- Georgia's New Restrictive Covenant Act Impact on Tech Companies/Entrepreneurs - Part 2
- June 4, 2010 | Authors: Brian M. Harris; John C. Yates
- Law Firm: Morris, Manning & Martin, LLP - Atlanta Office
The Georgia legislature approved a proposed constitutional amendment to give effect to House Bill 173 (the “Georgia Restrictive Covenant Act”). The Act will dramatically change the enforceability of restrictive covenants in employment agreements which are entered into after the Act takes effect.
This is Part 2 of a two part series addressing important considerations for technology companies and entrepreneurs in Georgia. Part 1 addressed general questions relating to the impact of the Act. Part 2 looks at specific sections of the Act and provides practical pointers for drafting restrictive covenants in employment agreements.
Old Law Versus New Law
Significantly, the Act is not a replacement for current law governing restrictive covenants in Georgia. The Act would apply only to those agreements entered into after the new Act’s effective date (November 3, 2010 if approved by voters). Existing agreements would still be interpreted and enforced under current case law.
Given the new Act’s expansion of the permissible scope of restrictive covenants and the greater ease with which such covenants may be enforced, employers should prepare a strategy now for implementing new contracts to take maximum advantage of the protections afforded by the new Act.
The Act differs from current case law in five key areas by: (1) expressly permitting restrictive covenants, including non-compete covenants; (2) relaxing certain standards for drafting enforceable covenants; (3) granting Georgia courts the power to “blue pencil” (i.e. judicially modify) restrictive covenants; (4) defining common terms, which definitions expand the permissible scope of certain covenants; and (5) establishing presumptively reasonable time limits for restrictive covenants.
The Act expressly authorizes noncompete covenants in employment agreements, if reasonable in terms of time, geographic area, and scope of activity. However, such covenants may only be enforced against employees who meet one or more of the following tests:
(a) customarily and regularly solicit customers or prospects;
(b) customarily and regularly engage in making sales;
(c) have a primary duty of managing the enterprise (or a department or subdivision), direct the work of two or more other employees, and have the authority to hire or fire other employees (or have particular weight given to recommendations as to the change of status of other employees); or
(d) perform the duties of a “key employee” or of a “professional.”
A “key employee” is broadly defined as an employee who, by reason of the employer’s investment of time, training, money, or other factors, has gained a high level of notoriety or reputation as the employer’s representative, or has gained a “high level of influence or credibility” with customers, vendors, or other business relationships. The definition also includes employees “intimately involved in the planning for or direction of the business” and those with “selective or specialized skills, learning, or abilities or customer contacts or customer information” acquired as a result of working for the employer.
A “professional” is an employee whose primary duty involves performing work requiring advanced knowledge “customarily acquired by a prolonged course of specialized intellectual instruction” or requiring talent “in a recognized field of artistic or creative endeavor.” The term specifically excludes technicians performing work using knowledge acquired through on-the-job or classroom training, such as a mechanic.
Drafting non-compete covenants under the new Act is not a one-size-fits-all proposition; employers must examine their workforce to determine which of their “employees” fall within the statutory definition. Georgia courts are likely to enforce noncompete restrictions against higher level employees within the organization, those in position to exert the greatest influence over customers and other business partners, or those who can cause the most damage upon defection to a competitor.
A. Relaxed Drafting Standards
The Act also eases many of the restrictions affecting enforceability under current case law. The most significant examples appear in the new statutory provision regarding nonsolicitation of customers covenants. While such covenants must remain limited to prohibiting solicitation for the purpose of providing products or services competitive with the employer’s business, “no express reference to geographic area or the types of products or services considered to be competitive shall be required in order for the restraint to be enforceable.”
To enforce a nonsolicitation covenant under existing case law, employers must clearly define and limit the scope of products or services considered competitive, usually accomplished by reference to a clear definition of the employer’s “business.” Such covenants must also be limited either by express reference to a narrowly defined geography or to those customers with whom the employee had material contact during his or her employment.
Nonsolicitation covenants under the new Act are not restrained by such requirements. A general reference to prohibiting soliciting or attempting to solicit business from customers will be presumed to apply to (1) customers or prospective customers with whom the employee had “material contact” (a term much more broadly defined under the new Act; see below), and (2) products or services competitive with (meaning the same as or similar to) those provided by the employer.
Such a relaxed drafting standard could invite litigation regarding whether a particular product or service is, in fact, competitive. Employers might still consider defining the applicable scope of products and services, if only to avoid the issue at a later date.
B. Broadly Defined Terms: “Material Contact” Example
As noted above, a nonsolicitation covenant under the new Act presumptively applies to any customer or prospective customer with whom the employee had “material contact.” Under existing case law, “material contact” is interpreted to mean contact between the employee and customer for the purpose of establishing, maintaining, or furthering a business relationship.
The new Act, however, extends the meaning to customers or prospective customers (a) “about whom the employee obtained confidential information in the ordinary course of business as a result of such employee’s association with the employer; or (b) “who receives products or services authorized by the employer, the sale or provision of which results or resulted in compensation, commissions, or earnings for the employee within two years prior to the date of the employee’s termination.” This definition dramatically increases the scope of protection afforded by nonsolicitation covenants and prohibits solicitation of customers or prospects with whom the employee may never have dealt.
The Act would grant Georgia courts the authority to judicially modify covenants in employment agreements that would otherwise be too broad to enforce. Without the authority to blue pencil in the employment context, Georgia courts today often render an entire covenant unenforceable on the basis of a minor flaw. Currently, if one covenant is unenforceable, it can prevent enforcement of other covenants in the same agreement that might otherwise be enforceable.
The Act, however, limits the court’s new authority by defining “modification” to mean “the limitation of a restrictive covenant to render it reasonable in light of the circumstances in which it was made. Such term shall include: (a) Severing or removing that part of a restrictive covenant that would otherwise make the entire restrictive covenant unenforceable; and (b) Enforcing the provisions of a restrictive covenant to the extent that the provisions are reasonable.”
The definition excludes the ability to rewrite or add terms to a covenant. Employers crafting agreements to comply with the Act should consider language that, if found overbroad, is readily susceptible to selective deletion.
Note that the proposed Constitutional amendment that would give effect to the Act contains broader blue pencil authority than the text of the Act itself. The proposed amendment states that the “authority granted to the General Assembly¿ shall include the authority to grant to courts by general law the power to limit the duration, geographic area, and scope of prohibited activities¿.” The amendment suggests a broader power than merely striking through overbroad terms, which could mean subsequent legislation to expand the authority to “blue pencil.”
Presumptively Reasonable (and Unreasonable) Time Limits
Existing case law provides employers no uniform standard for determining the reasonable length of a post-termination restrictive covenant. Employers only know generally that the duration of such covenants must be limited.
The new Act sets definitive, presumptively reasonable, time limits. For example, for enforcement of restrictive covenants against former employees, the Act allows up to two (2) years following termination of their employment. Any such covenant for more than two (2) years following termination is presumptively unreasonable. Given the presumption, it is hard to imagine many employers implementing covenants for time periods less than those stated in the Act.
In addition, the Act expressly permits nondisclosure covenants protecting confidential information (that does not rise to the level of a trade secret) to remain in effect for so long as such information remains confidential. The lack of a reasonable, definitive time limit is fatal to nondisclosure covenants under current case law. Both existing law and the new Act permit protection against use and disclosure of trade secrets for so long as the information constitutes a trade secret as defined by Georgia law.
In addition to the limitations stated in the non-compete section above, the Act specifically limits its application to covenants executed by more senior-level employees, including executives, research and development personnel (including independent contractors) in possession of important confidential information, and those with selective or specialized skills, learning, or abilities or customer contacts, customer information, or confidential information obtained as a result of having worked for the employer. The Act specifically excludes from the definition of “employee” any employee who lacks selective or specialized skills, learning, or abilities or customer contacts, customer information, or confidential information.
Potential Litigation Concerns
The Act will also change the focus of litigation concerning enforcement of restrictive covenants. Under current case law, the courts’ application of strict scrutiny and inability to blue pencil usually focuses the dispute on the language of the covenant itself. Under the new Act, disputes will focus on much more fact intensive issues, making litigation a more expensive proposition.
The initial question will be whether the individual subject to the covenants meets the definition of “employee” under the Act. If the agreement contains a noncompete covenant, the inquiry extends to whether the person fits within a category of employee who may be subject to a noncompete restriction under the new Act.
Assuming the above thresholds are satisfied, the dispute will focus on whether or not the covenants are reasonable under the circumstances. The analysis will involve examining such issues as (a) the actual services provided by the employee for both the current and former employer, (b) the geographic territory within which those services were and are provided, (c) whether and to what extend the former employer competes with the new employer, and (d) the economic hardship to the employee caused by enforcement of the covenants. If the covenants are unreasonable as drafted, the court will then consider whether, and to what extent, the covenants may be blue-penciled (i.e. whether the court may strike through certain terms) to render the covenant reasonable.
Employers should begin preparing to implement new contracts with employees designed to comply with and extract maximum benefit from the Act if it takes effect. First employers should evaluate which of their employees are subject to broader restrictions under the new Act. New contracts should include covenants that (a) restrict a broader scope of activity, including a possible noncompete restriction for appropriate employees, (b) are susceptible to judicial modification, if necessary, (c) rely on updated definitions, and (d) remain applicable for increased time periods post-termination.
Devising a strategy for rolling out new covenants agreements will be nearly as important as the agreements themselves. Although continued employment alone is sufficient legal consideration to support a covenants agreement, employers should decide whether simultaneously offering some form of benefit might ease the transition and lessen the risk of losing good employees who may choose to jump to a competitor before signing the new agreement. Potential strategies might include coupling new agreements with an annual salary increases, bonuses, or issuance of stock options.