NJ Restrictive Covenants / Covenants Not To Compete
REASONABLENESS OF A RESTRICTIVE COVENANT REMAINS A HIGHLY FACT BASED INQUIRY
The Solari/Whitmyer test has long been the standard by which New Jersey courts determine the enforceability of restrictive covenants (e.g.,covenants not to compete, non-solicitation clauses). Under that test, a plaintiff seeking to enforce a restrictive covenant must establish that the covenant is reasonable. Reasonableness is proven by demonstrating that the covenant “simply protects the legitimate interests of the employer, imposes no undue hardship on the employee and is not injurious to the public.” Solari Industries, Inc. v. Malady, 55 N.J. 571, 576 (1970). The considerations of the first two prongs of the test are balanced against each other. Ingersoll-Rand Co. v. Ciavatta, 110 N.J. 609, 634-35 (1988). “In cases where the employer’s interests do not rise to the level of a proprietary interest deserving of judicial protection, a court will conclude that a restrictive agreement merely stifles competition and therefore is unenforceable.” Id. at 635. The third prong requires the reviewing court to consider matters of public concern, such as the interest in “safeguarding fair commercial practices,” protecting against the misuse of employer proprietary information, and “encouraging technological improvement and design enhancement of all goods in the marketplace.” Id. at 639.
The central aspect of the Solari/Whitmyer test is the identification of a legitimate interest served by enforcement of the covenant. Because there is no legitimate interest in merely preventing competition (Whitmyer, 58 N.J. at 33), a plaintiff is required to demonstrate some protectable interest that goes beyond just a mere desire to prevent a competitor from entering the market. Thus, an employer has a legitimate interest in protecting against the use of its trade secrets or confidential information to compete against it. Whitmyer, 58 N.J. at 581. An employer also has a legitimate interest in protecting its customer relationships. Id.
The identification of a legitimate interest, however, does not end the legitimacy inquiry. Rather, courts must determine whether the identified legitimate interest supports the duration, geographic limits, and the scope of activities prohibited by the restrictive covenant. Community Housing Group, Inc. v. More, 183 N.J. 36, 58 (2005). “Each of those factors must be narrowly tailored to ensure the covenant is no broader than necessary to protect the employer’s interests.” Id. at 58-59. Thus, for example, a court may shorten the duration of a two-year non-compete that is based on an employee’s receipt of confidential information if it appears that the information will lose its value before the end of the two year period.
Accordingly, the question of the degree or extent to which a restrictive covenant is enforceable is an important aspect of restrictive covenant litigation. The New Jersey Appellate Division’s recent opinion in Truong, LLC v. Tran, Docket No. A-5752-11T1, 2013, N.J. Super. Unpub. LEXIS 64, at *1 (App. Div. Jan. 9, 2013) illustrates that point. In Truong, the Chancery Division entered a preliminary injunction enforcing a two-year non-compete clause against former employees of a nail salon. The Court based the injunction, in part, on a finding that the plaintiff had demonstrated a legitimate interest in protecting its confidential customer list. Id. at *11. However, the court did not receive or consider any evidence regarding whether the two-year duration of the covenant was appropriate. Id. at *25. The defendants were granted leave to take an interlocutory appeal and the Appellate Division vacated the injunction based, in part, on the plaintiff’s failure to demonstrate the reasonableness of the two-year duration of the covenant.
In reaching its holding on that issue – one of several interesting issues addressed in the opinion – the Appellate Division wrote that, “in the case of customer lists, the court should consider what percentage of the employer’s customers persist after the contractual time period.” Id. The court reasoned that, “if only a small fraction do persist, then the covenant may unreasonably bar competition to protect an obsolete list.” Id. The court also emphasized the need to consider how long it would take for the plaintiff “to solidify customer relationships with new salon employees.” Id. Given that the plaintiff had not presented evidence on either of these points, the Appellate Division held that it could not meet the “likelihood of success” prong of the test for obtaining a preliminary injunction. Id.
At bottom, Truong serves as a reminder of the need for a plaintiff seeking to enforce a restrictive covenant to present a complete set of proofs establishing the bases for the scope and duration of the restriction. It also highlights the fact that defense counsel should carefully examine the proofs presented by a plaintiff seeking to enforce such a covenant and, where shortcomings exist that might undermine the enforceability of the covenant, attack those shortcomings vigorously. Although the considerations pertinent to the appropriate scope and duration of a restrictive covenant may differ depending on the nature of the interest a plaintiff relies upon to support a restrictive covenant (e.g., trade secrets as opposed to customer lists), the determination of that issue is always fact specific. Pierson v. Med. Health Ctrs., P.A ., 183 N.J. 65, 69 (2005) (“We continue to adhere to the case-by-case approach for determining whether a restrictive covenant in a post-employment contract is unreasonable and unenforceable.”). Thus, it is particularly important that litigants pay attention to the factual details that bear on this issue when presenting their proofs.
© 2013, Jason B. Lattimore, Esq. LLC