Understanding Restrictive Covenants and Trade Secrets
Reprinted with permission of Upstate Business Journal
In last month’s segment, we discussed the common-law duty of loyalty that exists during employment. There are two sources of restrictions that may to employees even after employment ends: Restrictive covenants and the law governing trade secrets.
Restrictive covenants generally take one of two forms. There are the traditional non-compete agreements that require an employee to stay out of a certain industry within a certain geographical area for a prescribed period of time. Non-solicit agreements, on the other hand, are aimed more at specific customers than at merely attempting to avoid competition itself.
The enforceability of a restrictive covenant is determined by measuring the covenant against five related factors. First, the covenant must be supported by valuable consideration. This means that the covenant was entered into either at the beginning of employment, or the employee received something of value in exchange for the agreement. Second, it should be only as broad as necessary to protect the legitimate interests of the employer. Legitimate interests include such things as protecting a customer relationship. A mere desire to dominate a market area is not a legitimate interest. Third, the covenant must be reasonably limited in operation with respect to time and place. Fourth, the covenant many not be unduly harsh and oppressive in curtailing the legitimate efforts of the employee to earn a livelihood. Fifth, the covenant must be reasonable from the standpoint of sound public policy.
Other than these general principles, it is not possible to provide general guidance on what would be considered enforceable, as each case must be evaluated according to its unique facts. For example, whether the employer breached obligations to the employee before the separation from employment is an issue that frequently arises and may affect the outcome of the case.
The nature of the market involved also is a key issue that must be examined under the particular facts of the situation. For example, a geographic restriction that coincides with a franchisee’s territory of two counties may be reasonable in one case, but the same geographic restriction may be overly broad in another industry or field.
Many employers have wisely abandoned the traditional non-compete agreement and have utilized specific non-solicit agreements that prohibit efforts to divert work from customers with which the employee had contact while employed. These present somewhat different issues, but generally are far more defensible if limited properly.
In addition to these general legal principles, there are several key issues most judges also will consider. These include the circumstances under which the employee is no longer with the employer (i.e. did he or she quit voluntarily), whether there is evidence that the employee engaged in wrongdoing in seeking to “steal business,” and whether the employee had customer contact, experience, and knowledge gained prior to the employment at issue. Although these factors are not written down in the law, our experience has been that they are influential in guiding judges in their efforts to balance the interests of the parties.
South Carolina law provides significant protections for employers’ legitimate trade secrets regardless of whether a restrictive covenant is in place. The Trade Secrets Act provides companies with a right to sue for the misappropriation of trade secrets. It defines a “trade secret” as information that is valuable because it is not generally known or easy to determine. The person claiming to own the information also must take reasonable steps to maintain its secrecy. Misappropriation of trade secrets includes taking, using, or disclosing the information.
Employees are generally entitled to take the skills and general knowledge acquired or increased during previous employment. What constitutes “general knowledge” versus knowledge that is a “trade secret” is tricky at times and often hotly-contested. In addition, there is some information that, by itself, may not be a trade secret (for example, the identity of certain customers in an industry), but certain compilations of that information may constitute a trade secret when the compilation adds value or contains information that is not readily available.
For employers, it is essential to take reasonable steps to protect the information at issue before there is an issue. Changes in technology have caught many employers by surprise. For example, many companies now encourage employees to “bring your own device” (a/k/a BYOD) that allows them to use devices the company does not own or control. Some of those companies, however, take no steps to prevent, for example, the same employee from donating their computer, complete with hard drive, or from selling it at a garage sale. The use of popular file sharing software (e.g. Dropbox, Evernote) also can remove data from systems previously implemented to maintain and track it. Policies and systems that once were adequate to protect trade secrets simply have not passed the test of time.
As mentioned above, the position held by a former employee often influences the outcome of a particular case. In our final segment, we will discuss issues specific to those in a fiduciary relationship with the company, including officers and equity owners. We also wrap up with some general advice for both employees and employers to aid in planning and protecting their respective interests.