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In a global economy, where business grows and traditional loyalties wane, a key issue for businesses seeking to expand or move into new territories—or shift key managers around the world—is how to inhibit well-invested people assets from jumping ship to the highest bidder and gutting new initiatives or going into direct competition.
The simple answer is to apply tried-and-tested restrictive covenants (RCs) in employment agreements, which include classic noncompetition clauses (NCs), as well as their close cousins, the nonpoaching of employee and clients clauses (NPs). However, it’s not that simple. Getting these restrictions right so that they have any chance of enforceability is often where well laid plans are exposed or are subject to voracious attack by the competition.
These five guidelines provide the basis for plotting the strategy for use of these covenants, including the exceptions. Knowing how to navigate the rules and the exceptions provides the best possible protection in an otherwise imperfect scenario.
Why Use a Noncompete?
Why? and Who for? are the starting points of any company policy on restrictive covenants because such restrictions may be a disincentive for attracting and hiring the best workforce. On the other hand, nonuse encourages an anything goes attitude to jumping ship, and a properly done noncompete is a powerful incentive not to do so. Companies who use them therefore should consider their goals carefully. We recommend a balance-of-harm test so that the company only applies such covenants to top-level managers who can do the most damage and/or to other similar tiers of management or by category of manager or employee, and then examine their needs division-by-division or tier-by-tier. Staff functions are not usually made subject to noncompetes unless they are in sensitive fields such as research and development, where companies may instead use a combination of well-drafted intellectual property rights and confidentiality clauses (which should be in all well-prepared contracts anyway), plus nonpoaching agreements, as a default alternative. In short, the noncompetes should be used selectively, but when used, consistently across types of employees to avoid disparate treatment complaints, and alternative protective clauses must be considered as well.
Are They Really Enforceable in Practice?
Yes they are but, using a well-worn legal phrase, it all depends. In over 75 percent of the most-developed countries, by our survey, NCs and NPs are enforceable if carefully drafted and applicable law rules are analyzed and complied with. In about 3-4 percent of the world, including places such as Russia and India (as well as California), they may be illegal and void.
As with any employee covenant, the issue then becomes do the enforceable ones really work in practice? The answer is, again, yes, but it depends on the country where enforcement is sought, the strength of the evidence and the speed and efficiency of the courts. By and large in most countries, particularly common-law countries, suits may be brought, and injunctions are available, as well as seizure orders to aid in investigations in the most egregious cases. In less developed countries, the clauses may also be enforceable, but access to efficient civil justice may not be possible, in which cases companies should remember that basic criminal law protects most companies from theft of confidential business information or its misuse—an issue common to serious noncompetition breaches. So if your contract is hopeless, you can also consider in the right case calling the police. Or if the courts are bad, but you have a good contract, you can write the competition and warn them off on the basis of having an enforceable NC and NP in place which could deter them from activating the asset, for a while at least. This can have a marvelous effect if used properly.
How Do I Draft Them?
The general global rule, as well as the classic common-law test, is that the employer bears the burden of proving the noncompete is reasonable in terms of scope of industry, geography and period of time, all of which include an element of proportionality. What the competition is (e.g., the product or industry segment) must be carefully defined in the NC, especially if there are multiple company divisions and only one is at risk, or a blacklisting approach can be taken. Geography is tricky. In some regions, such as Europe, pan-European Union NCs can work for example, depending on the employee’s work authority; in others (e.g., Brazil and Dubai) the agreement cannot be enforced outside the country itself. In yet others (e.g., Turkey and Tunisia), an NC cannot be enforced outside specified regions or even cities.
Duration is the most important element. In over 70 percent of the countries where noncompetes are possible, between 6 months and 1 year of restraint are deemed reasonable, so those periods have become a good default for mid-level and higher level managers respectively. The higher and more global the position the longer or broader the covenant can be (as well as the geographic scope). While noncompete agreements for two years or more are possible in theory (e.g., Switzerland and Italy) in about 45 percent of the world, proving a constraint over one year in duration as fair and proportional can be difficult. But there’s another solution: if backed by hefty mutually and privately agreed compensation for the noncompete, well, who’s to complain?
Not the well-compensated executive who will stay at home with pleasure if he keeps getting a check even if the clause is not enforceable.
Restrictions against poaching employees and clients must be limited in many countries (especially many common-law countries) to those with whom the employee can be shown to have had material dealings within a certain period prior to termination.
Did Someone Mention Pay?
Yes indeed. Aside from cutting a big check to induce someone to stay at home or do something else for a year or so, in about 30 percent of countries, companies are actually required to pay for periods of noncompetition. In common law there must be adequate consideration, which traditionally means the job contract itself, but in civil-law countries, payment in excess of compensation and after termination may be required by statute or other law, depending on the country. The amounts can range from 20-30 percent of salary in China to 60 percent of base salary in Sweden to 100 percent of salary in the Czech Republic. The compensation principle also applies in many common-law countries where companies try to impose an agreement during employment without new inducements.
Not only that, but once committed to paper, in many “payment” countries you cannot change your mind and waive the NC clause unless, depending on the country, both parties agree to the possibility of a waiver, or the employee consents to giving up that contracted stay-at-home pay check. Many companies as a result will make an exception and not require a noncompete in the “payment” countries or insert such a covenant in employment agreements so that employees may think it is enforceable, where it is actually not.
Globalism invites complexity and even more so with cross-border enforcement of NCs. Contracts for global managers often make the mistake of having NCs and NPs made under the law of the host-company location when the expat may never end up in the host country or may move to a third country. Since enforceability of noncompetes and other RCs is often a matter of public policy or order in many countries, what is most critical is the law of the country where the expat is likely to end up after employment. If the RCs are too broad or uncompensated in the country of likely enforcement, then the employment contract clause may be unenforceable at the time enforceability is needed most.
There are two common solutions: in those cases where the company thinks it likely the expat will return home and stay, having RCs including NCs under the laws of the home country is key. This is true even if the structure involves a dual local employment agreement. Where there is no certainty about the expat’s future, then the solution is often to address this later, particularly where the company has leverage in a dissolution negotiation, and it can resolve the post termination RCs in a settlement agreement which addresses this issue in real time and takes into account the relevant jurisdictions and laws at the time of termination in a new agreement which supersedes the old.
There are a number of other issues which require careful scrutiny, including the importance of preparing basic templates as a starting point and localizing from there; the possible impact of collective bargaining agreements, which can set limits or rules on RCs; how salary is defined for calculating monthly payments when payment is required; and where NC payments are taxed.
By and large, however, working with restrictive covenants worldwide is a bit like learning to swim. It is very, very difficult starting out but once you do it enough, if you have good business sense, a clear idea of your end goals and experienced advisors, you can keep your company protected to the greatest degree possible.
Erik D. Lazar, is founder and director of Labor Law Plus, a division of Transatlantic Law International, a leading global business law service based in London.
Copyright 2015 © Labor Law Plus. All rights reserved.
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