Why you should read this article about noncompete agreements
Every bank should be evaluating:
• Whether they need to implement noncompete agreements with key employees (using enforceable state-specific language).
• Whether they must update noncompetes already in place to ensure enforceability.
• Whether incoming employees are abiding by noncompetes with their former employers.
• Whether outgoing employees are honoring their valid noncompete agreements.
On the flip side, individual bankers, CEOs, and other key employees need to know their options before entering such agreements. They need to know how to deal with noncompete agreements during changes in employment.
Finally, directors and trustees need to be sure that the bank’s interests are protected.
This is an expanded version, with more applicable detail, of the overview article presented in the July 2010 ABA Banking Journal.
As a director for my family-owned community bank and as a labor/employment practice attorney, I have seen some banks use noncompete agreements quite effectively. However, others don’t use them as they might.
In this volatile economy, and with the many changes confronting banks, including, in many cases, laying off or terminating key employees, banks should be taking advantage of this tool critical to protecting their goodwill. All banks should be creating and using enforceable noncompete agreements for key employees, and directors should be aware of their benefits.
On the flipside, individual bankers, CEOs, and other key employees who are bound by noncompete agreements also need to be aware of their options before entering into such agreements and methods for dealing with noncompete agreements during changes in employment.
And board members must have a general understanding of noncompete agreements, both to maintain competitive ability and to be sure the bank isn’t risking legal difficulties from either side of a noncompete.
Competitive Armor For Your Bank
An enforceable noncompete agreement can benefit your bank in many ways. For example, such agreements are vital to protecting your bank’s goodwill and preventing unfair competition by key employees who are terminated or leave on their own. Noncompete agreements protect the bank’s customer relationships—which it paid the departing employee to develop for its benefit. It does this by preventing the former employee from pursuing those customers so that the bank has time to hire or assign another employee to the customer so that he or she has time to build relationships with the clients. A critical element of noncompete agreements is also protection of the bank’s confidential business and proprietary information.
What can you do when someone violates a noncompete?
There are several remedies which banks can pursue if a former employee violates an enforceable noncompete agreement.
These remedies include injunctive relief—a court order prohibiting the employee and/or the employee’s new employer from violating the agreement.
For example, in SunTrust Investment Servs., Inc. v. Cleary and Citigroup, the federal court for the District of Columbia recently granted SunTrust Investment Services a temporary restraining order prohibiting the defendants (the former employee and his new employer) from soliciting business from SunTrust customers with whom the employee had material contact. The defendants were also barred from using or disclosing SunTrust client information. Further, the employee was ordered to return any records relating to SunTrust’s customers immediately.
The other remedy is monetary relief, in the form of recovery of revenues lost due to the employee’s violation of the noncompete agreement.
This remedy was demonstrated in a 2010 case out of Massachusetts, People’s Choice Mortgage, Inc. v. Premium Capital Funding, LLC. In that case, the court ordered a former employee and his new employer to pay the former employer lost profits for deals made in violation of the noncompete agreement, along with an award of attorney fees and court costs.
Importantly, if your bank has been harmed by an employee’s violation of a noncompete agreement, the bank should act swiftly in pursing legal action to enforce the noncompete. There must be no appearance of acquiescing in the former employee’s competitive actions.
Enforceability of noncompetes
Enforceability is key. State laws vary widely in the requirements for an enforceable noncompete agreement. Thus banks should consult legal counsel experienced in noncompete law, to ensure that the agreements they use are airtight and contain the language required by its state’s law.
Courts in some states, such as Nebraska, strictly require specific language to enforce a noncompete. For example, the Nebraska courts have repeatedly held that: “[a] covenant not to compete in an employment contact may be valid only if it restricts the former employee from working for or soliciting the former employer's clients or accounts with whom the former employee actually did business and had personal contact.” [C & L Industries, Inc. v. Kiviranta, 698 N.W.2d 240, 248 (2005) (emphasis added)] If that “magic language” is missing from the agreement, it is almost certainly unenforceable.
Thus, banks cannot use a form agreement in each state without first making sure it satisfies state-specific requirements.
In general terms, however, banks should use the following three-part test in evaluating their enforceability:
1. Is the restriction reasonably necessary to protect a legitimate business interest?
Banks have a legitimate business interest in protecting their goodwill and customer relationships and confidential information which give them a competitive advantage. Therefore, the restrictions must be reasonably limited to protecting those interests.
2. Is the restriction unduly harsh and oppressive on the employee?
Most courts look to the “time” and “space” restrictions in the noncompete agreement to answer this question.
Time: Generally, in terms of time, a one-year limit is the safest bet in most states. Some states routinely allow a two-year restriction. Anything longer may require special justification.
Space: Likewise, a restriction preventing the employee from working for a competitor anywhere in the U.S. will almost always be inappropriate. Some states require a specific geographic limitation, while others require a customer-specific restriction and will not allow any geographic limit.
In any event, the noncompete agreement should be limited to the region or area in which the employee performed the work and/or the customers with whom the employee did business. In some states, the limitation can include prospective customers, but special drafting is required.
In evaluating whether the restriction is unduly harsh, courts may look at the actual risk to the bank of losing customers; whether the identity of the bank’s customers is confidential or is within general or public knowledge; the employee’s title and actual position and influence, and the community or area served by the bank. The court may balance those factors against the employee’s personal needs; how the noncompete agreement could affect the employee’s family; and the current job market and economic conditions. If the noncompete agreement effectively prevents the employee from working, it will be deemed too harsh.
3. Is the restriction injurious to the public?
This is rarely an issue in a non-medical or non-emergency services industry.
If the bank’s noncompete agreement language is included in its standard employment contracts, there is a danger that an unenforceable clause anywhere else in the contract could invalidate or void the entire contract, including the noncompete agreement provision. Many states, such as Nebraska and Wisconsin, will not “blue pencil” or revise employment agreements in favor of the employer. Therefore, it may be advisable to use an entirely separate noncompete agreement with your key employees.
As more banks merge or buy other banks, other noncompete agreement issues arise. Generally a noncompete agreement will be enforceable by the successor bank. However, if the transaction is just an asset purchase, the question of enforceability becomes less clear and new or amended noncompetes may be advisable at the time of purchase. Since purchasing banks often regard noncompetes as valuable assets in an acquisition, any bank which hopes to be acquired should make sure that the noncompete agreement is drafted so that it can assign or transfer the agreement to the purchasing bank.
A matter for “consideration”
Noncompetes must be a two-way street. That is, in addition to meeting these requirements, the bank’s noncompete agreement must be supported by adequate consideration. That is, what did the bank give to the employee in exchange for the employee’s promise not to compete or solicit business after termination of employment?
Of course, the ideal time to have your employee enter into a noncompete agreement is at the beginning of employment. In that way the consideration is the actual offer of employment. In those circumstances, the agreement is entered into at the time the job is offered and before the employee begins working.
However, as employees develop and key employees emerge during employment, some states have found continued employment and other options to suffice as consideration for a noncompete entered into during employment. If the bank wants to obtain or amend a noncompete thereafter during employment, the continued employment may or may not be enough consideration by itself to create an enforceable noncompete agreement. These requirements vary by state. Therefore, banks should always list “continued employment” as consideration. However, the bank should also offer other consideration such as a bonus or pay increase.
Banks also should include language in all noncompete agreements which states that the bank is providing employees with access to its customers, confidential information, trade secrets, and business infrastructure as consideration for the agreement. This has been recognized as sufficient consideration in some states, for example, in Missouri.
Confidentiality and nonsolicitation provisions should also be included
It is also advisable to include provisions protecting the confidentiality of the bank’s business information, client lists, trade secrets, financial information, marketing strategies, and similar factors in conjunction with a bank’s noncompete agreements. These confidentiality provisions are also critical to protecting these important assets and to discourage former employees from trying to take such business information with them upon departure.
Furthermore, it is common to also include a nonsolicitation provision with your noncompete agreement. Many states will also enforce carefully drafted provisions prohibiting a separated employee from soliciting (for a certain period of time) bank employees to leave and join them in their new employment or at their new bank. For example, a nonsolicitation agreement is expressly allowed by statute in Missouri, but expressly outlawed in other states.
Honoring Noncompete Agreements Of Incoming Employees
There is a flip-side here: What should a bank do when an incoming employee is bound by a noncompete agreement?
Banks must also be diligent in honoring enforceable noncompete agreements which incoming employees have with their former employers. However, it is not unusual to see employees come in with noncompetes in which an overzealous employer has placed such onerous restrictions or burdensome language that the agreement is likely unenforceable.
On the other hand, many employers use only a form noncompete agreement which does not comply with their state’s requirements and therefore those types of agreements may also be unenforceable.
Therefore, banks should consult legal counsel for advice regarding the enforceability of an incoming employee’s noncompete agreement.
However, assuming the agreement is enforceable, banks should instruct employees in writing that they are expected to abide by the agreement and the new hires should be required to sign off on this instruction indicating their acknowledgement.
Banks should also instruct the employee on what to say if a former customer contacts them, to ensure compliance with the noncompete agreement and they should keep a record of this compliance.
The risks of not honoring a valid noncompete agreement are great. It can result in messy and costly litigation; injunctions against the employee and the bank; bad publicity; and, potentially, loss of profits.
Your Own Noncompete Agreements
On the flipside, what can bankers, CEOs, CFOs, or other key employees do to protect themselves individually in regard to noncompete agreements?
First, read the fine print before signing the dotted line. As with any legal document, you should read everything thoroughly before signing. It may be difficult in the honeymoon period to imagine parting ways with your bank someday, but you should carefully review any noncompete agreement and seek legal advice before signing.
You should not assume that the agreement is non-negotiable. The bank employer may be willing to negotiate certain terms and limitations at this point in order to secure your employment. You should also obtain and keep a copy of your signed noncompete agreement for your own records.
What can bankers do to protect themselves when facing changes in employment knowing they are restricted by a noncompete agreement?
1. Know your state.
If the state law governing your noncompete agreement is that of a state such as California, which “generally condemns” noncompete agreements, you will be in a much stronger position to challenge your noncompete agreement or negotiate regarding it.
2. Seek experienced legal counsel.
It will be well worth it to know whether your noncompete agreement is actually enforceable to assist you in the process of finding other employment.
3. Try negotiating at the back end, too.
You may be able to negotiate some changes in the terms or restrictions even at the point of departure, especially if there are questions as to the enforceability of the agreement as written.
For example, there may be an issue of whether your separation itself, if initiated by the employer, complies with the terms of the agreement in which the noncompete clause is contained.
If you are in a state which will not blue-pencil, or revise, such agreements, the entire agreement, including the noncompete clause, may be invalid. Therefore, the employer may be more than willing in those situations to reach an amicable resolution and agreement to limit you from contacting a more limited, specific group of clients, which will make it easier for you in your job search or new employment.
The employer also might pay you to agree to an enforceable limitation.
Finally, if the bank is offering a noncompete agreement in exchange for a severance package, it is advisable to consult your own legal counsel to evaluate the enforceability of noncompete agreements in those situations and to negotiate on your behalf.
In some cases, an employee may take “preemptive” legal action by filing a lawsuit asking the court to declare the noncompete agreement unenforceable. If a court must evaluate a noncompete agreement, it may look at the following factors, which an employee should be ready to address: Degree of inequality in bargaining power regarding the noncompete agreement; your training and education; your health; the health, education, and other needs of you and your family; current economic conditions in your area; and the necessity of having to move or uproot your family in order to comply with a noncompete agreement.
However, be advised that this course of action is expensive.
What Should A Bank Board Member Know
About Noncompete Agreements?
It is critical that bank directors have a general understanding of noncompete agreements and when they should be used.
In any hiring decision in which the board is involved, perhaps a new CEO or a new President, the board will want to ensure that a valid and enforceable noncompete agreement is required of such key employees. Given these high-level employees’ important positions with the bank, their relationships to clients, their access to confidential information, and their influence with customers, employees, and the community, a valid noncompete agreement is critical.
Steps a board can take include:
1. Get state-specific counsel.
The board should consult experienced legal counsel to provide an enforceable agreement that complies with the applicable state law.
2. Avoid cookie-cutter solutions.
The board should not just readily rely upon a standard form noncompete agreement or “the agreement we always use,” as employment laws change rapidly.
3. Get the agreement up front.
A board of directors should take steps to obtain the noncompete agreement at the time of the employment offer so that the validity of consideration is not an issue. A board may also want to consider using a noncompete agreement as a condition of the employee’s deferred compensation. This would require highly-paid executive employees to refrain from competing against the bank so as not to his or her deferred compensation, and the restriction can be more broadly drafted if the deferred compensation plan is governed by the Employee Retirement Income Security Act.
The board could therefore impose numerous conditions that state law would not otherwise enforce and violations would result in loss of the deferred compensation, although the other remedies available under state law may not apply Lindsay v. Cottingham & Butler Insurance, Co. (Iowa 2009).
What about agreements already made?
Board members may also be concerned about the noncompete agreements that the bank currently has in place for key high-level employees or those employees hired by the board. Updates or even new noncompete agreements may be necessary to ensure enforceability, and the board should determine if those changes can be tied to a raise or bonus or other offer to the employees at issue.
As a board member, especially for those in smaller communities, you may become aware of information suggesting that a former employee is competing with your bank in violation of his or her noncompete agreement. Do not ignore these facts as you do not want to appear to acquiesce in the employee’s actions or to waive any violations of the noncompete. Rather, pursuant to the board member’s fiduciary duty to the bank, a director or trustee learning of such information should provide those facts as quickly as possible to the bank so that swift action can be taken for “damage control.”
Furthermore, litigation is not always inevitable in these situations, and a low-cost resolution can often be reached with simple but effective measures to protect your bank. Often, a simple phone call or letter reminder of noncompete obligations to the employee is sufficient and prevents further violations.
In the case of a noncompete agreement which raises doubts as to enforceability or meaning, the parties may still be able to negotiate and resolve any issues regarding the noncompete agreement without resort to litigation, which is costly to both sides.
These negotiations may include an agreement by the parties providing a specific list of customers which will be “off limits” to the former employee so that there is no confusion. The parties may also agree on realignment of geographic limitations, shortening time limits, or other creative solutions.
Board members should also be aware that even where the bank does not have a noncompete agreement in place, the bank may still have available to it several common law and statutory weapons to combat a former employee’s competitive behavior. Depending upon the facts, causes of action may include breach of the employee’s duty of loyalty to the bank, breach of fiduciary duty, misappropriation of trade secrets, and tortious interference.
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