Restrictive Covenants Enforcement, Chicago Securities and Commodities Attorney

QUESTION

Under what circumstances will a court enforce a restrictive covenant?

ANSWER

Generally, an employer does not have a protectable business interest in its customers. However, courts will enforce a non-compete agreement if it is reasonable in geographic reach and duration, and it is necessary to protect a legitimate business interest of the employer. In determining whether a restrictive covenant is necessary to protect a legitimate business interest, courts will compare the scope of the prohibited conduct with the interests to be protected. If the court finds that the scope of the covenant is unreasonable or overbroad it will be deemed an invalid restraint of trade, and it will not be enforced.

Some courts are critical of non-compete agreements that last for more than two or three years, but other courts have enforced covenants that last much longer. In determining whether the geographic reach of a covenant is unreasonable, the courts will consider where the business operates. A covenant covering the entire nation may be enforced if the company does business throughout the nation and other criteria are met.

There are two circumstances where a protectable business interest will be found: (1) where, by the nature of the business the employer has developed a "near-permanent" relationship with its customers and but for his employment, the former employee would not have had contact with the firm's customers; or (2) where the former employee learned trade secrets or other confidential information and tried to use the information for his own benefit after the termination of his employment.

The factors considered by the courts in determining whether an employer's relationship with its customers is near-permanent include: (1) the number of years required to develop the clientele; (2) the amount of money invested to acquire clients; (3) the degree of difficulty acquiring clients; (4) the extent of personal customer contact by the employee; (5) the extent of the employer's knowledge of its clients; (6) the duration of the customer's association with the employer; and (7) the continuity of the employer-customer relationships. The competing weight of the evidence regarding these factors often leads to hotly contested trials that examine the very way a firm operates and may endanger the revelation of confidential information in the litigation itself. For this reason, courts will usually enter a protective order that prohibits the use of confidential documents and information that a party produces in discovery to the litigation itself. For example, if a Broker-Dealer suing one of its former brokers claims that a broker misappropriated a confidential customer list, the firm will usually request a protective order that would not only prevent the use of confidential documents and information that a party produces in discovery to the litigation itself, but it would also require the other parties to file all documents produced by other parties that contain confidential information to be filed with the court under seal.

Some courts will not rely upon the foregoing seven factors when a business is engaged in professional services or sales. Courts will usually find a near-permanent relationship when professional services are involved. For example, a medical practice usually has no trouble showing that it has a near-permanent relationship with its patients. By contrast, a near-permanent relationship generally will not be found when an employee was engaged only in sales - unless the product sold is unique or the employer's customers are not readily ascertained from telephone directories and professional publications, and are not well known by the employer's competitors. For example, if an Investment Advisor sells complicated investment products to sophisticated customers who are not known to its competitors, the Investment Advisor may be able to demonstrate a near-permanent relationship with its customers if it can also demonstrate that it has had a longstanding relationship with them and that they do not purchase such services from other Investment Advisors. On the other hand, when customers regularly purchase products or services from an employer's competitors, the courts usually will not find a near-permanent relationship. Therefore, using the example of the Investment Advisor once again, if a firm has institutional customers that are well known in the securities industry, and the customers do business with multiple Investment Advisors who sell the same or similar investment products, it may be difficult for the firm to show that it has a near-permanent relationship with its customers.

If the employer has contracts with its customers that require the customers to do business with the employer for an extended period of time, the courts will often find a near-permanent relationship. The fact that a customer occasionally does business with a competitor may not result in a finding that the employer does not have a near-permanent relationship with the customer. When an employer can show that customers maintain their relationships with the employer for an average of five years, the courts have found a near-permanent relationship.

The courts are more likely to enforce a covenant not to solicit customers with whom an employee had contact or developed a relationship than a covenant that prevents an employee from soliciting any customers of the firm. For instance, if an employee only had contact with a small percentage of a firm's large customer-base, the courts may be reluctant to enforce a covenant not to solicit any of the firm's customers. Courts will not require geographical boundaries when an employee has signed a reasonable covenant not to solicit specific customers of the firm. For example, if a broker had worked for a Broker-Dealer in its office in Dubuque, Iowa, and had signed a covenant that only prevented him for a short period of time from soliciting the customers with whom he had contact or developed a relationship while employed by the Broker-Dealer, the courts would probably enforce it, even though it has no geographical boundaries and the broker's customers are located throughout the United States.

A "trade secret" may be a plan or process, tool, mechanism, compound, or informational data used by a person in his business operations and known only to him and such other limited persons to whom it may be necessary to confide it. The courts have held that a restrictive covenant that restricts a former employer from divulging or using "confidential" information is broader than a covenant not to disclose or use a "trade secret," and a covenant that prevents the disclosure of confidential information will be enforced if the employer has a protectable business interest in the confidential information and the confidential information is adequately identified in the contract. The courts, however, will not prevent an employee from utilizing basic skills he developed during his employment.

The factors courts consider when deciding whether an employer has a protectable business interest in a trade secret or other confidential information include the extent to which the information is known outside the business and by other employees within the business who have no need to know the information; the extent of the measures taken to guard the secrecy of the information; the value of the information to the employer and his competitors; the amount of effort and/or money expended in developing the information; and the ease or difficulty with which it could be acquired or duplicated by others.

Disputes about customer lists arise frequently between Broker-Dealers and brokers who have terminated their employment with the firm. The Broker-Dealers will emphasize the difficulty and cost of developing the customer list, and its confidential nature. The brokers, on the other hand, will emphasize the relative ease and the limited cost of developing the list, and that the names on the list are widely known or easily ascertainable. In many cases, the brokers are able to demonstrate that they brought the customers to the firm from earlier employment with still another Broker-Dealer. The Broker-Dealers, on the other hand, are often able to show that they paid the broker for his customer list when they induced him to join the firm with a substantial bonus or a "forgivable loan".

The courts also recognize an employer's right to maintain a stable work force by enforcing covenants not to solicit or induce other employees to leave the firm. For example, disputes often arise between competing Broker-Dealers when one of the Broker-Dealers has hired a group of brokers away from the other Broker-Dealer. These cases are frequently described as "raiding" cases. The Broker-Dealer that lost the group of brokers will usually claim that the firm that hired them tortiously interfered with the contractual relationships it had with the individual members of the group, and tortiously induced the members of the group to violate their covenants not to solicit other employees (in essence, each other) to leave the firm.

Some courts distinguish between covenants that prohibit an employee from soliciting an employer's customers from those that prohibit an employee from accepting orders from the employer's customers. Stated differently, some courts will allow a former employee to conduct business with the employer's customers if the customer contacted the employee (but not vice versa) because the customer is not a party to the contract between the employer and the employee and should be allowed to ask anyone to provide services to him. Yet, other courts have enforced agreements that prevent a former employee from accepting orders from the customer if there are a number of competitors with whom the customer could do business.

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