You have finally found a prospective employee who meets all of your search criteria and is a superstar (or prospective superstar) in the field. You want to move forward with the hiring process on an expedited basis. You extend a generous offer, which is promptly accepted. And then you discover, one way or another, that this individual has a restrictive covenant agreement (a “Covenant Agreement”) with a prior employer. What should you do? What if you don’t find out about the Covenant Agreement until after you have hired the individual?
Covenant Agreements are becoming ever more common and they come in many forms. This article will familiarize you with Covenant Agreements generally and will provide you with guidance regarding what you can do to protect yourself from legal liability and business disruption.
I. LIABILITY AND DISRUPTION: RISKS TO YOUR BUSINESS
A. What is a Covenant Agreement? Let’s be clear about what we are talking about. For purposes of this article, a Covenant Agreement is a contract between your (prospective) employee and a current or prior employer that restricts the activities of the employee after the employment relationship terminates. The restrictions can take many forms and the terms vary significantly from one Covenant Agreement to another.
Covenant Agreements are often referred to as “non-competes” or NDAs (short for “non-disclosure agreement”) and some are indeed just that. Non-competes include terms that restrict an employee from engaging in activities that compete with the prior employer. NDAs restrict the use of the former employer’s confidential information and trade secrets. In most cases, however, Covenant Agreements include a number of different restrictive covenants so, if a prospective employee tells you he or she has an NDA with a prior employer, do not assume the document is indeed “just” a non-disclosure agreement.
Indeed, the majority of Covenant Agreements include at least two and often several different post-employment restrictions on conduct, such as provisions restricting the employee from:
- contacting customers, suppliers, and/or employees of the prior employer;
- saying or otherwise communicating damaging or negative information about the prior employer;
- using materials that the employee developed with the prior employer;
- keeping information or documents acquired in connection with the prior employment; and
- using information acquired in connection with the prior employment.
Also, Covenant Agreements are not necessarily separate, stand-alone agreements. They may be included in the terms of another, broader agreement, such as an employment agreement or a separation agreement. Covenant Agreements may also be embedded in equity and bonus award agreements, transaction agreements, and deferred compensation agreements. In short: when assessing whether a prospective new hire is bound by a Covenant Agreement—and, if so, what restrictions apply to the new hire—do not depend on the “label”; review the document itself.
B. Why Do I Need to be Concerned? I’m Not a Party to the Covenant Agreement. It is basic contract law that a party to a contract can pursue its remedies against the other party to the contract in the event the other party breaches the agreement. Clearly, a former employee who breaches a Covenant Agreement is liable for whatever damages are imposed by law or contract. But how can a Covenant Agreement impact a subsequent employer who isn’t a party to the Covenant Agreement? The answer is: it depends on a number of factors, but the following is a brief summary of the possible ways a Covenant Agreement can disrupt the business of—or even create legal liability for—the subsequent employer.
Injunctions Against the Employee. Practically without exception, Covenant Agreements permit the former employer to seek an injunction. An injunction is a court order preventing the former employee from engaging—either temporarily or permanently—in the conduct that the former employer alleges is a breach of the Covenant Agreement at issue. For example, if the employee has allegedly breached the Covenant Agreement by working for his or her current employer, the injunction can bar the employee from continuing such employment. If an employer is relying on the skills and contribution of that employee, an injunction can be very disruptive.
Legal Claims Against the Current Employer. A former employer that is a party to a Covenant Agreement has many causes of action that it might allege against the current or future employers even though there is no contract between the two employers. These include: tortious interference with a contractual relationship; intentional interference with business relations; inducement to breach; civil conspiracy; misappropriation of trade secrets and proprietary information; conversion; and unfair competition.
It is important to note that, in some instances a candidate’s behavior may be actionable even in the absence of any Covenant Agreement. In most jurisdictions, employees have a common law duty of loyalty (and often a fiduciary duty) to act in the best interest of their current employer, even after tendering a notice of resignation. Violation of this duty of loyalty can result in substantial damages against the employee and, to the extent a subsequent employer is found to have assisted the employee in breaching his duty of loyalty, there is potential exposure to the new employer for aiding and abetting the employee’s breach.
C. What Can an Employer Do? Whether the hiring employer will be directly liable to the former employer is largely predicated on the hiring employer’s intent and good faith, and whether it actually benefitted from the new hire’s unlawful conduct. Being able to show the following can provide a powerful defense for the hiring employer against this liability:
- The hiring employer took diligent steps to determine at the pre-hire stage whether the employee was subject to post-employment restrictions.
- The hiring employer was advised by legal counsel that, by hiring the employee, it would not interfere with an existing contractual restriction.
- The hiring employer instructed the new hire that he or she was not expected or permitted to (1) use or disclose any trade secrets or confidential information belonging to his or her former employer, (2) improperly divert business opportunities belonging to the former employer, or (3) engage in any other conduct that would breach his or her Covenant Agreement.
- The hiring employer instituted internal protocols to ensure against the inadvertent use or disclosure of the former employer’s trade secrets or confidential information.
- The hiring employer continued to monitor the new hire’s conduct to ensure continued compliance with any post-employment restrictions that the former employer imposed.
- The hiring employer used due diligence to ensure that it did not benefit from the new hire’s use or disclosure of the former employer’s trade secrets or confidential information.
II. INVESTIGATE COVENANT AGREEMENT ISSUES DURING THE INTERVIEW PROCESS
Ask the Candidate If He or She Is Subject to Any Covenant Agreements. The first thing an employer should do is ask a prospective employee whether he or she is subject to any Covenant Agreement. This should be thoroughly vetted well before a decision is made regarding hiring the individual. If the employer engages in adequate due diligence before it hires a candidate who is subject to a Covenant Agreement and makes a reasonable hiring decision based upon such due diligence, it would be very difficult for the former employer to assert any of the causes of action indicated above against the new employer. (This, however, would not allay the possibility that the candidate would be enjoined from working for the new employer, in whole or in part, temporarily or permanently.)
Keep in mind that, as a general rule, restrictions imposed by Covenant Agreements may extend for a period of two years after employment terminates and in certain cases even longer. Therefore, you should inquire not only about a candidate’s current or immediately prior employer, but also about earlier employers. The take away here is that when you endeavor to determine whether a candidate is a party to a Covenant Agreement, be sure to ask the right questions and review all agreements between the candidate and its prior employers.
If the Answer is “No” – “I Don’t Have A Covenant Agreement” and Other Tall Tales.
Going back to the facts described in the first paragraph of the introduction above, let’s assume that you asked the prospective superstar-employee whether he or she is subject to a Covenant Agreement and he or she says, “no.” That should not be the end of your inquiry for a number of reasons. First, strange as it may seem, employees often forget that they have signed Covenant Agreements. Second, if the Covenant Agreement is embedded in another agreement, they might not realize that they are subject to one. Third, the employee may unilaterally decide that although he or she has a Covenant Agreement, employment with you would not breach it and that therefore not disclosing it to you would do no harm. Fourth, the prospective employee may want the job you are offering badly enough or believe the risk of enforcement is low enough that he or she decides to not disclose the fact that he or she is a party to a Covenant Agreement with a prior employer.
If the candidate affirms that he or she is not subject to any Covenant Agreement and you decide to hire him or her, then, as a pre-requisite to employment, require him or her to sign a notarized statement verifying that he or she is not subject to any Covenant Agreement with any current or former employer and stating that this verification is a pre-condition to the hiring decision, and that if the foregoing proves to be false for any reason, he or she would be subject to immediate termination of employment and be solely liable for any costs and expenses you incur if any action is brought against you because of it.
If the Answer is “Yes.”
Ask for a copy of the Covenant Agreement and have it reviewed by legal counsel who is knowledgeable about Covenant Agreements and the law implicated by them. Your legal counsel should provide you with an assessment of whether the Covenant Agreement is enforceable, along with a plain English translation of what the Covenant Agreement prohibits, including the time limits, geographic scope, and the precise activities prohibited if the Covenant Agreement is enforceable and enforced. Be sure to give your attorney enough specific information about what activities the prospective employee would perform for your company, if hired by you, so your attorney can advise you as to whether the prospective employee would violate the Covenant Agreement by working for you.
If you and your attorney determine that a candidate would be in breach of a Covenant Agreement by working for you and that the former employer is likely to sue, you can avoid that liability completely by not hiring the individual. However, the issues are most often not so black-and-white. In this case, you would need to consult with your attorney to weigh various factors to arrive at the decision as to whether to hire the candidate, including, for example: (i) the risk (and potential cost) of litigation and the potential disruption to your business (including the risk that your new hire will be enjoined from working for you, either temporarily or permanently); (ii) the likelihood that the former employer will be successful in enforcing the Covenant Agreement and your business’s potential liability for money damages; and (iii) any steps you can take to minimize or avoid a claim that the new hire is violating the Covenant Agreement.
III. MANAGING COVENANT AGREEMENT ISSUES
Because Covenant Agreements are so common these days, there is a high likelihood that any new hire will be subject to a Covenant Agreement. Even if you have determined that the anticipated scope of duties the candidate will perform for your business isn’t likely to violate a Covenant Agreement, you should still implement policies—whether in your standard employee manuals, offer letters, and/or employment agreements—to demonstrate your expectation that your employees will comply with their obligations to prior employers, such as a prohibition on the unauthorized use or distribution of property, confidential information, or trade secrets of a third party.
However, if you and your legal counsel determine that a candidate is subject to an enforceable Covenant Agreement, and that the position for which the candidate is being considered might be construed as requiring the candidate to violate the terms of that Covenant Agreement, there are a number of things you can do to minimize the risk of litigation if you decide to proceed with hiring the individual. Possibilities include: (i) if feasible, restructuring the position so that the duties and responsibilities do not run afoul of the Covenant Agreement (or at a minimum), placing the new hire in a temporary position that does not violate the Covenant Agreement for the duration of any contractual restriction period; (ii) asking the former employer to waive the restrictions or negotiate restrictions that both of you can live with; or (iii) structuring the new hire’s work to insulate him or her from departments or projects involving confidential information or clients for which the new hire might possess competitively valuable information belonging to his or her former employer. Also, the hiring employer should consider whether it should leave itself an “out” by requiring the candidate to acknowledge and agree that if litigation is threatened or arises over any Covenant Agreement, it reserves the right to terminate the candidate or alter the candidate’s job requirements.
Lastly—and regardless of the steps you may have taken to avoid or minimize the risk that your new hire is violating a Covenant Agreement—there is always a risk that the prior employer will nonetheless suspect a violation or threaten legal action against you. As such, there are actions you should take after hiring an employee who is subject to a Covenant Agreement if you receive a “cease and desist” letter or any other communication regarding the terms of the Covenant Agreement from the former employer. Proper management of this situation can reduce, limit, or eliminate your potential liability in connection with an employee’s Covenant Agreement with a prior employer. You should contact your attorney immediately, both to formulate a strategy for responding to the prior employer and to ensure that you are taking the proper internal steps to preserve evidence that may become important if the matter proceeds to litigation.
If you have any questions or would like additional guidance regarding restrictive covenant agreements or other employment law issues, please contact Suzanne Arpin at SArpin@fh2.com or (770) 399-9500.