Dealing with Vendors and Suppliers: Restrictive Covenants and Nondisclosure Agreements

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May 04, 2018

Restrictive Covenants and Nondisclosure Agreements

Restrictive covenants and nondisclosure agreements are commonly used and effective tools to protect the confidential nature of trade secrets and other proprietary data. Restrictive covenants are provisions that prevent a person or an entity from engaging in an activity, soliciting a set of clients, or competing for a stated period of time.

The three key dimensions of restrictive covenants are the time, geography and field of endeavor affected by the covenant. A customer should take care in drafting such provisions, because courts are reluctant to enforce overly broad restrictive covenants because their application threatens to deprive the affected workers of the ability to make a living. See, e.g., PharMethod v. Caserta, 382 Fed. Appx. 214 (3d Cir. 2010). There are also potential antitrust issues when actual or potential competitors agree not to compete for certain business or for certain customer. See, e.g., Nichols v. Spencer International Press, Inc., 371 F.2d 332 (7th Cir. 1967).

Courts will require a party seeking to enforce a restrictive covenant that the covenant’s scope  is “reasonable” in relation to the competitive harm sought to be avoided, balanced against the interest of the employee in making a living, in light of the interests of the public. PharMethod, supra. Some courts have a practice of “blue-lining” an overly broad covenant to enforce itsrestrictions in a more narrow way. See The 7’s Enter., Inc. v. Del Rosario, 111 Haw. 484 (2006). Others refuse to do so and invalidate the entire provision. See Kalani v. Gluska, 64 Cal. App. 4th 402 (1998).

In light of this uncertainty and unevenness in the handling of restrictive provisions, the better practice is to have a legitimate and rational basis, in light of the commercial and competitive realities facing the customer, behind the contours of any restrictive covenant. In addition, as with other important aspects of the contract, the customer should objectively define the classes of customers, business, or fields of endeavor that are off-limits for the vendor to pursue. Ambiguity with respect to these items often incentivizes opportunistic behavior on the vendor’s part and jeopardizes the customer’s ability to prevail in any resulting litigation.

Non-disclosure agreements are either free-standing agreements, or sets of provisions within agreements, whereby one or both parties agree to keep certain categories of information confidential and/or to limit use or disclosure of information to certain permissible purposes outlined in the agreement.

As with restrictive covenants, to be most effective, non-disclosure agreements should be as specific as possible. Ideally, they should name the specific items of intellectual property or proprietary information sought to be protected. This will reduce the possibility of a factual dispute over whether a particular item is within the agreement’s intended scope.

Preliminary or temporary injunctive relief is often the most effective, and in some cases, the only effective remedy with respect to threatened unfair competition and improper disclosure of confidential information. Courts are sometimes reluctant to grant this type of relief because the parties have often not had the opportunity to have full discovery and the opportunity for a full trial on the merits. For this reason, courts require a heightened showing as a prerequisite to obtaining this kind of relief. Typically, to obtain injunctive relief, a movant must demonstrate (1) a likelihood of success on the merits of the claim; (2) the imminent threat of irreparable harm that cannot be addressed by monetary damages; (3) that the defendant will not suffer more harm from the grant of the injunction than the movant would suffer if an injunction did not issue; and (4) that the grant of an injunction would serve the public interest. New York Pathological & XRay Laboratories, Inc. v. Immigration and Naturalization, 523 F.2d 79 (2d Cir. 1975).

In light of this required showing, customers should move quickly in the event of a threatenedor  actual breach of a restrictive covenant or non-disclosure agreement. Otherwise, the court may not be convinced that the customer is at risk of imminent harm, or that the harm is such that the parties cannot wait until the ultimate resolution of the lawsuit. Together with clear drafting and thoughtful and reasonable construction of the scope of a restrictive covenant or non-disclosure agreement, quick action to enforce these provisions will maximize the customer’s probability of obtaining meaningful relief.

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