Lindabury, McCormick, Estabrook & Cooper, P.C. Firm News & Events
I. Where We Are
A. What Are Restrictive Covenants in the Employment Setting in New Jersey?
Generally speaking, restrictive covenants in an employment setting take one of three forms: a covenant not to compete, a non-solicitation covenant, and/or a non-disclosure covenant.
A covenant-not-to-compete restricts a former employee from becoming employed with a competitor of his/her former employer for a period of time. The covenant-no-to-compete most often defines a competitor, lasts for a specific period and is frequently limited to a specified geographic territory.
A non-solicitation covenant restricts a former employee for a limited period from (i) soliciting business from the clients/customers of a former employer; (ii) soliciting employees of the former employer to cease working for the former employer and to become employed by the employee or the employee’s new employer; and (iii) doing business with business partners, referral sources, joint venturers, etc. of the former employer.
A non-disclosure covenant prohibits a former employee from using trade secrets or other confidential and proprietary information of the former employer in connection with the employee’s subsequent employment or business ventures.
B. The Enforceability of Restrictive Covenants in New Jersey
i. Elements of an Enforceable Restrictive Covenant
It is well established in New Jersey that restrictive covenants are generally disfavored as restraints of trade and will be narrowly construed by the courts . The New Jersey Supreme Court has also emphasized that “an employee’s covenant not to compete after the termination of his employment is not as freely enforceable [as other types of restrictive covenants] because of well recognized countervailing policy considerations.”
Nevertheless, restrictive covenants will be enforced if reasonable under the circumstances. The enforceability of restrictive covenants is governed by the what has been judicially identified as the Solari/Whitmyer test. The reasonableness of a restrictive covenant requires a balancing to determine, amongst other things, whether the restrictive covenant is necessary to protect the employer’s legitimate interests. Whether a restrictive covenant is enforceable is a question of law to be decided by the courts.
In Ingersoll-Rand Co. v. Ciavatta , the New Jersey Supreme Court attempted to clarify the circumstances under which a covenant would be considered reasonable. In so doing, the Court held that a restrictive covenant will be deemed reasonable and enforceable if (i) it protects the legitimate interests of the employer; (ii) it imposes no undue hardship upon the employee; and (iii) it is not injurious to the public interest. Conversely, a covenant will be deemed unreasonable and unenforceable as written if it: (i) extends beyond any apparent protection that the employer reasonably requires; (ii) prevents the employee from seeking other employment; or (iii) adversely impacts the public. Those factors must be balanced on a case-by-case basis.
With respect to the first element of the test, it is well settled that employers have a legitimate interest in protecting trade secrets, proprietary and confidential information, and customer relations. However, courts will not enforce restrictive covenants that are “principally directed at lessening competition.”. “Simply defeating competition from experienced former employees is not a legitimate business interest.”
Because restrictive covenants “probably interfere with an employee securing a position in which he could most effectively use his skills, [while] at the same time depriving society of a more productive worker,” the court must balance protection of the employer’s legitimate interests with the hardship upon the employee. “A restrictive covenant can cause undue hardship to an employee if it places substantial limitations on where an employee may work or if it prevents an employee from engaging in his or her livelihood.” Similarly, the courts recognize that an employee’s knowledge, skill, expertise and other information acquired during the course of his employment “belong to him as an individual for the transaction of any business in which he may engage . . . including a competitive business with his former employer.” Id. In Ingersoll-Rand Co., the former employer was attempting to enforce a contractual provision requiring the former employee to assign any and all inventions developed within one year after terminating his employment with the former employer if the invention was conceived as a result of his work with the employer. Reversing the trial court’s granting of injunctive relief to the employer, the Appellate Division determined that the scope of the protections sought by the employer were overbroad and were simply restraining trade. In so ruling, the Appellate Division stated:
An employee who uses no confidential information imparted to him by his employer has every right to market competitive products and otherwise to compete with his former employer. Limitations on this right, expressed in contracts of adhesion, must be strictly construed against their drafters; whether phrased in terms of direct restrictions against competition or of imposition of other restrictions having similar anti-competitive effects, such limitations must be carefully analyzed applying the Solari/Whitmyer standards. The line between these competing interests may be difficult to draw, and the employer bears the burden on this issue. Id. at 638.
Thus, an employer seeking to enforce a non-competition agreement bears the burden of proving the agreement’s enforceability. And unlike traditional contracts, employers face a heightened burden when seeking to enforce a restrictive covenant. As observed by the court in Magic Fingers, Inc. v. Robins:
[C]ourts have attributed much strength to the social policy that every man should be free to earn his own living and have also recognized that an employee who is asked to sign a covenant may not have the full freedom to bargain about its terms that exists in other business situations. In other words, contracts of this type – if they are enforced – must pass a stricter test than other types of contracts; it is not enough to say the parties signed a document in good faith and are, therefore, bound to all of its terms.
As stated, an employer has a legitimate interest in protecting its client relationships. However, it has also be held
{E}mployers should not be permitted to include the broadest possible restrictions in an employment contract, thus achieving the greatest possible amount of protection for themselves, to the unreasonable restriction of an employee’s right to use his skills to the best advantage, and then be enabled to enforce so much and so many of the restrictions as can be found by a court to be reasonable under the circumstances. If such were the rule, it would afford employers an unconscionable advantage over their employees.”
“The balance is struck thusly: if the contractual prohibition is reasonably necessary for the protection of the employer’s business and at the same time is neither unreasonably restrictive of the rights of the employee with regard to time period or territory, nor prejudicial to the public interest, it will be enforced.” Id. at 513. “As stated by Professor Corbin, ‘the restriction is deemed excessive ab initio if its limit in either space or time is greater than is necessary for the employer’s protection against ‘unfair’ competition.’” 6A Corbin, Contracts (1962), § 1394.
In BDO Seidman v Hirschberg , New York’s Court of Appeals determined that a restrictive covenant barring an employee from soliciting all clients of the employer’s Buffalo office, regardless of whether the employee had contact with the client while working for the employer, was overbroad and a restraint of trade. The Court denied enforcement of the covenant. In so doing, the Court of Appeals , said:
BDO’s legitimate interest here is protection against defendant’s competitive use of client relationships which BDO enabled him to acquire through his performance of accounting services for the firm’s clientele during the course of his employment (Blake, op. cit.,at 647-661). Extending the anti-competitive covenant to BDO’s clients with whom a relationship with defendant did not develop through assignments to perform direct, substantive accounting services would, therefore, violate the first prong of the common-law rule: it would constitute a restraint “greater than is needed to protect” these legitimate interests (Restatement [Second] of Contracts § 188 [1][a]).
Although the New Jersey Supreme Court has not had the occasion to rule on a similar restrictive covenant prohibiting an employee from soliciting business from all clients of the former employer, it has suggested that it will follow the holding of the New York court. In Solari Industries the New Jersey Supreme Court was called upon to consider the enforceability of a restrictive covenant. The trial court had determined that the restrictive covenant at issue therein was overbroad and unenforceable, as it barred the former employee from soliciting the business of any of the former employer’s customers or engaging in a competing business. In its seminal decision, the New Jersey Supreme Court determined that New Jersey should adopt the “blue-penciling” concept of judicially modifying overbroad restrictive covenants to make them reasonable. In remanding the matter to the trial court to reconsider the breath of the restrictive covenant in light of its authorization to “blue-pencil” the restrictive covenant, the Court said:
[P]laintiffs are entitled … to that limited measure of relief within the terms of the noncompetitive agreement which is reasonably necessary to protect their legitimate interests, will cause no undue hardship on the defendant, and will not impair the public interest.
* * *
[T]here was general acknowledgment on the part of the plaintiffs that their legitimate interests would be adequately protected by a limited restraint against Malady’s dealing with any of Solari’s actual customers or prospective customers in the United States with whom he had substantial dealings on Solari’s behalf while in Solari’s employ (emphasis added).
In A.T. Hudson & Co. v. Donovan , the Appellate Division also recognized the Solari court’s determination that a restrictive covenant should be limited to restricting an employee from soliciting a former employer’s clients with whom the employee dealt. In A.T. Hudson & Co., the Appellate Division was confronted with a restrictive covenant that provided, “[f]or a period of two (2) years after you leave the employ of the Company, you will not directly or indirectly, for yourself or for any other Business Entity, solicit any business from, or render any services to (a) any business entity which has been a customer of the company….” . The trial court determined that the restrictive covenant was unenforceable because it impaired public interest. On appeal, the Appellate Division reversed and remanded. However, in so doing, it specifically recognized the limitations set by the New Jersey Supreme Court in Solari of a limited restraint against the employee’s dealing with any actual customers or prospective customers in the United States with whom the employee had had substantial dealings on behalf of the former employer.
Likewise, employers should not be permitted to enforce any restrictions against the solicitation of its prospective clients with whom the former employee had no dealings or about which the employee acquired no knowledge while in the employ of the former employer. In Platinum Management v. Dahms , the court reasoned that to the extent a restrictive covenant prohibited the solicitation of prospective customers, it was overbroad and unenforceable.
In ADP, LLC v. Rafferty , and ADP, LLC v. Kusins , two recent decisions, the courts were confronted with a non-solicitation clause that restricted employees from soliciting all clients of the former employer for a period of one year subsequent to terminating their employment with the former employer. In both cases, the courts refused to find that the restrictive covenant was a restraint of trade. In both cases, however, the courts concluded that the restrictive covenants were overbroad.
In ADP, LLC v. Rafferty , the Third Circuit concluded that ADP had a legitimate reason for imposing a non-solicitation clause upon sales persons who met certain sales objectives and were awarded company stock. The non-solicitation clause restricted former employees from soliciting any of ADP’s clients after terminating their employment. The Third Circuit also concluded that the non-solicitation clause was overbroad and had to be blue-penciled to make it reasonable. The Third Circuit reversed and remanded the matter to the district court to blue-pencil the applicable restrictive covenant.
In ADP, LLC v. Kusins , the Appellate Division consolidated six cases appealed from two Chancery Courts. In three of the lower-court decisions, the trial court determined that ADP’s non-solicitation clause within its restrictive covenant agreement imposed upon only salespersons who met certain sales objectives and who were awarded company stock were restraints of trade and unenforceable. In three other lower court decisions, the trial court determined that ADP’s non-solicitation clauses were enforceable but were overbroad and had to be blue-penciled. In those cases, the trial court determined that the non-solicitation clauses had to be limited to the actual ADP clients with whom the former employee had dealt while employed by ADP. The Appellate Division found that ADP had a legitimate business interest in protecting its client relationships and in imposing the more onerous restrictive covenants upon only a subset of its employees; as such, it concluded that the non-solicitation clause was not a restraint of trade. Alternatively, the Appellate Court concluded that the non-solicitation clause was overbroad and needed to be blue-penciled. It then reversed and remanded all six cases to the trial courts to reconsider their decisions with the Appellate Division’s guidance.
Although the Appellate Division began its decision by stating that the lower court’s “treatment of the various lawsuits has been inconsistent” and that it was striving “to bring some clarity and uniformity to the consideration of [ADP’s restrictive covenant agreement], and to provide the parties guidance for the drafting of such covenants,” the Appellate Division reversed and remanded all six trial court decisions in what can best be explained as a contradictory and confusing decision. The Appellate Court initially concluded that the former ADP clients were prohibited “from soliciting any of ADP’s actual clients with whom the former employee was directly involved or who the employee knows to be ADP’s client.” The Court never indicated when the former employee had to obtain knowledge of the ADP client. The same court subsequently stated, “we conclude that the RCA is not unenforceable per se, but is subject to blue-penciling regarding both the solicitation of prospective clients and the solicitation of ADP’s actual clients to require that defendants were actively involved with or had knowledge of these clients while at ADP.” The Appellate Division did not attempt to clarify its inconsistent statements. The Appellate Division concluded, however, one of the former employees had violated the non-solicitation clause of the restrictive covenant agreement, because he had successfully solicited business from an ADP client during the one-year non-solicitation period. The salesperson had not dealt with or acquired knowledge of the ADP client while he was employed by ADP. At best, the former employee learned that the client was using ADP’s services and was an ADP client when he solicited its business subsequent to terminating his ADP employment.
As a result of the recent Appellate Division decision in Kusins, it appears as though an employer can effectively preclude the solicitation of all of its clients for a one-year period. The Appellate Division held that (1) the former employee cannot solicit clients of its former employer with whom the employee may have dealt, and (2) the former employee must stop any and all solicitation of clients of its former employer if he/she learns during the sales process that the client is an ADP client.
There has been one trial-court decision concerning the same ADP restrictive covenant agreement since the Third Circuit and Appellate Division decisions have been rendered. In ADP, LLC v. Trueira , Judge Kevin McNulty issued a revised, preliminary injunction against a former ADP employee. In so doing, Judge McNulty relied upon the Appellate Division’s Kusins decision and determined that the non-solicitation provisions of the ADP restrictive covenant restrained the former employee from soliciting clients with whom the employee had dealt substantially while employed by ADP or of whose identity the employee learned while employed by ADP.
Clearly, the extent to which an employer can restrict a former employee from soliciting its clients after terminating his/her employment is still unresolved.
ii. Consideration
Under New Jersey law, the employer’s initial offer of employment or continued employment after hire is sufficient consideration for a restrictive covenant . Thus, throughout the course of the employment relationship, the employer’s agreement not to exercise its right to terminate an at-will employment relationship is deemed sufficient and will not void an otherwise reasonable restriction for lack of consideration.
iii. The Blue-Pencil Doctrine
New Jersey has adopted the “blue pencil” doctrine that permits the court to modify overbroad restrictive covenants to make them enforceable . However, a court may decline to employ the doctrine if it finds that the restrictions are not aimed at protecting the employer’s legitimate interests, but rather are aimed at stifling competition from a former employee and are thus unenforceable restraints of trade. Id.
Employers who draft overbroad restrictions with the expectation that a court will blue-pencil the agreement run the risk of having the entire agreement struck down if they cannot show that the protection of legitimate interests was the motivating factor behind the restriction. In light of the recent decisions in Rafferty, and Kusins, it appears that the risk of having an entire agreement struck down has been minimized.
iv. Length of Time of Restrictive Covenants
Although the reasonableness of the temporal aspect of a restrictive covenant is directly related to the nature and scope of the other aspects of a restrictive covenant (such as geographic scope, client restrictions, etc.), New Jersey Courts will generally enforce restrictive covenants having no more than a two-year period of restraint in the employment setting.
v. Geographic Scope of the Covenant
The enforceable geographic scope of a non-compete covenant will frequently depend upon the nature and geographic scope of the former employee’s job. A non-compete covenant mandating that a nuerosurgeon could not engage in the practice of medicine within a thirty mile radius of his former hospital employer was held to be reasonable. . Id.. A two-county non-solicitation covenant was upheld for a dental supply salesperson . A twelve-mile restriction against opening an office in competition with his former employer was upheld against a physician . And in the recent Kusins decision, the Appellate Division confirmed that a non-compete covenant restricting a former employee from working in the same geographic territory in which that employee had worked for the former employer was valid and enforceable.
C. Remedies for Breach of a Restrictive Covenant
i. Temporary Restraining Orders and Preliminary Injunctions
Preliminary injunctive relief is an “extraordinary remedy that should be granted only in limited circumstances” and will not issue except when absolutely necessary to prevent substantial, immediate and irreparable harm to the party seeking such relief . That said, injunctive relief should be granted when a party shows all four of the following requirements: (1) a likelihood of success on the merits; (2) that it will suffer irreparable harm if the injunction is denied; (3) that granting preliminary relief will not result in even greater harm to the nonmoving party; and (4) that the public interest favors such relief. Moreover, “[i]f either or both of the fundamental requirements — likelihood of success on the merits and probability of irreparable harm if relief is not granted — are absent, an injunction cannot issue.” The Third Circuit has held that it “cannot sustain a preliminary injunction . . . where either or both of these prerequisites are absent.” Where a party has failed to both articulate and adduce proof of actual or imminent harm that cannot otherwise be compensated by money damages, it has failed to sustain its burden of showing irreparable harm.
“To demonstrate irreparable harm the plaintiff must demonstrate potential harm which cannot be redressed by a legal or an equitable remedy following trial. The preliminary injunction must be the only way of protecting the plaintiff from harm.” An alleged violation of a restrictive covenant does not automatically give rise to ‘immediate irreparable harm to [ ] goodwill and reputation. Rather, to establish a showing of irreparable injury, a plaintiff must show more than a mere risk of injury; it must make “a clear showing of immediate and irreparable injury.” Moreover, general statements pertaining to alleged trade secrets, business methods and practices and the defendant’s knowledge of an employer’s clients are insufficient to support a finding of irreparable harm. It is well settled that “[t]he availability of adequate monetary damages belies a claim of irreparable injury . . . [because] a purely economic injury, compensable in money, cannot satisfy the irreparable injury requirement.” As the Court stated in Saturn Wireless , “harm is considered irreparable if it is not redressable by money damages at a later date, in the ordinary course of litigation.” Although the Third Circuit has recognized that loss of business opportunities and goodwill constitutes irreparable harm, there must still be showing that there is a diversion of a former employer’s clients and/or the disclosure of confidential and proprietary information.
The party seeking injunctive relief bears the burden of showing that all of the factors weigh in favor of preliminary relief.
ii. Equitable Tolling
Absent a specific tolling provision in a restrictive covenant agreement, the covenant expires at the end of its designated term and, once expired, it is not generally extended. Although there is a paucity of case law in this state regarding the equitable tolling of a restrictive covenant, the New Jersey Supreme Court in Community Hospital Group, Inc. v. More, determined that because restrictive covenants were not favored, there was no justification to extend or toll the period set forth in the agreement. The Court held that the employer’s remedy was limited to monetary damages. Similarly, in Vanguard Dealer Services, LLC v. Scarano , the Appellate Division upheld a lower court’s refusal to extend the restrictive covenant. The Vanguard court explained:
Other than contending that it did not get the “benefit of its bargain” from the restrictive covenant with defendant, Vanguard has provided neither the trial judge nor this court with any sound basis to extend that restrictive covenant. Beyond seeking a punitive measure for defendant’s violations, Vanguard offers no explanation as to how extending the restrictive covenant would protect its interests … Moreover, Vanguard has not cited, and we are not aware of, any controlling legal support for this relief. (Emphasis added).
iii. Permanent Injunction
It is well settled that equitable relief in the form of a permanent injunction is an extraordinary remedy that should be granted only in very limited circumstances and will not issue except when absolutely necessary to prevent substantial, immediate and irreparable harm to the party seeking such relief. The burden on a party seeking an injunction is a “particularly heavy” one, “such that the moving party’s right to relief must be indisputably clear.”
Injunctive relief should only be granted where a party shows, by clear and convincing evidence, all of the following factors: (1) immediate and irreparable harm if the relief is not granted; (2) that the legal right underlying the claim is well settled, the material facts are substantially undisputed, and, therefore, the moving party has a reasonable probability of success on the merits; and (3) that the hardship imposed upon the defendant and the public by the issuance of the relief are not greater than that which would be suffered by the party seeking relief if same were not granted.
Each of these factors must be clearly and convincingly demonstrated in order for an injunction to be granted. That is because “the issuance of an injunction… represents the strongest weapon at the command of the court of equity” and “represents a significant intrusion into the affairs of the parties, and, as here, the interests of the public.” “An injunction is primarily a preventive remedy intended to afford relief against future acts or conduct which are against equity and good conscience rather than to remedy what is past and done or to punish for wrongs already committed.”
II. Where Are We Going
Without considering the pending legislation to regulate the use of restrictive covenants in New Jersey , it appears from recent decisions that the courts are not inclined to strike a restrictive covenant agreement regardless of its overbroad provisions; the courts prefer to blue-pencil the covenants to make them reasonable. In so doing, the courts seem to be permitting employers to exert their unequal bargaining power and to take advantage of their employees by compelling the employees to accept overbroad restrictive covenants without the fear of the covenants not being enforced. At worst, if a restrictive covenant is challenged and determined to be overbroad, the court will simply blue-pencil and then enforce the modified agreements. In short, it appears as if the courts are not requiring employers to act reasonably in the drafting and implementation of post-employment restrictive covenants.
Stay tuned, however, as petitions for certification have been filed with respect to the recent Appellate Division decisions.