Previously, we have written about the Top Ten Things to do When an Employee Resigns to Join a Competitor and the Top Ten Mistakes Made by Departing Employees.  Given the favorable feedback, we continue with the following Top Ten Things to Consider When Drafting a Non-Compete  Agreement. 

1. Tailor restrictions to the jurisdiction in which employees work or reside.   In some states, an overly broad non-compete clause can be fatal because courts will refuse to enforce the entire agreement even if the non-compete is slightly overbroad.  In other states, courts will “blue pencil” overly broad provisions (i.e., simply strike the offending language).  Still, other state courts will modify overly broad language to make it enforceable.  If you are drafting agreements in a multi-jurisdictional context, generally a handful of versions – a few for “problem” states and others for “typical” states – will account for most variations in the law.

2. Include choice of law & venue provisions.  Many employers are tempted to choose the law and venue of the state where they are incorporated or headquartered.  If this requires the application of law contrary to the public policy of the state where the employee works or resides, or if it requires an employee to defend an action far from home, these provisions may not be honored.  In many instances, tying the choice of law and venue provisions to the state where the employee works or resides is a good choice because it may spread the risk of negative court decisions and minimize the chance that the choice of law or venue provision will be rejected. 

3. Tailor the contract to the employee’s position.  A common refrain among courts is that a non-compete or non-solicitation agreement must be no more burdensome than necessary to protect a legitimate interest of the employer.  Legitimate interests commonly recognized by courts include confidential information, goodwill, and/or unique training.  Tailoring the duration, scope, and geographic restrictions of the covenant to the particular position and circumstances of the employee (or category of employees) is likely to enhance the enforceability of the agreement.
  
4. Determine what constitutes sufficient consideration for the covenant.  Virtually all states agree that covenants executed prior to the start of employment are supported by consideration (note, however, some states say that an agreement is not supported by consideration if it is executed after the offer is accepted by the employee).  Other states hold that if execution of the agreement is followed by a substantial period of continued at-will employment, the employment will suffice as consideration.  But other states require specific, additional consideration for agreements signed after the start of employment. 

5. Determine what type of restrictions most appropriately protect the company.  Do you need a non-competition, non-solicitation of customers, non-solicitation of employees, non-disclosure provision, or all four?  Identify the legitimate interests that you seek to protect, and choose a restraint suited to protect each interest.

6. Include provisions regarding injunctive relief.  Consider including clauses providing for a presumption that any harm done is irreparable and difficult to quantify, and consenting to injunctive relief.  Including such a clause rarely makes injunctive relief a certainty, but the absence of such a clause can hurt even more.

7. Consider an attorneys’ fee provision.  You may be able to increase your leverage with a clause providing that the company will be reimbursed for reasonable attorney’s fees and costs in the event litigation is required to enforce the covenants.   However, be aware that some jurisdictions may not enforce a one-sided provision that purports to award fees only to the employer.  Some jurisdictions may convert such a provision to a “prevailing party” provision, meaning that the “loser” is required to pay the other side’s fees.  

8. Require return of confidential documents and information.  Contracts should require employees to return any information or documents relating to the company upon request or within a short time after their termination.  Don’t forget to cover copies, derivations of company documents, and information contained on electronic devices, such as cell phones, blackberries and the like. 

9. Include an assignability provision.  Many states will not enforce a restrictive covenant when the identity of the employer has changed (e.g., by an asset sale) unless an agreement includes a consent to assignability.  Where the jurisdiction permits and/or requires such a provision, make clear the company may assign the covenant to an affiliated company or successor in interest without notifying the employee.  Defining the "Company" at the beginning of the agreement to include the company, its successors and assigns is also a good idea.

10. Include language extending the term of the covenant in the event of a breach.  If the jurisdiction permits such a restriction, make sure your contract states that the period of the covenant is automatically extended for any time during which it was being violated. 

A merger that looks good on paper can lose value when too many employees in the target company get nervous about what life will be like after the deal closes -- Will the culture be different?  Is the acquiring firm too big?  Too rigid?  Will they understand how we do business?  These risks have had enormously negative impacts on many mergers.  Employee attrition following mergers and acquisitions is so common that it has been the subject of psychological studies, has been written about in Human Resources publications, and even has spawned its own name -- “Merger Syndrome.”  Back in 1986, Psychology Today published an article called, “The Merger Syndrome: When Companies Combine A Clash Of Cultures Can Turn Potentially Good Business Alliances Into Financial Disaster.”  What can an acquirer’s Legal Department do to manage this risk? 

            Check the Old Restrictive Covenants – Do They Exist?  Are They Enforceable?.  Start early in the process.  During due diligence, check whether the target company has its key people under enforceable restrictive covenants.  Don’t just inventory HR files.  Analyze what restrictions are in the contracts.  Where are the employees located?  Are those restrictions enforceable in those states?  Were the contracts signed at the inception of employment or later?  If they were signed later, then consideration may be an issue, depending on the state. 

            Will You Have Standing to Enforce the Old Covenants After the Deal Closes?.  Even if there are non-compete agreements in the file for the right groups of employees, you must determine whether you – as the acquiring entity – will have the right to enforce the old non-competes after the deal closes.  Do the covenants have clauses providing that the agreement is assignable, or better yet automatically assigned, to a successor upon merger or acquisition?  If the clauses are there, you probably can enforce.  If not, the question may be much trickier – it will depend on the state’s law that governs, and on the form of the transaction.  Mergers and stock purchases are more likely to transfer the right to enforce.  Asset purchases are less clear. 

            Think About New Covenants.  If you find that many of the old contracts are not enforceable, then you want to build into the negotiation a strategy for getting newer and better agreements from the key people, especially for executives you want to retain after the merger.  Everyone knows that.  But make sure you identify the types of attrition that can turn a great deal into a disaster.  Often the sales force is a key.  In September 2005, Wall Street giant Merrill Lynch agreed to purchase AXA’s Advest brokerage unit for $400 million.  By May 2006, it was being reported that 417 out of Advest’s total of 505 brokers had jumped ship.  See K. Burke, “Failure to Launch,” Registered Rep (May 1, 2006).  It literally became a case study of a failed merger.  See S. Grantham, Risk Assessment as a Function of a Successful Merger: Merrill-Advest Merger, 11 Journal of Communications Management 247-57 (2007). Mergers and acquisitions can be especially stressful for employees lower down the chain of control, who have access to less information.  As one study noted, mergers “can change an individual’s working life significantly but fail to provide the individual with any control over the event.”  Julie K. Anderson, “People Management: The Crucial Aspect of Mergers and Acquisitions,” Industrial Relations Centre, Current Issue Series (1999).  Don’t make the mistake of only worrying about the top few executive non-competes.  Carefully assess points of exposure to potentially damaging employee defection, and then craft restrictive covenants that will protect the company.

Consideration for New Agreements.  If new contracts are required, you must address issues of timing and consideration.  The demands of adequate consideration vary depending upon the form of your transaction, and the states in which key employees are located.  In a statutory merger or stock purchase situation, the employment of target-firm employees continues uninterrupted through and after closing.  In many states, simply agreeing to continue employing people is legally sufficient consideration to support execution of a covenant not to compete executed during the midst of employment – what some cases refer to as “mid-stream” covenants.  But in a substantial and important minority of states, merely keeping someone on the job is not sufficient consideration for a mid-stream covenant.  In these states – North Carolina and Pennsylvania are two examples – you must give each employee new and sufficient consideration.  Sufficiency will be measured in proportion to the employee’s pay level and duties.  A check that would be sufficient for one employee will not be seen as sufficient for a much higher compensated employee.    

Determine Whether Key Employees are Located in “Problem States”.  It is inconvenient, to say the least, that nearly all of the legal issues relevant to the risk of employee defection are governed by varying state laws, rather than by one consistent federal standard.  In fact, it is so inconvenient that many companies simply ignore this undeniable reality.  They do so at great risk to their ability to protect themselves against defections.  One size rarely fits all when drafting restrictive covenants.  If you roll out one version of your agreement, it may well fail in any number of key locations, including tricky states such as California, Georgia and others.  You probably can cover the national map with anywhere from three to six versions of an agreement, depending upon how many different types and levels of employees you are signing up.  You may be tempted to side step this problem by inserting choice-of-law/forum clause, but this often fails and is inadvisable in any case.  It is dangerous to put all your eggs in one basket.  If things turn bad in your chosen state, you are out of luck everywhere.    

Don’t Forget to Use Carrots with Your Sticks. The company of course is even better off if employees decide to stay on board, and are happy about doing so.  This is why the most effective method is to roll out an attractive employee retention plan designed to induce important players at all levels to stay around long enough get to know what is good about your company.  Consider stay-bonuses, with repayment obligations that kick in if an employee leaves within a year (or two or three  years, as the case may be) after receipt.  Salary or minimum bonus guarantees also can ease concern about transition into a new compensation environment.  At a minimum, you can use retention agreements to be sure key employees stay with you long enough to get through the transition period after the deal closes. 

Communicate Your Retention Offers Early.  Retention packages are more effective tools when deployed rapidly and when their benefits are communicated effectively.  Deal with this immediately after announcement of the pending merger.  Don’t wait until closing.  Headhunters will waste no time starting to recruit the most valuable employees from your target company.  The last thing you want is for the dominant voices to be those of recruiters calling in and reinforcing the natural fears of employees whose company is being acquired. “[T]he period following the announcement of the takeover is one of intense personal risk analysis, in which the individual decides whether s/he will leave the organization or stay.”  Gunter K. Stahl & Sim B. Sitkin, “Trust in Mergers and Acquisitions”, in Mergers and Acquisitions: Managing Culture and Human Resources (G.K. Stahl & M. Mendenhall, eds., Stanford University Press 2004).  Effective retention packages offer sufficient financial inducement for employees to remain on board, and ideally are communicated before the headhunters are out in full force.  You know the announcement is coming before they do.  Take advantage of that head start -- don’t announce until you are ready to convey information about retention packages almost simultaneously. 

Employee attrition will always be a risk factor in mergers and acquisitions, but careful attention to restrictive covenants and retention packages can go a long way toward minimizing those risks.