Restrictive Covenants…Can Be Powerful Tools For Safeguarding Intangible Assets!

Michael D. Moberly   November 26, 2012

The objectives of this post are to…

  • Recognize restrictive covenants as constituting a type of intangible asset that when effectively designed and implemented contribute to safeguarding company’s key proprietary – trade secret information, i.e., intellectual, structural, and relationship capital
  • Encourage senior security, HR, c-suite, and legal executives to collaborate insofar as formulating specific, transparent, and defensible restrictive covenants.

Intangible assets are now the globally universal and dominant sources of most company’s value, revenue, profitability, and sustainability.  Conservatively, 65+% of most company’s value, sources of revenue, and ‘building blocks’ for growth, profitability, and sustainability lie in – evolve directly from intangible assets.

So, whether one is a senior security executive and part of a company’s c-suite and/or management team, a key objective is to build and maintain a profitable and sustainable firm.  An integral strategy for achieving this, is coordinating best practices with restrictive covenants that collectively aid in – contribute to sustaining control, use, ownership, and monitoring (intangible) assets’ value, materiality, and sustainability throughout the assets’ respective life, value, and/or functionality cycle.

There Are No ‘One Size Does Not Fit All’ Restrictive Covenants…

Every company has an obligation, if not fiduciary responsibility, to develop, nurture, distinguish, and safeguard its most valuable, revenue, and competitive advantage producing assets, i.e., intangibles.  Unfortunately, for a significant number of companies, a strategy to achieve these obligations, which we now recognize as being integral to most every company’s profitability and sustainability is relegated to shoehorning employees, irrespective of position, into signing, what I would describe as generic, one-size-fits-all restrictive covenants which are frequently absent language and/or position specificity and transparency to employees.

This oversight renders broad, all-inclusive, one-size-fits-all restrictive covenants frequently vulnerable to being challenged and contested during litigation for the reasons noted above, particularly in litigation in which misappropriation, infringement, and/or theft of intangible (IP) assets is being alleged. Typically, the challenges to such restrictive covenants strikes at their non-specificity which, it is argued, leaves employees with a defensible sense of ambiguity and variance as to what actually constitutes a company’s proprietary information and/or knowhow.  Consequently, generically themed/conceived restrictive covenants pose a higher probability of being disallowed (dismissed) by a court.

Restrictive Covenants Should Convey Specificity…

A much wiser tactic today is for restrictive covenants to be as specific as possible by including, among other things, language and updates to reflect an employee’s evolution within a company in terms of position change responsibilities, and access to and/or handling of particular types of proprietary (trade secret) intangible (information–based) assets.

One indicator that the scope of a restrictive covenant is too broad lies in assessing how closely it reflects the company’s actual business interests. That is, each business is unique and employees develop their own operational nuances (intangible asset, i.e., structural, intellectual, and relationship capital) that (a.) when acknowledged, and (b.) appropriately managed contributes value to a company and/or business unit in the form of efficiencies, effectiveness, output, etc.

Given these realities, using standard (off-the-shelf) restrictive covenants for employees to safeguard a company’s most valuable (intangible) assets and trade secrets is surely unwise.  So, a company’s often unique and nuanced operational knowhow demands, at minimum, carefully tailored restrictive covenants relative to a company’s specific operational and sustainability, profitability, and sustainability, and business environment.

It’s worth repeating, if restrictive covenants are overly broad and not obviously reflective of (a.) the nature of a company’s actual business, (b.) its mission, or (c.)  an employee’s position within the company, such oversights will collectively elevate the probability that the restrictive covenants will be contested on their merits.

Ultimately, if/when restrictive covenants are contested as part of litigation strategy, plaintiff’s counsel must effectively demonstrate the covenants were designed, administered, and updated with (a.) sense of fairness, (b.) reasonableness, (c.) transparency, and (d.) relevant to an employee’s position.

It’s also prudent for introductory language to restrictive covenants draw attention to – explain how unfair competition will surely result should departing employees be allowed to share proprietary operational know how, i.e., intellectual, structural, and relationship capital gleaned from their former employer with a new employer.

With respect to departing – terminated employees, it’s both prudent and meaningful to ensure their exit interview includes re-familiarizing them with…

  • previously signed (perhaps successive/progressive) restrictive covenants, and
  • specific trade secret, proprietary information and operational knowhow they had access to and presumably know.

Effectively tailoring employee restrictive covenants requires, in my view, (a.) genuine collaboration among senior security, HR, and legal counsel, etc., and (b.) evidence which demonstrates…

  • unique and valuable information that has been developed and is being applied in the company, has been identified and distinguished, e.g., customer lists, R&D, marketing plans, any other information-based (intangible) assets that deliver value, produce revenue, and/or contribute to achieving competitive advantages…
  • whether or not particular any of the above information qualifies – meets the requisites of trade secrecy?, and, if so, are correct safeguards in place…
  • that employees receive adequate training (orientation, understanding) about how to safeguard information-based (intangible) assets the company considers valuable to its mission, profitability, and sustainability…
  • whether (employee) restrictive covenants are being periodically reviewed and updated to reflect an employees (a.) promotion, (b.) assumption of new responsibilities, and/or (c.) access to and use of additional confidential – proprietary information…
  • transparency with respect to restrictive covenant development and implementation that brings maximum clarity to signatories, (be they applicants, new hires, or long time employees), regarding (a.) content, context, and purpose, (b.) covenant enforcement, and (c.) consequences for violation.
  • companies have/are not treating restrictive (employment) covenants as insignificant addendums to conventional employee ‘on-boarding’ processes, nor are they imposed unexpectedly and compelling employee signatures as a condition of employment, absent explanation or allotting sufficient time (for employees) to review, reflect on, and/or intellectually absorb covenant language and consider – inquire what affects it may have relative to (a.) their current position, (b.) their future employment prospects, and/or (c.) departure from the company.

Correctly conceived and implemented restrictive covenants are extraordinarily (increasingly) important intangible assets to companies in as much as they…

  • describe which information assets are determined to be proprietary, confidential, and/or constitute a trade secret, and
  • represent important (strategic) indicators about where a company believes its value and sources of revenue originate and its sustainability resides.

When executed professionally and articulated respectfully, restrictive covenants can…

  • contribute to solidifying – embedding a long term company culture receptive to safeguarding valuable intangible assets, and
  • convey intolerance to those who may, at some point, become inclined to disregard the covenants.

In summary, it’s prudent that restrictive covenants should…

  • be drafted as narrowly and specifically as possible, without incurring over-reach.
  • be tailored reflect the employer’s particular business and not in a ‘one size does not fits all’ (generic) context.
  • be disclosed during employment interviews as a condition of employment and in a manner that elevates applicants understanding of their purpose and consequences for violation.
  • inspire a culture of confidentiality.
  • be implemented as quickly as is feasible and enforced consistently.

Avoid Developing Restrictive Covenants That Are Over-Reaching…

I’m confident we are familiar with some companies whose explanation-rationale for utilizing restrictive covenants includes one-off events, anecdotes, and/or ‘war stories’ which, in my view, leaves many new hires as well as existing employees with the impression that either…

  • everything about the company is, in some manner, proprietary or confidential, or perhaps worse,
  • the company management team and c-suite are unfamiliar with its revenue – competitive advantage producing intangible (information-based) assets and uncertain about how or which ones to safeguard.

The reality is, while many business’s may rely on important, valuable, and presumably secret or proprietary information and knowhow, when challenged, they may find much of it does not meet the legal definition of trade secret or confidential information.  Consequently, while much operational information is very important to a company, it may well not warrant the time and resources to safeguard it as either a trade secret or even confidential.

My message is; put efforts toward safeguarding information a company can and must be kept out of the public domain and certainly out of the hands of competitors!

It’s worth noting, when challenged, if a company is unable to clearly articulate sound (business) reasons why certain information assets warrant protection, it’s unlikely the company will be able to effectively – successfully identify a reason when ‘secret’ information assets walk out the front door with a former employee or insider. Again, if, when litigation becomes necessary should counsels’ opening remarks not meet the burden (requisites) of proof, professional embarrassment may be the least of one’s worries at that point. So, a second message is, in my view, avoid minimizing the significance and value of the information assets that a company has assessed as genuinely warranting protection.

Implement Restrictive Covenants As Quickly As Possible…

In litigation, adequately safeguarding intangible assets for the long term should not be perceived nor characterized as either boiler plate or a ‘snap-shot-in-time’ initiative.  Rather, it must be demonstrated as ongoing with regular reviews and ‘tune-ups’ when and where necessary. Simply drafting a restrictive covenant plan, absent thoroughly considering its execution, will generally be for naught.  It’s advisable then, to avoid designing any restrictive covenant plan that is unnecessarily comprehensive, and challenging to implement and enforce.

Enforce Restrictive Covenants With Consistency…

It’s important to acknowledge that a restrictive covenant plan/strategy will be quite ineffective absent specific efforts to incorporate – embed it into a company’s culture and practice with consistency.  Otherwise, restrictive covenants may prove quite difficult, regardless of counsel’s grasp of the English language, to successfully persuade a judge that the company is doing everything correct relative to safeguarding its proprietary information, knowhow, and trade secrets.

Therefore regular (consistent) training, teaching, and refreshers about employee’s obligations (to their restrictive covenants) are important, necessary, and convey a strong sense of seriousness to courts when challenges and/or litigation occurs.

Conducting periodic, or, at minimum, annual audits and assessments of a company’s intangible assets that not merely (a,) identifies or accounts for them, but (b.) unravels the assets’ location and origin, (c.) assesses their stability, vulnerability, sustainability, and contributory value, and (d.) determines their respective value and functionality cycles’ is a very positive activity, especially when courts seek – want convincing of same!

Comments regarding my blog posts are encouraged and respected. Should any reader elect to utilize all or a portion of this post, attribution is expected and always appreciated. While visiting my blog readers are encouraged to browse other topics (posts) which may be relevant to the circumstance. And, I always welcome your inquiry at 314-440-3593 or [email protected]

Please watch for Mike’s book ‘Intangible Assets: Security Managers Roadmap’ to be published soon!

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