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RESTRICTIVE COVENANTS AND NON-DISCLOSURE TERMS IN EMPLOYMENT CONTRACTS UNDER NEW JERSEY LAW

06.19.2012
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AN OVERVIEW OF AUTHORITIES

By

Kevin R. Gardner

©2001 Connell Foley LLP

Contractual agreements that restrict the post employment activities of employees are generally subject to enforcement under New Jersey law provided established criteria are satisfied. In the employment context, restrictive covenants have been utilized to prohibit employees from revealing confidential, proprietary information and/or trade secrets of the employer after the termination of employment; to prohibit the former employee from competing with the employer and barring individuals from soliciting the clients or other employees of a former employer.

RESTRICTIVE COVENANTS

Standard Of Review

To be enforceable under New Jersey law a restrictive covenant must be shown to be reasonable. See Karlin v. Weinberg, 77 N.J. 408, 417 (1978)(restrictive covenants are enforceable to the extent they are "reasonable under all the circumstances of the case."). In assessing the reasonableness of restrictive covenants, the New Jersey Supreme Court has articulated a three-prong test under which a covenant will be found to be reasonable if it is established that:

             (1) the covenant protects a legitimate interest of the employer;

                        (2) the covenant imposes no undue hardship upon the employee; and

(3) the covenant is not injurious to the public interest.

Solari Industries, Inc. v. Malady, 55 N.J. 571, 581 (1970). Covenants are subject to enforcement in whole or in part to the extent they satisfy the established criteria of reasonableness.

Application Of The Standard Of Review

1. Legitimate Interest of Employer

The first factor to be evaluated in assessing the enforceability of a restrictive covenant is whether the provision in question protects a legitimate interest of the employer. It is plain, however, that a restraint which intended solely to aid the employer in preventing business competition is not directed to a legitimate interest and is therefore unenforceable. See Ingersoll-Rand Co. v. Ciavatta, 110 N.J. 609, 634 (1988); Ellis v. Lionkis, 162 N.J. Super. 579, 585 (App. Div. 1978)("a restraint against competition is invalid when its sole purpose is to prevent competition, for it does not protect any legitimate interest of the employer and therefore is not reasonable.").

The following considerations have been determined by the courts to be legitimate interests which are subject to protection by restrictive covenants of employment:

Customer Relationships

The ongoing professional relationship between an employer and its clients is generally established as a legitimate business interest that is subject to protection through a restrictive covenant. Whitmyer Bros., Inc. v. Doyle, 58 N.J. 25, 33 (1971); Mailman, Ross, Toyes, & Shapiro v. Edleson, 185 N.J. Super. 434 (Ch. Div. 1982). Note, however, that an employee may not be restrained from continuing relationships with customers that the employee developed prior to his or her employment. Coskey’s T.V. & Radio Sales v. Foti, 253 N.J. Super. 626 (App. Div. 1992).

Trade Secrets/Confidential Proprietary Information

Employers have legitimate interests in trade secrets and confidential business information through the use of restrictive covenants. Ingersoll-Rand Co. v. Ciavatta, 110 N.J. 609 (1988); Raven v. A. Klein & Co., 195 N.J. Super. 209 (App. Div. 1984).

u Manufacturing/Processing Techniques

The protection of unique methods and procedures utilized by a business are a legitimate interest that will justify restrictive covenants with company employees. Raven v. A. Klein & Co., Inc., 195 N.J. Super. 209, 214 (App. Div. 1984).

2. Undue Hardship

The second factor that the courts will consider with regard to the enforceability of a restrictive covenant is the reasonableness of the duration and scope of the restrictions to be imposed upon the employee. In this regard, the courts have generally held that enforcement will not issue as to restrictions that pose an undue hardship on former employees.

Absent extenuating circumstances the personal inconvenience and financial hardship of the employee do not rise to the level of undue hardship. Karlin v. Weinberg, 77 N.J. 408, 417-18 n.3 (1978). However, the inability of the employee to find other employment in his or her area of expertise/experience is a factor which has been considered by one court to be a factor which may rise to the level of undue hardship. Id. at 423.

In evaluating whether a particular provision imposes a hardship, the courts have generally directed their focus to two aspects of the restraint:

w Its geographic scope; and

w The time period for which the restraints will be in effect.

 Geographic Restraints

The reasonableness of a geographic restraint in a restrictive covenant is largely a function of the character of the business at issue and the relative competitive market. See Chas. S. Wood & Co. v. Cain, 42 N.J. Super. 122, 127 (App. Div. 1956). To that end, where the geographic area specified in the covenant is closely related to the area in which the employer regularly conducts its business, the prospect of the provision being enforceable increases.

In the absence of a specified geographic area of restraint is not necessarily a fatal flaw as the court may interpret the covenant so as to impose a reasonable area of restraint. Mailman, Ross, Toyes & Shapiro v. Edelson, 183 N.J. Super. 434, 440 (Ch. Div. 1982). Moreover, a geographic area need not be specified where the covenant is directed to preserving existing relationships rather than protecting an employer’s geographic area of operation. Schuhalter v. Salerno, 279 N.J. Super. 504, 511 (App. Div.), certif. denied, 142 N.J. 454 (1995); Platinum Mgt., Inc. v. Dahms, 285 N.J. Super. 274, 299 (Law Div. 1995).

Temporal Restraints

The degree to which the court will evaluate the reasonableness of the time period for which a former employee must submit to a restrictive covenant is largely a function of what the facts will support as being reasonably necessary to protect the legitimate interests of the employer. As a matter of course, restrictive covenants with durations of two (2) years are commonly sustained. See Schuhalter v. Salerno, 279 N.J. Super. 504 (App. Div.), certif. denied, 142 N.J. 454 (1995); A.T. Hudson v. Donovan, 216 N.J. Super. 426 (App. Div. 1985). Coordinate with recent developments in business and industry, particularly information technology and computer industries, some courts have measured the time period of restraints against the rapidly evolving nature of the subject business. See Earth Web Inc. v. Schlack, 71 F.Supp.2d 299 (S.D.N.Y. 1999), remanded, 205 F.3d 1322 (2d Cir.), aff’d, 2000 USApp LEXUS 11446 (2d Cir. N.Y. May 18, 2000)(holding one year covenant in internet company officer’s employment to be "too long given the dynamic nature of the [information technology] industry … and Schlack’s former cutting-edge position with Earth Web where his success depended on keeping abreast of daily change in content on the Internet."). Double Click v. Henderson, 1997 W.L. 731413, No. 116914/97 (N.Y. Co.Ct. Nov.7, 1997)(reducing one year covenant to six months in light of the rapidly changing field of internet advertising).

3. Injury to the Public

This final factor in the assessment of restrictive covenants is of concern largely in connection with agreements involving individuals offering professional services. In such cases, the concern rests with the effect of the restraints upon those clients of the professional who may unilaterally decide to move their business with that individual when he or she moves to other employment. See Karlin v. Weinberg, 77 N.J. 408 (1978)(physicians); Mailman, Ross, Toyes & Shapiro v. Edelson, 183 N.J. Super. 434 (Ch. Div. 1982)(accountants); Dwyer v. Jung, 133 N.J. Super. 343 (Ch. Div. ), aff’d o.b., 137 N.J. Super. 135 (App. Div. 1975)(attorneys).

Blue Pencil Doctrine

A court in evaluating the enforceability of a restrictive covenant is vested with the discretion to enforce only so much of the agreement as it finds reasonable. Provisions that are unreasonable will not be enforced and, where the court finds the agreement to be deliberately oppressive, the court may invalidate it in its entirety. Solari Industries Inc. v. Malady, 55 N.J. 571, 585 (1970).

Drafting Considerations

An essential predicate to enforcement of a restrictive covenant is an enforceable agreement. Accordingly, the agreement must be drafted with an eye toward the legal standards, as well as anticipated avenues of challenge.

  •  Assure that the restrictive covenant is supported by adequate legal consideration
  • Specify the confidential information or other interests of the employer that warrant protection and provide for an acknowledgment by the employee of the need to protect such information.
  • Specify applicable time periods and geographic territories that are both reasonable and justifiable.
  • To the extent there exists any interest which might arguably be beyond the scope of the restrictive covenant, such as pre-existing customer relationships of the employee, a comprehensive list of such items should be included.
  • Include a provision that the employee agrees to the payment of reasonable attorneys fees and costs that may be incurred by the employer in seeking to enforce the agreement in the event of a breach by the employee.
  • Specify the applicable law that will govern the interpretation and enforcement of the agreement.
  • Include a severability clause.
  • Specify that the employer will enforce the agreement through injunction and that the employee acknowledges that a breach of the covenant will result in irreparable harm.

NonContractual Bases for Relief

  • Breach of employee’s duty of loyalty;
  • Breach of employee’s fiduciary duty;
  • Corporate opportunity doctrine; and
  • Tortious interference with prospective economic advantage

NON DISCLOSURE/CONFIDENTIALITY AGREEMENTS

The trade secrets and confidential proprietary information of an employer may be protected from disclosure by employees through non disclosure/confidentiality agreements. Such agreements are commonly used by employers to preserve the confidentiality of technical information, data and specialized know-how that afforded a competitive advantage in the market place.

Trade Secrets Defined

A trade secret may consist of a formula, process, device or compilation used by one business to secure an advantage over competitors who do not know or use it. Sun Dial Corp. v. Rideout, 16 N.J. 252, 257 (1954). Accordingly, the protection form compelled production that extends to trade secrets has been extended to pricing information, formulas, business strategies, client demographics and customer marketing materials.

In evaluating whether information rises to the level of trade secrets, the court will assess the following criteria:

  • The extent to which the subject information is known outside of the employer’s business;
  • The extent to which the information is known by employees and other individuals involved in the employer’s business;
  • The extent to which the employer (or owner of the information) has under taken efforts to safeguard the secrecy of the information;
  • The value of the information to the employer and its competitors;
  • The amount of effort or money expended in creating or developing the subject information; and
  • The extent to which the process of duplicating the subject information would be easy or difficult for others to undertake.

Ingersoll-Rand vs. Caviatta, 110 N.J. 609, 637 (1988); see 4 Rest. Torts §757.

While an employer is entitled to protect its trade secrets and other confidential information from disclosure, it may not restrict the facility, skill or experience learned or developed during an employee’s tenure with an employer. Ravin v. A. Klein & Co., Inc., 195 N.J. Super. 209, 213-14 (App. Div. 1985).

Misappropriation of Trade Secrets

To successfully press a claim that a former employee and their new employer has misappropriated trade secrets, an employer must sustain the burden of establishing the following predicates:

  • A trade secret exists;
  • The information comprising the trade secret was communicated in confidence by the employer to the employee;
  • The secret information was disclosed by that employee in breach of that confidence;
  • The secret information was acquired by a competitor with knowledge of the employees breach of confidence;
  • The secret information was used by the competitor to the detriment of the employer; and
  • The employer took precautions to maintain the secrecy of the trade secret.

Rycolin Products Inc. v. Walsh, 334 N.J. Super. 62, 74 (App. Div.), certif.

denied, 165 N.J. 678 (2000).

Other Authorities

u The Economic Espionage Act of 1996, 18 USC §1831-39. Individuals who misappropriate an employer’s trade secrets may be subject to federal prosecution and subject to imprisonment for up to 10 years, a substantial fine or both.

u The National Stolen Property Act, 18 USC § 2314-15. The use of the mail or other means to transport stolen trade secrets across state lines may expose former employees to federal criminal liability.

u N.J.S.A. 2C:20-1i (defining "trade secret" in connection with statutory provisions relating to "theft and related offenses.").

INEVITABLE DISCLOSURE DOCTRINE

The doctrine of inevitable disclosure is an evolving development in the area of trade secret protection that may apply to enjoin an employee from disclosing a former employer’s confidential information and trade secrets to a competitor even in the absence of a restrictive covenant. Significantly, the inevitable disclosure document does not require proof that the former employee actually removed trade secret information or is actually using or even intends to use the trade secret information to benefit his new employer. Rather, injunctive relief may issue where there exists a sufficient basis for the court to infer that duties and responsibilities attendant the former employee’s new position with a competitor will "inevitably cause the individual to reveal the former employer’s trade secrets even in the absence of ill-will or improper motive." The doctrine of inevitable disclosure may thus serve as a basis to enjoin a former employee from working for a competing entity where there exists a rational basis for the court to conclude that restraints are necessary to prevent the disclosure of confidential information retained in the memory of the employee to which the employee will inevitably resort to fulfill the duties and responsibilities for his new employer. See National Starch and Chem. Corp. v. Parker Chem. Corp., 219 N.J. Super. 158, 162-63 (App. Div. 1987); Pepsico, Inc. v. Redmond, 54 F.3d 1262 (7th Cir. 1995).

Protection of Trade Secrets

To assure the highest level of protection for trade secrets and proprietary information, employers should institute a comprehensive program of procedures and measures directed to preserving the confidentiality and safeguarding the information.

  • Utilize restrictive covenants in employment agreements;
  • Require execution of nondisclosure and inventor agreements;
  • Implement procedures and methods to restrict access by employees to confidential information to those with the "need to know";
  • Implement procedures to assure that confidential materials are maintained in secure location;
  • Restrict the mobility and access of visitors to plants, offices and other facilities;
  • Require potential customers and/or business partners to execute confidentiality stipulations
  • Require that all trade secret information be stamped with the legend "Confidential";
  • Implement programs to educate employees as to the necessity of maintaining the confidentiality of trade secret information;
  • Screen promotion materials and other publications to guard against the inadvertent disclosure of confidential information;
  • Screen presentations, speeches, web sites and business articles for trade secrets.
  • Institute computer security programs;
  • Utilize computer safe passwords and change them frequently; and
  • Caution employees about transmitting confidential information over the Internet.

RECOURSE AND RELIEF

The potential remedies available as redress for the breach of a restrictive covenant or nondisclosure agreement include both equitable and legal relief, the application of which will turn largely upon the facts present, conduct of the parties and the strategic interests/needs of the plaintiff employer.

Equitable Relief

Injunctive Relief

Accounting of Benefits

Imposition of Constructive Trust

Disgorgement of Profits

Legal Relief

Damages

Lost Profits

Consequential Damages

Past Wages

Liquidated Damages (per agreement)

Punitive Damages

Attorneys Fees (per agreement)

Interest/Costs of Suit

Attorneys

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