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Restrictive Covenants in Global Business Require Precision … And a Realistic View of their Scope

Contract Clauses

By Laura Steinberg May 7, 2013

Protecting Your Interests

The subject: Restrictive covenants’ place in global commerce.

The concerns: There are many, and there always have been. Overseas business increases the complications.

The reality: They may be unloved, but clients want them. If ADR is a component, they may work better.

Expanding abroad opens your company up to … new limits? Somewhat paradoxically, the increasing globalization of companies that used to be strictly U.S.-based has in some respects underscored the differences, rather than the similarities, in employer approaches, depending on location, to the protection of confidential and proprietary company information and property.

In the United States, use of restrictive covenants is common for key executives who carry company good will. There is a good likelihood of enforcing covenants that meet basic reasonableness criteria.

But outside the United States, the use of such covenants is much less commonplace. Even when the covenant is governed by U.S. law, enforcement remains much more problematic, and even if a company obtains a U.S. federal or state court judgment, despite international treaties. Outside the United States, enforcement can be an uphill battle.

The most effective way to surmount these problems and to create a uniform company-wide strategic approach is to use arbitration as the enforcement mechanism, rather than U.S. courts (which may lack jurisdiction) or foreign courts (which will likely view the covenant with disfavor). For the global company, ADR should be a preferred component of the enforcement toolkit deployed to protect confidential and proprietary company assets.

DIFFICULT CHOICES

A company that requires or seeks to enforce restrictive agreements only for its U.S. workforce and not for similarly situated personnel working outside the U.S. is likely to have enforcement problems even in the United States.

The obvious issue is that it becomes quite difficult to establish that a restrictive agreement is reasonably necessary for protection of specific company interests in the home state or country if the same interests apparently require no protection in other, non-U.S. jurisdictions.

This creates a compelling reason to try to treat similarly situated employees consistently around the world.

At the same time, in planning a company-wide restrictive covenant strategy, it is important to recognize that efforts to enforce apparently reasonable restrictive agreements outside the United States generally yield different results than enforcement efforts that play out within the U.S. Senior executives who seek to impose restrictive agreements on a global workforce may find that undertaking counterproductive if the covenants are held unenforceable in key cross-border situations. One such bad outcome may embolden other employees to flout their covenants upon departure.

The result is the exact opposite of the sought-after deterrent effect.

MAKING IT WORK

But there are ways to arrive at a contractual approach that can work both in the United States and elsewhere.

In order to do so, it is important to define what the company’s goals and interests are, and to understand what the likely enforcement results will be with respect to those goals and interests before a company adopts a specific restrictive covenant program. Such an analysis enables management to make an informed decision as to how the company’s interests can be best served world-wide. The dialogue must involve both business people and lawyers.

If a business executive is pressed to explain why he or she wants to make company personnel subject to restrictive agreements, the response typically will include one or more of six frequently mentioned goals:

  • To protect the company’s confidential and proprietary information;
  • To stop employees from competing with the company when someone leaves to set up his or her own shop or to go to a competitor;
  • To stop an employee from poaching the company’s customers following his or her exit;
  • To stop a departing employee from taking some of the company’s employees with him or her;
  • To create a deterrent effect that will encourage other employees to comply with their restrictive covenants; and
  • To punish misbehaving personnel.

These are all perfectly legitimate goals. But only some, not all, of them are realistically achievable in an international setting.

If a company has genuinely confidential or private proprietary information—and most companies do—the protection of that information is eminently attainable in many foreign jurisdictions, provided that there is a contractual undertaking to that effect.

In the absence of such a contractual restriction, there are a number of economically important countries where no duty of confidentiality would otherwise be owed post-employment. Thus, a permanent confidentiality requirement should generally be imposed on all employees with respect to the company’s confidential and proprietary information.

The company should be prepared to enforce that agreement actively. It should expect to succeed in enforcing such confidentiality worldwide. The two caveats are that (i) a restriction on the use of confidential company information will only protect information that truly is confidential or proprietary, and (ii) vigilant enforcement is required, or else even information that really is entitled to protection will be deemed to be of no particular importance.

Hence, once a company adopts a contractual confidentiality requirement, the company must be prepared to enforce it across the board. And when it brings an enforcement action, the company also must be prepared to make a compelling confidentiality showing as part of its case.

By contrast, to stop an employee from competing or from soliciting company customers or employees is much more difficult. Many foreign jurisdictions view such provisions as antithetical to free enterprise. Even when a restrictive agreement is clearly governed by the laws of a particular U.S. state, a non-U.S. forum may find noncompetition and non-solicitation provisions void as against the public policy of the place where the employee lives or works.

Even if a non-U.S. forum is willing to accept such provisions as valid and is theoretically willing to entertain the prospect of issuing injunctive relief, interim remedies are often hard to obtain. While a permanent injunction may be conceptually more palatable than an interim measure, even Protecting Your Interests so-called “permanent” enforcement measures are frequently limited abroad to a shorter period than might be deemed reasonable in the U.S.

The result is that, by the time the forum is ready to act, the restrictive period may have run out. In fact, a savvy former employee may deliberately delay the proceeding simply to run out the clock. Moreover, even if the agreement specifies that such proof is not necessary, many jurisdictions require some evidence of actual harm as a prerequisite to issuing an injunction, and that may be quite difficult to prove. For all these reasons, the likelihood of obtaining injunctive relief is significantly reduced for employees who work outside the United States.

REASONABLENESS AND ADR ARE KEYS TO EFFECTIVENESS

Despite these constraints, it is still possible not only to protect confidential information but also to create the desired deterrent effect.

Employers should be made aware, however, that interim and even permanent injunctive relief will likely be quite difficult to obtain outside the United States. It may not even be worth the cost of pursuing such relief.

If an interim or permanent injunction is sought but not obtained, the former employee will have a victory that you can expect him to publicize, and other employees may find that instructive and empowering. Accordingly, the company’s interests are probably better served by focusing on other forms of relief that are more likely to spur compliant behavior.

There are three simple mechanisms for doing so.

First, for employees who own unvested equity interests, a restrictive agreement can prescribe automatic forfeiture of those interests as one remedy in the event of established non-compliance with the agreement, provided that this is not in conflict with local law or the company’s organic documents.

Ironically, this typically matters to employees. (It also permits the firm to feel that it has indeed extracted the requisite pound of flesh for employee misconduct.) Employees actively fight against enforcement of forfeiture provisions. That seems to be because, even when an employee has voluntarily left and is engaging in conduct that is detrimental to his or her former employer, the departed employee still wants to reap the value of any equity that he or she continues to hold in the company.

Second, a restrictive agreement can stipulate that damages will be awarded for harm caused by the proscribed solicitation of established company customers and of active company customer prospects.

But again, to prove actual damages is often a difficult quantitative exercise. Lost revenues are not typically acceptable as a damages measurement; it is lost profits that matter. And quantifying lost profits may entail revealing profit margins that a company may not wish to disclose, particularly to a competitor and especially if interested customers are following the litigation.

The simple alternative is to include a reasonable liquidated damages provision in the restrictive agreement. So long as the agreement specifies that actual damages are likely to be difficult to quantify and the liquidated sum appears to be a reasonable proxy for actual damages, a foreign forum is likely to find this a palatable approach—unless such liquidated damages are void as against public policy in the forum.

And, finally, a restrictive agreement can provide that an employee who is found to have violated his or her covenant will be liable to pay the company’s legal fees and costs. Such cost and fee shifting is relatively common outside the United States, and can lead to a fees award that dwarfs actual or liquidated damages.

* * *

In sum, in the global setting, unless local law makes one or more of these provisions unlawful or otherwise inappropriate, a restrictive agreement should contain (i) a permanent proscription on violating confidentiality, (ii) a reasonable temporal prohibition on solicitation of key customers and customer prospects with whom the signatory employee has had a nexus in the year or two preceding his or her departure, and (iii) a reasonable temporal proscription on the solicitation of employees with whom the signatory has had personal interaction in the year or two before he or she leaves.

But the company should understand that injunctive relief will likely only issue to protect its confidential and proprietary information, and that the non-solicitation prohibitions are better protected by the alternative means discussed above.

Further, the company should recognize that the sought-after enforcement results are probably easier to obtain in international arbitration than in foreign courts. This will of course have an effect on the dispute resolution provisions of the restrictive agreement. A restrictive agreement that will be used in the international context should always provide for international arbitration in lieu of resort to any court. Even interim remedies can be obtained from an arbitrator and, indeed, there is a greater likelihood of obtaining such remedies outside the United States from an arbitrator than from a court.

MARKS’ ‘MEDIATING COMPLEX BUSINESS DISPUTES, PART 2’ WILL APPEAR IN NEXT MONTH’S ISSUE

Alternatives has postponed the publication of the second part of last month’s “Mediating Business Disputes: Why Counsel, Clients and The Neutral Must Emphasize Process, and Not Just an Event,” 31 Alternatives 49 (April 2013), by Bethesda, Md., mediator Jonathan Marks, until next month. Marks expanded his case hypothetical for Part 2, which will apply principles on complex mediation case preparation to developing the course of actual mediation sessions. The full scenario, stretching to two days of mediation, will be presented next month along with takeaways to help readers use the techniques in their own matters.

The author is a partner in the litigation department of Sullivan & Worcester’s Boston office.


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