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Feature

Christopher P. Stief and
Michael R. Greco
Partners
Employee Defection and Trade Secrets Practice Group
Fisher & Phillips

When a New CEO Comes In, Will Risk Walk Out?

How to create effective and enforceable restrictive covenant agreements

By Christopher P. Stief and Michael R. Greco

The breadwinners of the biggest companies leave at alarming rates when a new CEO is placed from the outside, according to a recent issue of Harvard Business Review. Not surprisingly, executives closest to the CEO carry the most potentially damaging knowledge about the company. Because CEO turnover is at an all-time high, according to a recent Booz Allen Hamilton study, more than ever, it’s important for management to ensure that high-ranking executives are under effective and enforceable restrictive covenant agreements. Moreover, it is important to take appropriate steps when an employee resigns. But beware of the following common pitfalls:

One size does not fit all
A common mistake made by companies with employees located in different states is taking a “one-size fits all” approach to post-employment restrictive covenants. Different states treat restrictive covenants differently. In fact, the same agreement that is enforceable in one state, may be unenforceable in another. Some states may have statutes that apply, whereas other states may have peculiar common law requirements. Consult your legal counsel to determine what law is likely to apply and to draft an agreement accordingly.

Provide employees with an appreciable benefit in exchange for their covenants.
Restrictive covenants, like any other contract, must be supported by adequate consideration. But what qualifies as sufficient consideration may differ from state to state. In some states, if an employee signs a covenant after the inception of employment, the employee must be given a new and appreciable benefit in exchange for signing the covenant. In other states, the courts will conclude that the mere promise of continued employment alone constitutes sufficient consideration. However, to avoid questions concerning the sufficiency of consideration, the safest course is to provide employees with an appreciable benefit to which the employee would not otherwise be entitled. Examples include a promotion, specialized training, or an appreciable grant of stock or a bonus.

Beware of expiring agreements
Restrictive covenants in a soon-to-be expired employment agreement should be looked at closely. The enforceability of covenants in an employment agreement for a fixed term, as opposed to an agreement for at-will employees, can present unique issues concerning enforceability. For example, imagine a CEO with an employment agreement providing for a three-year term of employment. Further imagine that the employment agreement contains a non-competition clause that precludes competition for a period of one-year after the agreement expires. Some employers may be content to continue employing the CEO under the terms of the old agreement upon the expiration of the three-year term. But what happens to the restrictive covenant? Does it begin to run upon the expiration of the three-year term? Or does it begin to run if and when the CEO terminates his or her employment? No surprisingly, different courts view this scenario differently. To minimize confusion, employers are well advised to: (a) renew or renegotiate expiring agreements promptly; and (b) include restrictive covenants in the agreement that expressly survive the termination of the agreement and begin running upon termination of employment.

Beware of liquidated damages provisions
Many employers like to include liquidated damage provisions in employment agreements that provide for the payment of a specific sum by an employee upon the breach of a restrictive covenant. Such clauses should be carefully drafted to make clear they are not intended to preclude the employer from seeking an injunction to enforce the restrictive covenants. Although most courts will not refuse to enforce a restrictive covenant by way of injunction because of a liquidated damages provision, some courts find that such provisions provide employers with a sufficient remedy in the event of a breach by a former employee thereby eliminating (in the court’s view) the need for injunctive relief. Employers are best advised to check the law governing the contract at issue, and to include language expressly stating that liquidated damages are in addition to the employer’s right to seek injunctive relief.

Include carefully drafted severability clauses
The enforceability of a restrictive covenant depends in large part upon a judge’s discretion. Courts are empowered to determine whether they believe a covenant to be reasonable (and therefore enforceable) under the circumstances. The rule in most states is that courts may modify and/or partially enforce overly broad restrictive covenants. Consequently, if a court determines that a three-year restrictive covenant is too long, more often than not, the court can modify the agreement and enforce it for two years if it deems two years to be sufficient. However, some companies include sloppily worded severability clauses suggesting that courts should sever, as opposed to modify, overly broad restrictive covenants. For example, some agreements contain language stating that the provisions of an agreement are severable and that unenforceable provisions should not affect the enforceability of the remaining provisions. This language might lead a court to conclude that overly broad restrictive covenants should be severed from the agreement, and not modified. A carefully worded severability clause should make clear to the court that the parties invite judicial modification of overly broad covenants as opposed to severance.

Ask about a departing employees’ new jobs and remind them of their contractual obligations
When an employee expresses his or her intent to accept employment with a competitor, it is time to start asking questions. Ask the employee to identify his or her new employer, new job position, duties, responsibilities, and office location. The refusal to answer these questions may be cause for concern. Ask the employee to confirm in writing that he/she has returned all company property in any form, whether paper or electronic, including all documents, records, and information. Of equal importance, provide the employee with a copy of his/her post-employment restrictive covenants, inform the employee that you expect his/her full compliance, and instruct the employee to provide a copy to the new employer.

Take steps internally upon learning of an employee’s intent to join a competitor
Departing employees have an advantage in that they can choose the time of their resignation. Employers need to be prepared to respond swiftly upon learning that an employee intends to join a competitor. Swift action can make a difference in thwarting removal of confidential information, or it may uncover such removal at an earlier time that it might otherwise be discovered. Upon learning of an employee’s intent to join a competitor, employers are well advised to talk to the employee’s co-workers. Interviewing co-workers can assist an employer’s efforts to gather information about the departing employee’s intentions and may uncover unusual behavior (e.g., off-hours access to the office or records, recruitment of co-workers, stock-piling of corporate opportunities). It is equally important to promptly disable a departing employee’s access to company information. It may be wise to disable the employee’s access to the premises, company computer systems, email, and voicemail. Inspect the employee’s office and files to ensure that company records have not been taken, altered or destroyed. Finally, a review of recent email and computer activity is always prudent as it may lead to the discovery of suspicious downloads or print jobs.

Obtain legal counsel
The issues addressed above are only the tip of the iceberg. Employers are well advised to review their legal options with counsel. Employers may have legal rights that extend far beyond the four corners of a contract. The appropriate response to an employee departure may include everything ranging from a demand letter to a lawsuit. In this day of increasing employee mobility, a prompt response can make all the difference.

Christopher P. Stief and Michael R. Greco are partners in the Employee Defection and Trade Secrets Practice Group with Fisher & Phillips, a national labor and employment law firm. They can be reached at cstief@laborlawyers.com and mgreco@laborlawyers.com, respectively.