Maw Trouble Ahead For Restrictive Covenants?

Sunday, February 1, 2004 - 01:00

The New Jersey Supreme Court is currently reviewing a ruling that an employer may be liable for a retaliation claim if it fires an "at will" employee for refusing to enter into a restrictive covenant agreement. The ruling, in Maw v. Advanced Clinical Communications, Inc., places employers' confidential information and business relationships at risk by undermining their ability to require, and enforce, restrictive covenants for existing employees.

The Maw Decision

Karol Maw was a graphic designer for Advanced Clinical Communications, Inc. ("ACCI"), a company that provided marketing and educational services to the healthcare and pharmaceutical industries. During Maw's employment, ACCI decided to require all of its employees above a certain level to execute agreements containing non-disclosure, non-compete and non-solicitation provisions. The non-compete provision was for a two-year duration and did not have a geographical limitation.

Maw requested revisions to the non-compete provision. When ACCI denied her request, she refused to sign the agreement and ACCI terminated her employment.

Maw filed a Complaint asserting common law and statutory (New Jersey Conscientious Employee Protection Act) whistle blowing claims. Maw alleged that the non-compete clause violated public policy because ACCI had no legitimate business reason to require her to sign it, and firing her for refusing to sign was unlawful retaliation. The trial court dismissed the Complaint on the ground that her discharge was a private dispute that did not implicate any public policy concerns - a required element of her claims.

On appeal, the Appellate Division reversed the trial court's decision. The Appellate Division noted that non-compete provisions may be necessary for employees who have contact with clients or access to trade secrets or other confidential information. However, the Court then went on to hold that if, as Maw alleged, the restrictive covenant agreement that ACCI had required her to sign was not intended to protect the company's legitimate interests but merely to lessen competition, then discharging her for refusing to sign it may have violated public policy and support a common law or statutory whistle blowing claim.

The Implications Of Maw

While some legal commentators view the Appellate Division's Maw decision as an unjustifiable expansion of New Jersey's common law and statutory whistle blowing law, the practical effect of Maw on employers seeking to implement and enforce restrictive covenant agreements is significant. First and foremost is the difficulty that employers now face in persuading existing employees to enter into restrictive covenant agreements. The fact that employees who refuse to sign agreements can no longer prudently be fired not only undermines morale among employees who do sign, but may also undermine the enforceability of the employer's existing restrictive covenant agreements with its workforce.

For example, a New Jersey employer could traditionally require an existing at will employee to execute a restrictive covenant agreement in exchange for continued employment. If the employee refused, the employer could fire the employee without risk of a retaliation claim. If the employee executed the agreement, it was generally enforceable as long as the employee subsequently remained employed for a sufficient length of time.

Since Maw, relying solely upon continued employment as consideration is riskier. Now, if the employer requires an existing employee to execute the agreement in exchange for continued employment and the employee refuses, the employer cannot discharge the employee without risking a lawsuit under Maw. But if the employee is permitted to continue working, then the employees who executed agreements in exchange for continued employment arguably received no consideration for doing so, thus jeopardizing the enforceability of their agreements. As evidenced by the fact that the employee who refused to sign experienced no impact on his or her employment status, executing an agreement was actually not a condition of continued employment.

Thus, post-Maw, a prudent employer may offer existing employees continued employment and additional consideration, such as a bonus, in exchange for executing the agreement. This approach should solve the consideration problem, as employees who execute agreements in exchange for a bonus will have limited success in arguing that their agreements are not supported by adequate consideration.

But what can an employer do when an employee refuses to execute a restrictive covenant agreement and simply declines the bonus?

Although the employer will have reason to be suspicious about the recalcitrant employee's loyalties and future plans, Maw should deter the prudent employer from summarily discharging the employee until we hear from the New Jersey Supreme Court. If the employee is permitted to continue working with access to the employer's confidential information and business relationships, however, those assets are at risk. In addition, the employees who signed agreements may argue in the future that their restrictions are unenforceable because, if the restrictions were truly necessary, the employee who refused to execute an agreement should have been denied access to confidential information and business relationships.

What Employers Should Do Pending The Supreme Court's Decision

Pending the Supreme Court's Maw decision, employers should proceed cautiously. As always, restrictive covenants should only be used to protect an employer's legitimate business interests, and agreements should be narrowly tailored to achieve this goal. For example, the Appellate Division was clearly troubled by the fact that there did not appear to be any business justification for the duration (2 years) and scope (worldwide) of the non-compete provision Maw was asked to sign. While such provisions may have some merit in certain industries, they are usually only intended to achieve a deterrent effect - which is undermined when the agreement is challenged. And now, under Maw, such provisions may give rise to a retaliation claim.

The following inquiries can be used as a starting point in examining the "reasonableness" of your company's agreements:

1. Are the restrictive covenant agreements implemented consistently? Employees with access to confidential information or business relationships should be required to sign; employees without such access should not.

2. Are the business interests that your company is seeking to protect clearly defined in the agreements?

3. Are the duration and scope of the restrictions unduly burdensome?

Companies should also adopt and implement protocols to protect confidential information and business relationships, which include restricted access to these business assets.

And if the restrictive covenant agreement includes a non-competition clause, the employer's legitimate interests and the consideration given to the employee in exchange for agreeing to the restrictive covenants should be detailed in the agreement itself. The agreement should also, ideally, provide that the employer will compensate the former employee during the non-competition time period. For example, payment of a bonus for signing the agreement could be deferred, at least in part, and paid at the termination of the employment relationship, during the period of non-competition.

The employer should also inform existing employees that executing a restrictive covenant agreement is a condition of their continued employment in a position that provides them with access to the employer's confidential information and business relationships.

Then, if an existing employee refuses to sign an agreement, the employer must limit the employee's access to those interests. If the employer determines, after continuing the employee's employment in a curtailed capacity, that it has no need for his or her services in this new capacity, then it may be an acceptable time to end the employment relationship without running afoul of Maw.

Although the former employee may still contend that the curtailment of his or her responsibilities amounted to retaliation, an employer will be in a far better position to demonstrate that termination was the only reasonable response to the employee's refusal to agree to justifiable and necessary restraints.

An important point is that Maw involved a request for an existing employee to enter into a restrictive covenant agreement. Requiring a candidate to agree to restrictive covenants as a condition of employment should not give rise to a retaliation claim. However, certain precautionary measures should also be implemented for new hires. Again, the restrictions must be narrowly tailored to protect legitimate business interests. The offer letter should clearly set forth that the offer of employment is contingent on the employee's acceptance of the covenants and provide a copy of the agreement for the candidate to review, including with counsel if he or she chooses.

At a minimum, Maw is a reminder that restrictive covenant agreements must be narrowly tailored to protect legitimate business interests. Presumably, the New Jersey Supreme Court will reaffirm the enforceability of well drafted, narrowly tailored restrictive covenant agreements.

Lynne Anne Anderson is a Member of the Employment and Labor Practice Group of Sills Cummis Epstein & Gross P.C. She regularly counsels clients on various employment issues, including implementation and enforcement of restrictive covenants. She also has significant experience in employment litigation in state and federal courts, including jury trials. William R. Horwitz is a Senior Associate with the Firm's Employment and Labor Practice Group. He also has extensive experience in litigating restrictive covenant disputes and drafting restrictive covenant agreements.

Please e-mail the authors at landerson@sillscummis.com or whorwitz@sillscummis.com with questions about this article.