Contractual Protection of Company Assets

Contractual Protection of Company Assets

In previous blogs, I’ve talked about a variety of vulnerabilities employers face. These vulnerabilities arise both internally and externally, and employers must be vigilant in protecting business assets. Here, we’re talking not about physical assets, but less tangible assets such as business goodwill, proprietary information and employee skill and know-how. And a few tools commonly applied to employees to protect such assets are contracts prohibiting competition post-employment, disclosing confidential information and solicitation of current employees. All can provide valuable protection of company assets, but as with many well-intentioned agreements, inappropriate application of these tools can leave an employer not only vulnerable but potentially liable.

Covenant Not to Compete

Covenants not to compete are designed to limit an employee from pursuing employment in a certain profession or geographic region following cessation of employment from a usually similar employer. In theory, this is a powerful tool for protecting a business. Employees learn all kinds of things while employed and this intelligence, even if not technically proprietary or a trade secret, can be quite valuable to a new employer. The challenge is that California is very deferential to employees and has determined that restricting a former employee from pursuing employment is fundamentally unfair and against public policy. Therefore, California generally finds such agreements unenforceable.

This restriction is found in Business and Professions Code section 16600 which reads “…every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” The courts have applied this restriction in a variety of contexts including the traditional employer/employee relationship, independent contractor relationships, as well as franchisor/franchisee relationships. Any attempt to restrict employment by way of contract will be unenforceable.

There are a handful of exceptions though. These primarily surround the sale and dissolution of businesses.  Long before dissolution or sale, business owners and partnerships should consider the appropriateness of such covenants. They can be particularly useful if business associates attempt to pursue competing opportunities upon dissolution or sale of a business.

Practically speaking, another exception historically existed for national employers. Employers outside of California, but with California employees, would often include in employment contracts foreign choice of law and choice of venue provisions along with a covenant not to compete. If the employee sought employment, often with a competitor, the former employer would use the terms of the employment contract, a foreign court and foreign law, to restrain the employee from taking a new job, as Business and Professions Code section 16600 would not be applicable in a foreign court. This end run around California’s public policy impacted California employees to such a degree that the legislature adopted Labor Code section 925. This section makes voidable any contract that requires as a condition of employment the employee agree to application of law other than California’s in a court outside of California. This restriction applies to employment contracts entered into after January 1, 2017.

But, it’s not all bad news for employers. There remain a handful of very powerful tools designed to protect business assets.

Non-Solicitation of Employees

A business raiding a competitor’s workforce is fairly common in the business environment and is often the result of onboarding someone who has significant leverage with former co-workers. In fact, hiring decisions often consider whether the candidate will be able to poach talent from a former employer. This can be devastating for a business not only in terms of human capital but also considering the business intelligence that not only will be lost but also transferred to the benefit of a competitor. And as suggested above, employers are powerless when it comes to restraining an employee’s mobility to move from one employer to another.

Fortunately, California courts have found there is not the same public policy concern in contracts that prohibit employee solicitation as is found in covenants not to compete. A contract that narrowly restricts an employee from soliciting company employees following termination of employment will generally be enforceable. While it’s not possible to stop someone from leaving a company by restricting post-employment opportunities, employers should consider the risk of a former employee soliciting away current employees and appropriately plan through protective employment contract provisions.

Non-Solicitation of Customers

Many employers believe that since the employer can’t keep an employee from seeking new employment, they will nonetheless limit the effectiveness of the former employee by having a customer non-solicitation provision in an employment contract. And while it is possible to limit such solicitation, California courts have routinely found that flat bans on solicitation of customers violate Business and Professions Code section 16600 rendering such provisions unenforceable.

So, what is an employer to do? A non-solicitation of customer agreement designed exclusively to protect employer trade secrets will likely be enforced so long as there are no other agreements or contractual provisions protecting such trade secrets. If an employment contract has a confidentiality provision, and a non-solicitation provision, it’s possible the non-solicitation provision would be found unenforceable as it’s designed to do the same thing as the confidentiality provision, but with a little extra to limit an employee’s opportunity to pursue a living. Or at least that’s how the courts will likely view it.

Before an employer utilizes a non-solicitation of customer provision in an employment contract, it is worthwhile to consider the true purpose behind the provision and consider if such a restriction can be accomplished by other means, possibly a confidentiality agreement, which has much greater acceptance in the courts than do non-solicitation of customer agreements.

Confidentiality Agreements

Also called non-disclosure agreements. Of all the options employers have available to protect company assets, confidentiality agreements represent the most powerful tool. Contractual agreements restricting the disclosure and use of trade secrets and confidential information are enforceable so long as they are reasonable.

Effective confidentiality agreements include a few key components. First, the definition of confidential information should be included. This definition should be comprehensive and note what information, no matter form or format, is included in the definition. Some common provisions include reference to design, development, research, techniques, customer and supplier lists, and compensation. The employer’s business should shape the contours of this list, but comprehensiveness is key.

The second component of a confidentiality agreement is the actual restriction. As to the employer, I recommend a comprehensive approach to this component, but an employer may decide that the only risk the employer wants to protect from is solicitation of customers. It is appropriate to indicate such limitations although robustness is generally favored over such limitations. The restriction should also include the duration. In protecting trade secrets, restrictions often are perpetual so long as the information remains a trade secret.

Conclusion

Employers invest significant capital and other resources into developing a competitive business. Intellectual property and intangibles should be given the same, if not more, protection than tangible assets. While not included here, there are other, more specialized ways to protect some company assets. Legal counsel can help you explore these options following a comprehensive business evaluation.

It is also important to remember that inappropriate use of these techniques can be problematic for employers. Overly broad restrictions may be found unenforceable leaving employers with no protection when a restriction more closely approximating the risk would have withstood scrutiny. Again, legal counsel can assist with these decisions.

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