The Enforceability of Restrictive Covenants Against a Terminated Employee

By Fredrick P. Niemann, Esq. of Hanlon Niemann, a Freehold, NJ Covenant Not to Compete Attorney

In New Jersey, restrictive covenants are enforceable but only to the extent that they are reasonable under the circumstances. Generally, the court considers three factors to determine whether a restrictive covenant is reasonable: whether the agreement (1) is necessary to protect the employer’s legitimate interests; 2) does it cause undue hardship on the former employee; and 3) to what extent does it impair the public interest. Courts apply “a balancing test” for the first and second criteria and then weigh the impairment on the public interest in reaching a final decision. In most cases it is the facts of the controversy that weighs heavily on the outcome.

Confidential and Proprietary Information

The protection of trade secrets and confidential information is protected under New Jersey law, and rightfully so. To prevail on a claim alleging breach or disclosure of trade secrets or confidential information, an employer must establish: “(1) the existence of a trade secret that was disclosed in confidence to the employee; (2) the wrongful disclosure or potential for wrongful disclosure of that confidence; (3) by or to a competitor with or without knowledge of the breach of confidence, and (4) has or will likely be used by the competitor to the detriment of the former employer.”

Whoever asserts the existence of a trade secret has the burden of proving that the information is in fact secret and not a matter of general knowledge in the industry.

A trade secret consists of any formula, pattern, device or compilation of information which is used in one’s business, and which gives him an opportunity to obtain an advantage over competitors who do not know or use it. It may be a formula for a chemical compound, a process of manufacturing, treating or preserving materials, a pattern for a machine or other device, or a list of customers.

The court will likely consider the lifespan of a trade secret or other protectable information but will strike down an overbroad restriction that prevents competition, distinguished from a restriction that protects an employer’s legitimate interest.

In one case, the United States District Court of New Jersey evaluated a non-solicitation provision of a non-compete agreement and determined that a covenant not to solicit prospective customers of a former employer was unenforceable. The court explained its decision based upon the public interest in free market competition. “Courts will not enforce a restrictive agreement merely to aid the employer in extinguishing competition, albeit competition from a former employee.

The court ruled that while employers have a reasonable interest in protecting trade secrets, proprietary information and customer relations, they have no legitimate interest in preventing competition. The court found the non-solicitation agreement was enforceable to protect the employer’s current clients, but also found the non-solicitation provision regarding prospective clients to be overly broad, and that enforcing that portion of the agreement would significantly impair the public’s interest, in large part because it would seriously and significantly impact upon the employee’s ability to work as a financial advisor, in New Jersey or elsewhere.

Hardship on the Employee

Whether a restrictive covenant imposes a hardship on the employee generally focuses on two considerations: 1) its geographic scope of exclusion, and 2) the time period for which the restraints will be in effect.

The “undue hardship” inquiry focused upon by the courts goes to the specific facts of the case, and the evidence presented with respect to undue hardship on the employee. The court also takes into account the articulated “legitimate interest” claim advanced by the employer as the basis for the restriction on the employee.

Courts will not enforce restrictive covenants unless the specific evidence presented weighs in favor of enforcing the restriction against the former employee in order to protect legitimate, actual interests of the employer that are demonstrated by the evidence presented.

Whether the geographic scope of a non-compete agreement imposes an undue hardship upon the employee, courts will consider “the likelihood of the employee being able to find employment in his or her field elsewhere” and secondly, the extent to which the employer or employee caused hardship on him or herself. While there is no per se rule on the permissible geographic scope of a covenant (ie., 1 mile vs. 500 miles), limited restraints will generally be enforced if reasonable”, but again, these terms are employed loosely and it is frustrating to predict the likely outcome of a contested case in the absence of truly outrageous facts and/or restraints.

As a general matter, New Jersey courts have considered post-employment restrictions with a duration of two years or less as reasonable. Two years seems outrageous but have been upheld in limited cases. However, in one Appellate Division case the restrictive covenant was unenforceable because the court determined that the two-year scope of the agreement was unreasonable based on the nature of the business at issue.

Indeed, the nature of the business involved may be critical. Courts will consider the demand for services offered by the employee and the likelihood those services can be provided by others working in the area.

Conclusion

Under New Jersey case law, the courts remain sensitive to the former employee’s interest in prospective employment, and the public’s interest in having a free and competitive marketplace.

 

 

Posted in Covenant Not to Compete.