Pitfalls of and Techniques to Surmount Non-Compete Agreements for Executives

Chances are that as a CEO or other senior executive you are currently subject to a non-compete agreement, one that includes restrictions on your ability to compete with your employer after separation. Non-competes are upheld to some extent in 47 states and the District of Columbia. The exceptions are California, North Dakota and Oklahoma, each of which broadly prohibit non-competes for employment.  However, even California allows for enforcement of non-competes in connection with the sale of a business but not on simple termination of employment.

This article discusses both the coverage and pitfalls of non-competes but also offers techniques for the CEO and senior executives to surmount non-competes and protect your career including the following:

• Coverage of non-competes under current Massachusetts law as an example of non-competes Executives may expect to have to cope with in most states
• Benefits of non-competes to the company and also to the executive, plus legitimate and illegitimate employer objectives in seeking to enforce non-compete
• Three separate techniques for surmounting non-competes – the “paid up” non-compete, the plan for navigating around the precise terms, and the use of an indemnity
• Key items to seek in other restrictive covenants for non-solicitation, confidentiality and assignment of inventions.

Massachusetts Law for Non-Compete Enforcement

The laws of Massachusetts on non-compete agreements are typical of most states.  Subject to certain limitations, Massachusetts law allows agreements that prevent an executive from engaging in a business competitive with his or her employer for a certain period after termination of employment.  To be enforceable, a non-compete must

• be necessary to protect an employer’s legitimate business interests,
• be reasonable in time and scope, and
• be consistent with the public interest.

The Massachusetts Supreme Judicial Court has held – “A covenant not to compete contained in a contract for personal services will be enforced if it is reasonable, based on all the circumstances. In determining whether a covenant will be enforced, in whole or in part, the reasonable needs of the former employer for protection against harmful conduct of the former employee must be weighed against both the reasonableness of the restraint imposed on the former employee and the public interest. If the covenant is too broad in time, in space or in any other respect, it will be enforced only to the extent that is reasonable and to the extent that it is severable for the purposes of enforcement”. All Stainless, Inc. v. Colby, 364 Mass. 773 (1974)

Additionally, enforcement is subject to the material change doctrine.  “Each time an employee’s employment relationship with the employer changes materially such that they have entered into a new employment relationship, a new restrictive covenant must be signed.”  Lycos, Inc. v. Jackson, 18 Mass. L. Rptr. 256, Mass. Super LEXIS 348 (2004).

Considering the three key criteria laid down by the courts and statutes, this further guidance is offered:

• Massachusetts courts recognize customer goodwill and confidential information as protectable business interests.
• In terms of scope, the courts look to geographic scope and also duration. Generally, one year or even 18-month non-competes have been upheld in case of employment.  If a business is being sold, then the buyer can impose a much longer non-compete on the seller – 5 years or longer to protect the goodwill the buyer is acquiring.
• In terms of public interest, Massachusetts has specific statutes that bar non-competes to the following classes of state regulated professionals.
  MGL c.112, s.12X Physicians
  MGL c.112, s.74D Nurses
  MGL c.112, s.129B Psychologists
  MGL c.112, s.135C Social Workers
  MGL c.149, s.186 Broadcasting Industry
  Mass. Rules of Professional Conduct 5.6 Lawyers

Benefits to the Employer and to the Executive

In general, your employer benefits more from a non-compete agreement than you do. Restrictions on your ability to compete provides protection from unfair competition created by your use of your employer’s proprietary information. Taking a non-compete agreement lightly, therefore, may have a significant and long-term negative impact on your future ability to continue working in your profession or line of business.  Prospective employers will often inquire if you have a non-compete and want to review its terms.  Thus, even if suit is not brought against you, the non-compete can have a chilling effect that deters a prospective employer from hiring you.

However, you as the CEO or senior executive can also derive benefit from a covenant not to compete:

• The non-compete, if clearly drawn, can provide clear guidance on what you are and are not permitted to do once you leave your employer.
• The existence of the non-compete can give the founder and company owner greater confidence to reveal important trade secrets that may enhance your knowledge as an executive.
• The contacts, work experience and trade secret knowledge imparted to you because the employer relied on that non-compete can significantly benefit you long after the expiration of the non-compete covenant.

Covenants not to compete become relevant when considering a job offer, facing changes in organizational control (through merger or acquisition) and leaving a job (especially via wrongful termination). The employer has every incentive to protect itself from the loss of intellectual property, trade secrets and other confidential or proprietary information. You, on the other hand, are as motivated to ensure that the restrictions imposed by a non-compete agreement are reasonable and do not place overly restrictive, unfair limitations on your career.

Tension Between the Employer’s Interest and Yours

The tension in the non-compete terms is often between two separate employer objectives – one legitimate the second illegitimate:  first, protection of the employer’s hard acquired trade secrets, vs. the second, keeping a CEO or senior executive out of their market because they know that executive would be a tough competitor.

It is a legitimate business purpose for a company to protect its trade secrets and to seek to prevent an executive with intimate knowledge of those secrets from letting its competitors use that knowledge against it.  Trade secrets are not just inventions or the “secret sauce,” but any proprietary knowledge or advantage in business that the employer maintains as a trade secret.  This could include pricing terms, customer buying history and specifications, new developments, business strategy and marketing plans.  It is not legitimate for you, the executive, to try to cash in on trade secrets by courting new employers with the promise that you know your company’s plans and are thus best positioned to help the competitor defeat them.

What is not legitimate for the employer would be to use the non-compete to lock you up to make sure your prior knowledge and talents cannot go over to the competition.  Executives are very often hired because of their prior training, knowledge, skills and track record in the industry.  Normally, it is not legitimate for the employer to shut down the executive for one year or more in the industry or market segment of his greatest knowledge and effectiveness.

“Paid-Up” Non-compete & Working Around the Lock-Up Period

The one exception where the CEO or senior executive could potentially accept such a lock up or shut down is when the employment contract earmarks sufficient compensation to the executive during the non-compete period so that the executive is paid not to go to a competitor.

Yet, even if there is a fully paid non-compete in place, you should negotiate hard over the limits and terms of the restriction. This negotiation can cover particular positions and types of work for which you are restricted and industry segments in direct competition.  The contract might even list 4-6 direct competitors of gravest concern or bar the executive from forming a company in the precise field or going “in house” taking a position with one or more of the company key customers that can also be listed in the contract.

When you enter into a non-compete agreement, you should have a plan in mind for where you can work, the markets and market segments where your skills would be in demand, during the 12 or 18 months of the non-compete period. 

Seeking Executive Indemnity When You are Taking a New Position

Often when taking a new position, the executive will be asked to represent that he or she is not subject to the terms of a non-compete or that his or her new employment will not be in conflict with an existing non-compete.  If you as the executive are in a situation where you are being heavily recruited for a new position, this is a clause you want to pay attention to.  Often the enforceability of a non-compete is unclear.  It may be overbroad and sometimes not enforceable. Yet, the old employer may try to enforce it and seek an injunction that could put you out of work with no rights or severance and a black mark against you as you now have to seek new employment.

In those circumstances, you as a candidate should not make the desired representation that there is no conflict.  Instead, both parties need to acknowledge the presence of this other agreement, and both parties also affirm their belief that it poses no conflict.  But for critical protection, you should seek an indemnity and hold harmless so that if the old employer does bring action, your legal fees in defense would be covered and you would receive some settlement or severance from the new employer if an injunction does issue.

Non-Solicitation and Other Important Restrictive Covenants

Besides the non-compete agreement, careful review should also be undertaken over these key restrictive covenants:

• Non-Solicitation of Customers. The danger for the executive here is generally two-fold.  First that the company is large, has multiple divisions and you cannot do any sort of business with any of those customers, including those you did not deal with and may not even know.  The second concern is a sweeping coverage of all “prospects” – this often covers a long period and does not specify the level of contact with the prospect and again where you had no involvement.  This can be important because these covenants are often two or three years post termination in duration.

• Non-Solicitation of Employees. The concern here is the bar it places to hiring former and trusted colleagues.  One of the reasons CEOs and senior executives are hired is their ability to bring in their team.  So, in place of the typical bar to hiring present or former employees or contractors, try to exclude contractors and those who voluntarily left employment either prior to your departure or who were not solicited by you to leave the company.

• Confidentiality. As a CEO or senior executive you are being recruited because of your knowledge, your contacts and experience.  The confidentiality / NDA needs to reflect that and specifically exclude information you had before you joined the company or acquired from non-company sources.  Also, you should try to have access to key company documents that you negotiated and your emails, so that if liability issues arise in the future, you have some ability to defend yourself.

• Assignment of Inventions. There should be exclusions for items you conceive or develop unrelated to the company’s business or on your own non-company time and not using any of the company’s facilities.

To avoid these pitfalls frequently encountered by senior executives when entering into a non-compete agreement, you would be well-served to retain counsel experienced in executive employment agreement matters capable of negotiating clear boundaries that will enable you to continue working in your chosen field.

Writte by:

Robert A. Adelson, Esq. is a business and tax attorney, and partner in the firm Engel & Schultz LLP in Boston, MA. He has an advanced LLM degree in the law of Taxation from NYU and has for more than 20 years represented CEOs, C-Suite and senior executives across the country in issues of senor executive employment including terms of non-competes, equity, compensation, severance, change of control, other restrictive covenants and other key executive issues.

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