Covenants Not to Compete
When certain types of information is valuable to a particular business, the employer may ask employees to sign “protective covenants.” These covenants, or agreements, prevent the employees from either divulging the information to actual or potential competitors, or using the information themselves to go into competition with their former employers. But the covenants cannot be designed merely to prevent competition.
Arizona courts have found restrictive covenants to be reasonable and enforceable when they protect some legitimate interest of the employer beyond simply protection from competition. For example, if an employee has access to a customer list and takes this information with him when his employment is terminated, he can be prevented, by prior agreement, from using this private information competitively for a specified length of time. A restrictive covenant may also prevent a former employee from going into direct competition with the employer for a reasonable period, to give the employer time to overcome the loss of the ex-employee. This may involve the hiring of a replacement and giving that replacement time to adapt to his or her new job.
The reasonableness of a non-compete provision has always depended on its duration and geographic scope. Neither of these elements may be any more broad than necessary to protect a legitimate business interest of the employer. But the concept of “reasonable geographic scope” was affected by Bed Mart v. Kelly. In this case, the “geographic” boundaries of a non-compete provision became secondary to a clause that specified a specialty market within the geographic scope of the agreement.
In Bed Mart v. Kelly, a salesman working for a prominent mattress specialty store was hired away by an arch-competitor. When he was hired by Bed Mart, Kelly had signed a covenant not to compete and to maintain the confidentiality of his employer’s trade secrets. In addition, a non-compete provision prohibited Kelly from obtaining employment with “any business for which the sale of mattresses accounts for more than 50% of sales revenue for a period of six months following termination” of Kelly’s employment with Bed Mart.
The trial court ruled that the geographic scope of the non-compete provision was overly broad and that “carving out” a specialty did not save the provision. But the Court of Appeals overruled the trial court, finding that the “carving out” of Bed Mart’s major competitors limited the reach of the non-compete provision, allowing Kelly to find employment as a sales person, even of similar products, at hundreds of other types of stores that were not precluded by the provision. The Court also held that the six-month duration of the provision was fairly based on Bed Mart’s need to protect its trade secrets from use by Kelly, as well as the amount of time it takes Bed Mart to train a new employee and to determine that employee’s effectiveness.
Bed Mart’s non-compete provision prohibited Kelly’s employment only with major competitors at which Kelly’s knowledge would give him and his new employer an unfair advantage. The agreement did not prohibit Kelly from working in his chosen field, as he could work at hundreds of furniture and bedding stores in the Phoenix area for whom mattress sales did not represent 50% of their business. Kelly could also have applied his sales training to a variety of other products besides mattresses.
So instead of restricting somebody from working within, for instance, ten miles of his ex-employer’s business, the court in Bed Mart allowed a non-compete clause that defined whom the employee could work for rather than where the employee could work. As long as the employee may find employment 1) in his or her chosen line of work and 2) in the same geographic area as the former employer, a non-compete provision, with a broad geographic range that is limited to specific competitors, is enforceable.
This case reinforced that reasonable non-compete agreements in Arizona are still valid and enforceable to provide protection from unfair practices of ex-employees. But it’s important to define a “major competitor” carefully, as did the Bed Mart provision, and to ensure that the threat of unfair competition from a former employee is legitimate. Employers must be careful to analyze their legitimate business interests and to craft non-compete provisions that do nothing more than protect those interests for a reasonable amount of time, whether that restriction is geographic or is intended to restrict employees from working for specific competitors.