Covenants not to compete can be a great tool to stop “rogue” employees from walking out the door with your company’s confidential business information and then using your information to steal customers and compete against your company. This tool, however, must be wielded wisely.
Covenants not to compete are not your “typical” contract. The fact that the covenant has been agreed to and signed by both the company and employee has limited bearing on whether it is enforceable. In Arkansas, courts will look behind the dotted line to ensure that the covenant (1) protects a valid business interest, (2) has a reasonable duration, and (3) has a reasonable geographical limitation. If a Court decides that any one of these three elements is overbroad, the entire agreement is invalid. Therefore, it is imperative that businesses keep these three principals in mind when drafting a covenant not to compete.
The policy driving the extra scrutiny of these agreements is that employers should not use covenants to prevent “ordinary” competition, which is bad for consumers, or to deprive the employee of the ability to earn a living. These considerations, however, must be weighed against the countervailing policy of preventing “unfair competition,” which is bad for the employer. Therefore, companies are allowed to protect their valid business interest for a reasonable amount of time within the geographical area they conduct business.
Valid Business Interest. Special training, trade secrets, confidential business information, customer lists . . . these are valid business interests that Arkansas courts permit companies to protect with covenants not compete. In short, it is information that would give your competitor an unfair advantage if he or she possessed it. A classic example is an insurance agent’s information regarding policyholders and his or her relationship with them. A company is allowed to prevent the agent from walking out with this information and then using his or her relationship to compete with the former company. What is not a protectable interest? Preventing “ordinary” competition by attempting to prohibit former employees from working for a competitor without regard to any protectable interest. This is especially true if the covenant tries to prevent the departing employee from working in a different area or with a different product. For example, if the insurance agent above previously sold only life insurance, the former employer might not be able to prevent him or her from selling car insurance for a new company. Additionally, an interest is only protectable if the public does not generally know it. In other words, if I can re-create your customer list by searching Facebook, it is more than likely not an interest you can protect with a covenant not to compete.
Reasonable Duration. Arkansas courts routinely uphold covenants lasting one or two years. Conversely, Arkansas courts routinely strike down covenants restricting former employees for time periods longer than two years. Additionally, courts have invalidated restrictions lasting two years where the court found that it would deprive the former employee of earning a livelihood (based on their level of education and line of work). Courts will also consider other factors such as how long the protected information would be useful. For example, if the information being maintained by the company is based on changing conditions that would only be valuable to its employees in the coming year, a two-year prohibition for departing employees is likely unreasonable.
Reasonable Geographic Scope. This should be the easiest aspect of the covenant not to compete. Nonetheless, it is not uncommon for companies to try to extend their footprint and include overly broad geographic areas. Additionally, companies that fail to include any geographic restriction at all could find that the covenant is altogether invalid unless the covenant is tied to other legitimate factors, such as specific customers with whom the employee dealt. In short, companies should include a geographic limitation that reflects where they do business. For example, if you are headquartered in Russellville and all of your customers are located in Russellville, do not craft a geographic limitation that includes Pine Bluff. Make a realistic assessment of where your company does business (not where you wish to do business) and make that the restricted geographic area.
Compensation for the Covenant. In Arkansas, continued employment is sufficient consideration for the covenant not to compete. In other words, the employer does not have to make additional payments to the employee in exchange for his or her agreement to the covenant. However, such payments could be a good idea. An Arkansas court has required a former employee to pay back a portion of his compensation that he received in exchange for the covenant despite the fact that the court declared the covenant invalid. The court found that the employee would be unjustly enriched if he were permitted to keep the additional compensation while the employer was barred from obtaining the benefit of the covenant. Therefore, such payments could serve as limited insurance in the event your company’s covenant not to compete is found to be invalid.
The Takeaway. When preparing a covenant not to compete, companies should be conservative in scope and ensure they are protecting a valid business interest. Otherwise you risk the covenant being declared invalid by a court.