Worklaw Alert – Georgia Legislator Pass New Restrictive Covenant Bill

Introduction

On Thursday, April 2, 2009, Georgia Legislators passed a bill radically changing Georgia’s restrictive covenant laws.  Long recognized as a state that disfavors work-related contracts that limit the right to compete, Georgia’s HB 173 reverses the long-held legal bias against enforcement of these “restraint of trade” restrictive covenants.  The introduction to the new restrictive covenant law provides.

The General Assembly finds that reasonable restrictive covenants contained in employment and commercial contracts serve the legitimate purpose of protecting legitimate business interests and creating an environment that is favorable to attracting commercial enterprises to Georgia and keeping existing businesses within the state.

Assuming Georgia’s Governor Perdue signs the legislation, the law would become effective only after the voters of Georgia ratify a related state constitutional amendment in next November’s general election [or the next general election].

Courts May Modify Otherwise Unenforceable Contracts

As in most states, Georgia’s restrictive covenants tend to be a prohibition against either the disclosure of a company’s confidential information, the solicitation of a company’s customers or potential customers, or competition in the company’s business.  Unlike most states, Georgia does not allow a judge to modify or “blue pencil” an otherwise unenforceable restrictive covenant.  The new restrictive covenant law would allow a court to strike through offending language or rewrite clauses to create a reasonable restrictive covenant consistent with the parties’ original intent underlying the restrictive covenant “as long as the modification does not render the covenant more restrictive with regard to the employee than as originally drafted by the parties.”

Categories of Relationships

The new law specifically applies only to the following types of parties:

1.         Employers and employees, as such terms are defined in Code Section 13-8-51;

2.         Distributors and manufacturers;

3.         Lessors and lessees;

4.         Partnerships and partners;

5.         Franchisors and franchisees;

6.         Sellers and purchasers of a business or commercial enterprise; and

7.         Two or more employers.

Recognizing the differing bargaining strengths of the parties within this array of contract types, the new law separates covenants into three groups:

1.         Restrictive covenants to be enforced against an employee (“employment”),

2.         Restrictive covenants to be enforced against  a distributor, dealer, franchisee, lessee of real or personal property, or licensee of a trademark, trade dress, or service mark and not associated with the sale of all or a part of a business (“mid-level relationship”); and

3.         Restrictive covenants applicable to the owner or seller of all or a material part of an entity’s assets, shares, partnership interest, limited liability company membership, or equity interest or profit participation of any other business, profession, or other commercial enterprise(“sale of business”).

Non-Disclosure Covenants

Georgia’s new restrictive covenant law preserves the existing definition of confidential information but provides that

Nothing … shall be construed to limit the period of time for which a party may agree to maintain information as confidential or as a trade secret, or to limit the geographic area within which such information must be kept confidential or as a trade secret, for so long as the information or material remains confidential or a trade secret, as applicable.

Courts have permitted lengthy restrictions (e.g. 10 years) on the disclosure of confidential information.  The new provision raises questions about how long a non-disclosure restriction may last.

No-Solicitation Covenants

The new Georgia law tends to memorialize the existing rules governing restrictive covenants.  The law also provides phrases that if used will be enforced and interpreted to result in a reasonable restriction.  For example, any reference to a prohibition against “soliciting or attempting to solicit business from customers or similar language” will be construed to apply to the employer’s customers and prospective customers with whom the employee had material contact and to products and services competitive with those provided by the employer.

Non-Competition Covenants

Under current case law, a non-competition covenant reasonable in scope, duration and geography during the term of employment generally will be enforced.  However, an otherwise reasonable non-competition covenant covering post-employment activity may be enforced only against an employee who:

1.         Customarily and regularly solicits customers or prospective customers for the employer;

2.         Customarily and regularly makes sales or obtains orders or contracts for products or services to be performed by others;

3.         Performs duties:

a.         primarily managing the employer’s enterprise;

b.         customarily and regularly directing the work of two or more employees; and

c.         with the authority to hire or fire or to influence a change in employment status (e.g. hire, fire, promote, etc.); or

4.         Serves as a “key” employee or professional.

The new law provides “presumptions” regarding the reasonableness of the use of covenant terms dealing with scope, temporal and geographical limitations.  With respect to a non-compete clause, courts are directed to presume as reasonable a non-compete limitation:

1. of 2 years following the termination of employment;
2. of 3 years following the termination of a mid-level relationship; and
3. for the sale of a business, of 5 years or a period equal to the time payments are being made to the owner or seller.

The description of prohibited activities, products, or services still may not exceed the activities performed, products sold, or services provided by the employee but may be qualified with the language “of the type conducted, authorized, offered, or provided within two years prior to termination.”  In addition, the new law allows the applicable geographical area to be described as “the territory where the employee is working at the time of termination.”

Employer Response

Allowing a judge to rewrite or blue pencil an offending provision should influence the number and manner of use of restrictive covenants.  Most employers desire to preserve a company’s confidential information, retain its customer base, and minimize competition.  If the new Georgia law significantly increases the chances that a court would enforce, at least, a semblance of an agreement’s restrictive covenants, companies may increase the use of such covenants knowing that most, if not all, of a restrictive covenant would be enforced.

Given Georgia’s current bias towards restrictive covenants in restraint of trade, many workplace and business contracts select the law of another state to govern the contract.  Georgia courts typically disregard these choice-of-law clauses if the other state’s law conflicts with Georgia’s restrictive covenant law.  The new law may result in the Georgia courts accepting an agreement’s choice of law for restrictive covenants.  If so, the strategy of developing an inter-state restrictive covenant will be reformulated?

While the new law requires approval of a state constitutional amendment before becoming effective, the law does identify many of the “reasonable” limitations that have been imposed by case law.  In the interim, any existing restrictive covenants that contradict the new law’s recommended terms, at a minimum, should be reviewed and, possibly, modified to preserve the covenant’s enforceability.