Part 2: Post-Employment Restrictive Covenants

Apr 15, 2009

In this four-part series, we will discuss the importance and use of post-employment restrictions in the pharmaceutical and biotech industries.  Each part of the series will address a topic of interest, including:  

  • An overview of post-employment restrictions
  • Tips on how to draft agreements containing post-employment restrictions to maximize the protection they can provide for your trade secrets and goodwill
  • How to enforce post-employment restrictions against former employees and their new employers (who are often direct competitors)
  • Alternatives to certain post-employment restrictions, such as trade secret statutes and, unfair competition laws

Part Two: How to Draft Effective and Enforceable Agreements
In last week’s article, we discussed how companies in the biotech and pharmaceutical industries are particularly vulnerable to former employees misusing trade secrets and customer goodwill.  We also discussed how employers can protect their trade secrets and goodwill by requiring employees who are in a position to misappropriate them to sign agreements containing post-employment restrictions on their ability to compete, solicit customers, and/or hire employees.

But a “one size fits all” agreement will not suffice.  For the agreement to be enforceable and to provide as much protection as possible, it must adhere to several requirements:

  • The employer must have a protectable interest
  • The restrictions should be tailored to the employee’s specific position
  • The agreement must be supported by consideration (i.e. something of value)
  • The restrictions must be reasonable in time and scope
  • The restrictions should not be broader than necessary to protect the employer

Let’s examine these requirements one-by-one.

Protectable Interest. An employer cannot enforce post-employment restrictions against an employee unless the employer has interests worth protecting (such as trade secrets or goodwill).  If a company does not actually have any trade secrets or goodwill, or if an employee was not aware of or did not have access to the trade secrets/goodwill, the company will be unable to restrict the employee’s post-employment activities. 

Tailored to the Employee’s Position. Employers should not simply use one post-employment restriction agreement for all employees. Rather, only certain employees should be considered for agreements, and the restrictions should be tailored to the particular circumstances of each employee. 

For example, an employee in R&D might have intimate knowledge of a pharmaceutical company’s most important trade secrets, such as current research, pipeline products, clinical trial results, and future funding. A comprehensive agreement containing broad restrictions limiting such an employee’s post-employment activities may indeed be necessary and appropriate. On the other hand, it may not be appropriate to use the same restrictive provisions for a salesperson who has no access to or knowledge of such critical R&D matters. It is likely that post-employment restrictions are appropriate for a sales person, but the nature and scope of such restrictions should be tailored to the sales person’s interaction with his/her company’s most important customers, and should therefore be different from the restrictions placed on an R&D employee. 

On the other hand, it may not be appropriate for an employer to try to restrict the post-employment activities of an administrative assistant or staff member, who does not have access to his/her employer’s trade secrets or significant interaction with customers.

Consideration. Like any contract, agreements containing restrictions on employees’ post-employment activities must be supported by sufficient consideration.  “Consideration” means that the employee must receive something of value in exchange for entering into the agreement. In most states, agreements signed by employees upon hiring containing these restrictions are deemed to be supported by sufficient consideration.  The consideration the employee receives is his/her hiring. 

Many states, however, have ruled that agreements containing post-employment restrictions that employees enter into during the course of their employment lack consideration if the employees do not receive anything of value in exchange for signing the agreement.  These states have ruled that continued employment is not sufficient consideration.  So companies that want to maximize the enforceability of agreements containing post-employment restrictions should either (i) require for employees to sign the agreements at the time of their hire, or (ii) provide something of value to employees who sign the agreements during their employment.  Many employers satisfy (ii) by having employees sign the agreements as part of a promotion, salary increase, rollout of a stock plan, or payment of a discretionary bonus.  Other employers simply “buy” the agreements by agreeing to make a one-time payment to employees to who sign such agreements. 

Some states have found agreements containing post-employment restrictions to be invalid if the employee’s position changed after initially signing the agreement. These courts have ruled that a change in position requires a new or modified restriction and/or new consideration. Therefore, if an employer promotes an employee who is party to an agreement containing post-employment restrictions, the employer must require the employee to either affirm his/her existing agreement or sign a new agreement.

Reasonable in Time and Scope. Courts have sought to balance protection of an employer and imposition on the employee by enforcing post-employment restrictions only to the extent that they are “reasonable in time and scope.”  While the limitations on these restrictions are case- and fact-specific, there are certain rules of thumb:

  • Restrictions that prohibit the specific activity for a period of one to three years are usually found to be reasonable, but the nature of the protectable interest is the determining factor. For example, if a company’s pricing and marketing plans are changed every three to six months, it will be difficult to have a court enforce a restriction of more than one year on an employee that had access to that information.
  • Restrictions are usually found to be reasonable in scope if they cover a geographic area that is similar to the geographic area previously serviced by the employee, or if there is a valid business reason to expand them, such as the nature of the protectable interest.  So if a sales employee’s territory is New England, but the pricing and marketing information to which he/she has access is national, a court may find that a post-employment restriction that covers the entire nation is reasonable and appropriate.

No Broader than Necessary to Protect the Employer. Post-employment restrictions that seek to cover an entire industry—particularly if the industry and the companies in it are diverse and only a few of them compete “head to head”—may be difficult to enforce. In the same vein, a restriction that prevents an employee from working for a “competitor” in any capacity whatsoever, without any regard for the employee’s prior position or the information to which the employee was exposed, runs the risk of being found unenforceable as overly broad.

Some courts will “blue-pencil” certain terms of post-employment restrictions that are either unreasonable in time and scope or overly broad, in effect rewriting them in a manner that protects the prior employer’s interest and allows the employee to take a new position.  But employers should not count on this, because many courts will not do it, and those that do usually only make modest changes. 

If the agreement is overly broad, unreasonable in time and scope, or is viewed by the court as seeking to restrain “ordinary competition,” it is likely that the agreement will not be enforced, or will be enforced in a manner that does not fully protect either the employer’s interests or its expectations.