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Restrictive Covenants in Employment Agreements

The Arizona Court of Appeals ruling in Orca v. Noder addresses how far companies can go in restricting the competitive activities of former employees

In a November 2013 article ("Customer List: Not Necessarily a Trade Secret"), we discussed the first of two important Arizona cases governing restrictive covenants between companies and their employees. That article addressed the Calisi v. United Financial Services case, which clarified what constitutes a trade secret and what companies should do to safeguard their legally protectable information.

In this companion article, we discuss the ruling by the Court of Appeals in Orca Communications Unlimited v. Noder, which discusses broader issues with respect to what companies may do in restricting the activities of former employees who start or go to work for competing businesses.

• See our related article about the Arizona Supreme Court's November 2014 ruling in Orca v. Noder

From 2002 to 2009, Ann Noder was the president of Orca Communications Unlimited, a Phoenix public relations firm. As part of her employment, Noder signed a Confidentiality, Non-Solicitation and Non-Competition Agreement (the "Agreement"). As its title implies, the Agreement contained a number of restrictive covenants, including:

  • a confidentiality covenant,

  • a non-compete covenant and

  • a customer non-solicitation covenant.

While on Orca's payroll, Noder contacted potential customers to advise them that she was planning to start her own public relations firm. Orca filed a lawsuit against Noder, claiming, among other things, that she breached the agreement mentioned above. Noder countered that the agreement's restrictive covenants were overly broad and should not be enforced against her. The trial court agreed with Noder and dismissed Orca's complaint. Orca appealed.

The Arizona Court of Appeals ruled in Noder's favor on the breach of contract claim, finding that the three covenants listed above were indeed overly broad and, therefore, unenforceable.

(It should be noted that Orca's lawsuit against Noder addressed a number of issues not covered in this article. At trial, the court dismissed Orca's lawsuit in its entirety, but the Court of Appeals reversed the trial court's dismissal of some of Orca's claims and remanded the surviving claims for trial.)

A closer look at the three covenants provides useful guidelines and limitations for companies seeking to restrict the competitive activities of their former employees.

Confidentiality Covenant

The following two important aspects of the confidentiality covenant at issue caused it to be unenforceable:

  • Noder was prohibited from competing with Orca as to any "confidential information," which was defined as "knowledge or information not generally known to the public or in the public relations industry" that Noder learned from her employment with Orca that related to Orca, its business partners, or the business of its customers or potential customers.

  • There was no geographical restriction on the covenant.

The Court of Appeals found that the Agreement's definition of "confidential information" was overbroad in two respects. First, it provided that even "public information" was confidential if the public would have to do "substantial searching" for it or combine information from multiple publications. Second, it deemed any information that Noder came across during her employment with Orca as confidential irrespective of whether the information was truly confidential. Accordingly, the Court of Appeals held that the confidentiality covenant was "nothing more than an unlimited restriction against competing with Orca."

As to the lack of a geographic restriction, the Court noted that a restriction on a former employee's right to compete is enforceable only if the restriction is limited in time and geography.

"Without a geographic restriction," wrote the Court, "the Agreement thus prohibits her from working anywhere in the public relations industry for twelve months." The Court concluded that the confidentiality covenant was "the equivalent of a geographically unrestricted non-competition agreement" and, thus, unenforceable.

Non-Compete Covenant

Because employers are barred from eliminating competition, restrictive covenants will be unenforceable if they go beyond protecting a legitimate business interest and prevent a former employee from using his or her skills and knowledge, wherever they were acquired.

Orca's covenants sought to prohibit Noder from advertising, soliciting or providing services that directly competed with services she provided, or acquired confidential information about, during her employment with Orca. The Court found this covenant to be so broad that it essentially prevented Noder from pursuing any type of work in the public relations industry, which Orca had no protectable interest in doing. Given that the non-compete covenant protected more than Orca's legitimate business interests, the Court held it was unenforceable.

Customer Non-Solicitation Covenant

The non-solicitation covenant met a similar fate. The covenant applied not only to actual customers but also to "potential" and "former" customers. The Court found that the prohibition was so broad that any person or company could be included as a potential customer. The Court held that Orca had no protectable interest in either potential customers or former customers, and therefore upheld the lower court's ruling that the non-solicitation covenant was unenforceable.

Conclusion

The ruling in Orca by no means prohibits employers from enforcing confidentiality, non-competition and non-solicitation provisions from their agreements with employees. It does, however, reaffirm that restrictions on post-employment activity must be reasonable, narrowly tailored as to time and place, and may not bar a former employee from making a living in their chosen field. It should also be noted that Orca has petitioned the Arizona Supreme Court for review of this decision.

In negotiating restrictive covenants with a current or prospective employee, it would be wise to consult with an attorney who can help you protect your legitimate interests and craft an agreement that will hold up to legal challenges.