Client Alerts

New Options in New Jersey Restrictive Covenants: Third Circuit Enforces Non-Competes Tied to Employee Stock Option Plans

Galit Kierkut, Martin C. Fojas

Restrictive Covenant, Trade Secret and Unfair Competition

May 06, 2019

On April 26, 2019, the Third Circuit Court of Appeals reversed two trial court decisions that held that voluntary restrictive covenant agreements tied to select, high-performing employees’ participation in an incentive stock option program were unenforceable per se.  The Third Circuit held that such restrictive covenants – properly drafted and narrowly tailored – may be enforceable to the extent that they protect the employer’s legitimate business interest of safeguarding confidential and proprietary information and the employer’s customer relationships. 

New Jersey courts tend to disfavor employee restrictive covenant agreements – such as non-compete, non-solicit, and non-disclosure agreements – as restraints on trade.  However, they will enforce these agreements to the extent that they are reasonable in scope and duration under the circumstances.  Broadly speaking, a restrictive covenant agreement is likely to be deemed reasonable if it protects an employer’s legitimate interest, does not impose an undue burden on the employee, and does not offend the public interest.  New Jersey courts have recognized as legitimate employer interests the preservation of client relationships, safeguarding trade secrets, and protection of confidential business information.

Prior to the Third Circuit’s recent decision, certain New Jersey federal courts had held that where restrictive covenants were tied to high-level employees’ stock option awards – and were not required of all employees as a condition of employment – the restrictive covenants did not serve the employer’s legitimate interest in safeguarding confidential business information.  Rather, several decisions had interpreted these types of restrictive covenant agreements as an attempt to “buy out” employees in order to “extinguish competition,” and declared such restrictive covenant agreements unenforceable per se. 

The Third Circuit disagreed and declined to adopt any bright line rules concerning the enforceability of restrictive covenant agreements tied to equity incentive programs.  The Court of Appeals found that a two-tiered system of binding only high-performing employees to restrictive covenant agreements engendered less of a restraint on trade than a single-tier system in which all employees were bound to a restrictive covenant agreement. 

Of course, this is not to say that restrictive covenants tied to equity incentive programs are per se enforceable.  The Third Circuit noted that, under New Jersey law, even enforceable restrictive covenants are routinely found to be overbroad with respect to the scope, geographical area, and duration of time covered by the restrictive covenant.  In such cases, New Jersey courts will typically “blue pencil” restrictive covenants, or modify them so as to be less restrictive, or more limited geographically and/or temporally.  In this way, New Jersey Courts may enforce even broad restrictive covenant agreements while balancing the employer’s legitimate interests against any hardship or burden the covenants may place on the employee. 

Employer Tips:
Although New Jersey Courts have expressed a willingness to enforce restrictive covenants tied to employee stock option awards, such agreements must be properly drafted and narrowly tailored to ensure that the agreements have their desired effect and are likely to be enforced as anticipated.  Employers should consult legal professionals to determine whether – or to what extent – their existing restrictive covenants, or any anticipated agreements, are enforceable and to revise them when necessary to meet the ever changing enforcement landscape.

This Client Alert has been prepared by Sills Cummis & Gross P.C. for informational purposes only and does not constitute advertising or solicitation and should not be used or taken as legal advice. Those seeking legal advice should contact a member of the Firm or legal counsel licensed in their state. Transmission of this information is not intended to create, and receipt does not constitute, an attorney-client relationship. Confidential information should not be sent to Sills Cummis & Gross without first communicating directly with a member of the Firm about establishing an attorney-client relationship.