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Belts and Suspenders (and More) for Non-compete Covenants

Belts and Suspenders (and More) for Non-compete Covenants Background Decorative Image

Have you seen situations in which executives are subject to non-compete and non-solicit covenants in their employment agreements, equity/shareholder agreements and a business sale agreement, all at the same time? Having three sets of similar restrictions all running simultaneously might seem like overkill, but there are often good reasons for it.

Although the restrictions are often similar in each agreement in various respects (such as the scope of the restriction and geographic area), there are important differences. This is because each restriction is protecting a slightly different interest, which in turn will affect both the drafting and the enforceability of the covenant.

  • In an employment agreement, the covenant is there to protect the business against the executive’s unfair exploitation of his or her position as an employee (including access to business secrets and the development of relationships with customers and other employees), and the restriction usually runs during employment and for some period thereafter. But courts are reluctant to enforce restrictions that limit the ability of employees to leave an employer and earn a living elsewhere. Employment-based covenants need to be narrowly tailored in order to stand any chance of enforcement.
  • A shareholder/equity-related covenant is a bit different and is tied to the executive’s ownership interest in the business. It will usually apply during the period of ownership and for a certain time after the shareholding ceases. Courts are typically more willing to enforce restrictions in this context because it is viewed as more of a commercial arrangement.
  • In a business sale agreement, if the executive has sold an interest then the covenant is there to protect the buyer’s investment. The scope is usually tied to a snapshot of the business that is being bought at the time of sale, and the period of restriction runs for a defined period from that date. These are usually the most enforceable types of covenants.

Understanding clearly what the restrictions are designed to protect, how they interrelate, and how they should be drafted (taking into account any considerations under applicable local law) will help businesses protect their legitimate business interests. What might seem like over-lawyering at the front end with overlapping covenants might be worth its weight in gold at the back end if the executive walks out the door.

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.