As employers, have you ever considered asking your employees to enter into covenants not to compete?
Have you wondered what the benefits of covenants not to compete are to your business or been concerned about the ability to enforce them? In light of a recent decision by the Supreme Court of California, Edwards v. Arthur Andersen, No. S147190, 2008 WL 3083156 (Cal. Aug. 7, 2008), it seems like the perfect opportunity to review what covenants not to compete are, when covenants are enforceable, why employers might want to utilize these covenants, and the potential impact of Edwards on Nevada courts' treatment of covenants not to compete in the future and how the decision affects employers who conduct business in California.
Covenants not to compete are agreements by employees not to compete with their employers for a limited time after termination of the employment. The covenant is usually included in a contract that employers ask employees to sign, either before or after employment begins. NRS 613.200(4) provides non-competition covenants are valid in Nevada as long they are supported by consideration and reasonable in scope and duration. Employers and employees can negotiate an agreement that prohibits an employee from pursuing employment with a competing business or disclosing certain confidential information learned during the course of employment. Because covenants not to compete restrict employees' ability to work in certain jobs after termination, Nevada courts will not enforce them unless the terms are reasonable. In determining reasonableness, the Nevada courts have considered the amount of time the covenant lasts, the territory it covers, and the hardship imposed upon the person restricted. The covenant will be enforced if it does not impose a restraint greater than reasonably necessary to protect the employer's business or goodwill. These guidelines are important for employers when they are considering whether such covenants are beneficial to their particular businesses and when drafting the covenants.
Generally, to make a covenant as reasonable as possible, a covenant not to compete should not restrict the employee for too long; for example, a Nevada court has held that a five-year covenant was unreasonable.
The covenant should only restrict employees from working in geographical areas which are logically connected to the former employment. An employer who only has a business location in Sparks and performs work locally, would likely not be able to enforce a covenant that attempts to restrict former employees from working in competing businesses anywhere in the United States. Employers need to articulate why the covenant is related to its business or goodwill. For example, employers might want to restrict employees post-employment because the employees were privy to confidential client lists or very specific know-how. Finally, the hardship on the employee is a factor for whether courts will enforce the covenant. Hardship on the employee tends to relate to whether the employer trying to enforce the covenant has a legitimate business interest to protect.
Employers use covenants not to compete to protect their businesses. For example, a restaurant might have confidential recipes it wants to protect from distribution by a former employee. A sales-oriented business might allow its employees to have close or exclusive contact with clients, and take measures, including use of covenants, to keep their client lists confidential. Other employers might provide employees with access to specific know-how and want to prohibit the employees from using the know-how to compete with their former employers.
In California, the law (California Business and Professional Code S16600) specifically provides that contracts purporting to restrict persons from engaging in a lawful profession, trade or business of any kind are void. This prohibition is subject to very few statutory exceptions, such as when the covenant is made in connection with the sale of a business, dissolution of a partnership or limited liability company, or the withdrawal of a partner or member from a partnership or limited liability company. Therefore, on its face, S16600 is more restrictive than Nevada's law. However, federal courts in California previously construed S16600 as allowing certain narrow exceptions to California's prohibition of covenants not to compete.
These federal decisions seemed to allow restrictive employment covenants as long as former employees were not completely restricted from pursuing a business, profession or trade and as long as the covenant was not unreasonable or overbroad. In other words, federal courts previously treated California's law similarly to Nevada's law on restrictive covenants.
The Edwards court, however, strongly rejected the federal courts' interpretation of California's law on restrictive covenants. The California Supreme Court held that S16600 invalidates restrictive covenants that restrict employees' abilities to practice their businesses or professions, unless the covenant falls within one of the limited exceptions. The California Supreme Court held that S16600 was not ambiguous, and the
Legislature of California would have included language that allowed reasonable, narrow covenants not to compete if that had been the intention of the law. California has clearly rejected the types of covenants not to compete that Nevada allows pursuant to NRS 613.200(4).
Since NRS 613.200(4) and Nevada's case law have clearly allowed certain types of restrictive covenants in Nevada, it is unlikely that Nevada courts would look to the Edwards decision as any sort of persuasive authority for changing the law in Nevada. Nevada's statute allows employers to impose reasonable post-employment restrictions on former employees when certain conditions are met. However, any Nevada business that utilizes covenants not to compete, and does business in California or intends to do business in California in the future, should be aware that a covenant not to compete will not be enforced unless it is within one of the specific statutory exceptions to S16600. Nevada employers should be very careful about entering into covenants not to compete with employees if there is any chance California law could be applied in a dispute with an employee subject to such a covenant. As for the use of restrictive covenants in Nevada, employers should ensure their covenants are narrowly drafted in time and scope to comport with Nevada's law.
Kimberly Albro, an attorney with McDonald Carano Wilson LLP, primarily practices in the areas of employment law, real estate litigation and commercial litigation.
