The Complexity of Non-Compete Agreements. What You Need to Know.
As the saying goes, good help is hard to find. In the cabinet industry, finding a qualified and skilled cabinet designer or installer is critical to the success of your business. Once you have found an employee who is the proper fit for your company, you entrust that employee with your trade secrets, client lists, pricing information and other data, all of which is proprietary to your company. But what happens when that employee is solicited by a competitor for employment and decides to leave you? Is there a way for you to prevent that former employee from sharing your proprietary information with his/her new employer? Restrictive covenants are contractual devices that can prevent employees from competing with your company, soliciting your clients and utilizing your trade secrets. Once primarily used by large corporations, restrictive covenants have become commonplace even in small "mom and pop" businesses. There are many types of restrictive covenants. The two most utilized are noncompete agreements and nonsolicitation agreements. NONCOMPETE AGREEMENTS A noncompete agreement is an agreement not to work for a competitor within a specified geographic region for a specified period of time. For example, if an installer decides to take a position with your competitor, a typical noncompete agreement may prohibit him from working as a cabinet installer within a 30-mile radius from your company for one year. While still enforceable in many states, courts typically frown upon noncompete agreements. In states that enforce noncompete agreements, they must meet established criteria. For example, under New Jersey law, a noncompete agreement must be found to be reasonable under a three-pronged test. The test requires such an agreement to (1) protect a legitimate interest of the employer; (2) impose no undue hardship upon the employee; and (3) not be injurious to the public interest. Most states enforcing noncompete agreements rely upon similar tests to determine the reasonableness of the agreement. These tests are applied on a case-by-case basis and provide plenty of wiggle room for a judge to hold them invalid. Some states have statutes that prohibit the use of noncompete agreements. For example, California prohibits noncompete agreements in their entirety. Other states, such as Massachusetts, have proposed legislation pending that would also prohibit noncompete agreements. However, states that prohibit noncompete agreements may still enforce nonsolicitation agreements. NONSOLICITATION AGREEMENTS A nonsolicitation agreement, by contrast, permits a former employee to work for a competitor, but not to solicit clients of his/her previous company. Generally, courts view nonsolicitation agreements with greater favor than noncompete agreements because nonsolicitation agreements typically restrict the employee from soliciting only a targeted subset of customers in a particular market and leave the employee free to work for a competitor and to solicit other customers in competition with the former employer and in the same geographic area. Lawsuits arising out of restrictive covenants typically require the court to attempt to balance the employee's interest in earning a living against the employer's interest in protecting its business. As noted above, the court's analysis of restrictive covenants is made on a case-by-case basis. Although cases, rules and law exist for the courts to look to, there is no certainty. Therefore, if you desire to have your employees sign a noncompete or nonsolicitation agreement, it is in your company's best interest to obtain the input of an attorney experienced in this field. A competent attorney will advise you that the general rule when creating such agreements is balance and fairness. In most cases, the only way to know if an agreement is enforceable is to try to enforce it. While it is not prudent for an employer to attempt to draft its own restrictive covenants, if your company decides to do so, it should analyze the following: (1) whether the proposed agreement is reasonably fair; (2) whether it protects your company's client lists, proprietary information and trade secrets; and (3) whether it allows a former employee to continue to earn a living. One area of restrictive covenants that is often overlooked relates to the hiring of employees who may be bound by prior agreements. Typically, one thinks of a noncompete or nonsolicitation agreement in terms of how such an agreement will protect one's business. Quite often employers forget to inquire about existing agreements entered into by a prospective employee and his/her former employer. When interviewing a prospective employee, it is wise to question whether he/she is bound by a restrictive covenant. If so, make sure that you request a copy of the agreement and have a lawyer review the document to determine if you may hire him/her. You surely do not want to end up as a defendant in a lawsuit over a new employee who is bound by a prior restrictive covenant. In general, restrictive covenants, especially nonsolicitation agreements, can be valuable tools for protecting your company's proprietary information. They can prevent employees from soliciting your existing clients, pilfering your other employees or divulging trade secrets to your competitor. However, great care must be taken in drafting an enforceable agreement. It is inevitable that even the most cautious designer, installer or kitchen design specialist will make mistakes from time to time. However, there are ways in which kitchen and bath professionals can attempt to limit liability arising from their errors or omissions. One such way is to purchase Errors and Omissions insurance (E&O), also known as Professional Liability insurance. E&O insurance is separate and distinct coverage from any Commercial General Liability policy (CGL) that you or your company may currently possess. While many may have heard of E&O insurance, very few people truly understand what it is. E&O is a piece of insurance that covers you individually, or your company, in the event that one of your clients sues you or otherwise holds you liable for a service that you provided, or failed to provide, that did not meet the expected or promised results. Most doctors, accountants, architects and engineers have some form of E&O coverage. E&O may also be beneficial to kitchen and bath professionals. For example, assume that your client has requested cabinets with a walnut finish. However, when the units are delivered, they turn out to be cherry. Your client had wanted the cabinets delivered and installed prior to a large social event that she was hosting at her house. Even though you offered to replace the cabinetry at no charge, she sues you, alleging that your negligence has resulted in her sustaining monetary damages as well as the loss of use of the cabinets for her special event. Without E&O coverage, you may end up paying to defend the claim out of your own pocket. It is important to note that the type of loss described in the example above would not be covered under a CGL policy, which typically contains exclusions for work product. If, however, you had a properly construed E&O policy, you may be entitled to coverage that would include the payment of all court costs, judgments, verdicts or settlements and attorneys' fees. While an E&O policy may seem like a panacea for any negligence on your part, you must be aware that insurance companies typically want to avoid paying out large sums of money on their insureds' policies. The way they avoid doing so is by building into their policies numerous exclusions that may be quite complicated for the average business owner to fully understand. Although E&O policies vary significantly, typical policies will not cover you for liability that you assumed under any contract or agreement unless you would have been legally liable in the absence of the contract because of your negligent act, error or omission in the performance of your professional services. This exclusion would apply if you entered into a contract that contained penalty clauses, guarantees, warranties, liquidated damages or certain other provisions. Other exclusions include liability (1) for damages or injury to real or personal property that is in your care, custody or control, or that you are repairing; (2) arising out of any dishonest, fraudulent or criminal act or omission, or for other intentional wrongful acts; and (3) for punitive or exemplary damages, fines or penalties or any multiplication of compensatory damages. E&O policies may contain a host of other exclusions of which you should be fully aware before purchasing the coverage. It is critical that you communicate to your insurance broker your needs for coverage under an E&O policy. You should explain to your broker exactly what services you provide and ask him to explain all of the limitations and exclusions contained in the policy to you. Be prepared to provide copies of your contracts, agreements, purchase orders and other documents to the insurance underwriters. They typically review such documents to determine their risks associated under the policy. Generally speaking, the higher the risk, the higher the premium. Determining whether an E&O policy is right for you takes a good deal of thought and some in-depth conversations with your insurance broker. E&O policies can protect you and your company from various errors and omissions and save you a good deal of money in the event that you are sued. However, high premiums and confusing or limiting exclusions may impact your decision to purchase a policy. Ultimately, so long as it is economical, having too much insurance coverage is better than being underinsured. Nevertheless, no amount of coverage can protect you from everything. Thus, the best way to limit liability is to utilize properly constructed contracts and to pay close attention to details when dealing with customers.