Restrictive covenants are clauses in contracts that limit what the parties can do. If you’re a business owner, an employee, or simply someone interested in the complex world of contracts, it’s a good idea to know how these clauses work.
Today, we’re taking a deep dive into the world of restrictive covenants and how they might affect you or your business.
What is a Restrictive Covenant?
A restrictive covenant defines what a party to a contract can do. Imagine it as a safety net that businesses use to keep their interests safe from harm. While these covenants are pretty standard in the business world, they’re also a hot topic of debate. Advocates for workers argue that these rules can be a raw deal for employees, limiting their freedom in the job market. But for business leaders, restrictive covenants are seen as essential guardrails that keep their companies secure.
Key Takeaway: Restrictive covenants limit what parties in a contract can do but are not without controversy.
Types of Restrictive Covenants
1. Non-Compete
This type of language restricts one party from competing directly with the other. In most states, non-compete language must be limited in time and geographic scope to be enforceable. A never-ending non-compete that applies worldwide probably won’t cut it.
Example:
A non-compete might say that a cybersecurity specialist can’t work for a competitor within 50 miles for a year after leaving their job.
2. Non-Disclosure (Confidentiality)
The non-disclosure clause prevents the sharing of confidential information. Like the non-compete, the more broad this language is, the less likely it is to be enforced. Often, there are exceptions to this language if disclosure is required by court order or administrative action.
Example:
A researcher can’t share details of a groundbreaking discovery with anyone outside their organization.
3. Non-Solicitation
Non-solicitation clauses prohibit approaching existing clients or poaching employees. Sometimes, these clauses only prevent approaching the clients or employees but do not prohibit the client or employee from approaching the person.
Example:
A salesperson who can’t take their clients with them if they leave the company.
4. Non-Circumvention
The non-circumvention clause prevents one party from bypassing the other to achieve a similar end. This is often used when a party doesn’t want to be cut out of a potential deal.
Example:
If you introduce a business partner to your supplier, a non-circumvention clause would prevent them from going directly to the supplier to cut you out of a deal.
Key Takeaway: Restrictive covenants can limit the ability to do business, discuss information, or pursue leads.
Why They Matter
Restrictive covenants can be used as a way to protect one’s business. But for employees or other companies, they can be frustrating. All the parties to a contract must understand what these limitations mean. Failing to do so can create a legal nightmare for you or your business.
Key Takeaway: These covenants can be helpful but must be understood.
Pros and Cons of Restrictive Covenants
Pros:
- Protects company assets and information
- Adds contractual strength
- Prevents employees and contractors from stealing clients
Cons:
- Could deter potential hires
- May frustrate employees, contractors and other companies
- Risk of legal challenges
Key Takeaway: The benefits and drawbacks must be carefully weighed.
Navigating the Legal Landscape
Contracts can be complex. Consulting a legal expert is crucial to ensure your restrictive covenants are enforceable. It’s also important for companies to understand changes in the legality of these covenants. There may be significant legal implications for existing contracts.
Key Takeaway: Legal matters are complex. Talk to a lawyer.
My Real World Experience
I have been on both sides of restrictive covenants. Accordingly, I can give you insight into how these play out in the real world.
Non-Compete
I have used non-competes in both employment agreements and agreements between businesses. Many companies look to add non-compete language after being burned by a former employee or partner who used their knowledge of the company to go after their market. Most articles don’t tell you that many companies are willing to negotiate or waive the non-compete. Sometimes, the company wants reassurance that they aren’t being targeted. Other times, they want something in return. It’s very dependent on the company and the people running it.
Non-competes require careful planning. If a company signs a non-compete when it’s in a similar industry as the other party, it could be a disaster.
Non-Disclosure
Almost any contract will have some form of confidentiality or non-disclosure language. Better-written non-disclosure agreements will be more descriptive of the information which cannot be disclosed. Some even require to mark such items as “confidential.” It can be challenging to prove that confidential language was disclosed, but not impossible. Such disclosures can sometimes appear in discovery (as part of a lawsuit) when text messages or emails are turned over, clearly showing the confidential information.
Non-Solicitation
Like the non-compete, non-solicitation language is often used when a company has had employees or clients get poached by a party they trusted. I see this clause most commonly in sales positions. Such language is also a part of the discussion when a company needs to disclose information about its customers to other parties (note that restrictive covenants can, and often do, overlap).
Non-Circumvention
The non-circumvention clause comes up a lot with joint ventures and strategic alliances. When two companies join up to tackle an issue together, the temptation can arise for one of the companies to cut the other out of the deal. This can also happen with brokerage agreements, where the broker will ask for this language to keep the parties from cutting it out.
The Legality of Restrictive Covenants: A State-by-State Affair
As stated, not everyone is a fan of restrictive covenants. Accordingly, these types of provisions are viewed differently across states. Some states limit or ban certain restrictive covenants due to “restraint of trade,” aiming to promote a competitive job market.
Proposed FTC Non-Compete Ban
The federal government has also weighed in on the restrictive covenant issue. Earlier this year, the Federal Trade Commission (FTC) shook things up by proposing a ban on non-compete clauses. The public comment period was open until April 19, 2023, and drew various opinions. While worker’s rights advocates have been largely supportive, the proposal has faced stiff opposition from industry groups and some legal circles, who argue that non-compete clauses are vital for protecting businesses. So, what’s next? The FTC is slated to make its final decision in 2024, keeping everyone on the edge of their seats.
Key Takeaway: The legal landscape of restrictive covenants is ever-changing.
Restrictive Covenants are a Part of Doing Business
Love them or loathe them, restrictive covenants are likely to cross your path at some point, whether you’re running a business or climbing the career ladder. For business owners, these covenants can act as a security system for your company’s valuable assets. On the flip side, if you’re an employee, knowing how these rules could limit your professional moves is crucial. Staying in the know about what these clauses do—and how the legal landscape around them is evolving—can save you from headaches and legal tangles in the future.
Final Thought: In the evolving world of restrictive covenants, being well-informed is your strongest shield against potential pitfalls.
This article is intended for informational purposes and should not be considered legal advice.