Include Restrictive Covenants In Equity Grants? Why Not?

Many companies require all new hires to sign restrictive covenant agreements (e.g., non-compete, non-solicitation, confidentiality and non-disclosure). While the enforceability of such provisions varies by state, courts often take a dim view of such agreements (particularly those with non-competes), and are reluctant to enforce provisions that are not reasonable in duration, geography or scope of duties. Courts may find these provisions overbroad and contrary to public policy because they are seen as limiting the employee's ability to earn a living without being narrowly tailored to the employer's legitimate business interests. See, e.g., Home Paramount Pest Cos. v. Shaffer, 282 Va. 412, 718 S.E.2d 762 (2011) (striking down a non-competition agreement that the court had upheld 22 years earlier, by holding that the provision no longer was narrowly tailored to protect the employer's legitimate interests).

A more refined approach is to apply the restrictive covenant only to those employees who are actually capable of competing unfairly in the event of termination of employment (e.g., senior executives and those in sales, strategy, design and innovation). This practice, however, requires constant supervision over moving talent, especially in organizations where employees are frequently promoted or where employee roles and functions rapidly change.

Restrictive covenants in equity grants of all varieties (e.g., options, restricted stock units and performance shares) traditionally have provided the perfect vehicle through which an employer may reserve the right to forfeit an employee's compensation (rather than restraining him from working) in the event he or she violates the covenant. Forfeiture provisions are viewed by courts as less restrictive than prohibitions against working for a competitor.

However, in certain circumstances, courts may be willing to go beyond forfeiture and actually impose injunctive relief against the employee − based on restrictions contained in an equity grant. As with other restrictive covenant cases, this analysis depends in large part on whether the facts are favorable to the employer (i.e., a seasoned employee who possesses confidential information, acknowledges covenant terms and seeks to compete directly with the employer). The significance, however, is that such covenants may provide a vehicle not just for forfeiture of awards, but also to restrict the employee's post-termination activities.

Current Developments

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