected. In my experience, this is where we run into problems. 

Have I seen people take their former employer’s trade secrets, or confidential or highly proprietary information, to their next job? Absolutely. But are there other cases where the information might not really be secret or proprietary? Yes, because there seem to be a lot of misconceptions about what really constitutes a trade secret or confidential information. 

For starters, just because an employer calls something a trade secret or says something is confidential, doesn’t mean that a court is going to agree. In fact, courts understand these terms very differently from most people. I think that if you asked a group of reasonably well educated people whether an employer’s client list is a trade secret, most would probably say it is. However, unless it would be really hard or almost impossible to figure out the identity of the clients on that list, many courts will say that list is not not a trade secret. The same goes for a list of vendors. 

In other words, in many circumstances, what people think are trade secrets aren’t actually trade secrets. In turn, this means that many restrictive covenants are less enforceable than many employers hope or believe.

However, there are a whole bunch of significant qualifications to this. Most importantly, just because a restrictive covenant may not be enforceable, or may be only partially enforceable, an employee doesn’t have the freedom to do whatever they want with their employer’s information. While someone is employed, they’re required to act in their employer’s best interests; they can’t, for example, influence a client to take its business elsewhere. Similarly, as a general rule, work product created during an employment relationship and on an employer’s equipment, belongs to the employer.

So while our governments and their agencies fight it out over changes to restrictive covenants, make sure you understand what any that apply to you or your company actually can enforce or prevent.