Third Circuit Permits Extra-Strong Restrictive Covenants for Extra-Good Employees

In a recent “precedential” opinion, the Third Circuit, applying New Jersey law, approved an employer’s use of an additional, extra-stringent restrictive covenant for its high-performing salespeople, subject to careful blue lining by the court to ensure that the covenant does not create an unreasonable burden for the employees.

ADP, LLC, the well-known provider of payroll and other human resources services, required its new sales employees, as a condition of employment, to sign a Sales Representative Agreement and a Non-Disclosure Agreement. Together, the two agreements essentially prohibited the employee, for one year after the termination of employment, from soliciting ADP customers “with which the Employee was involved or exposed” while employed at ADP.

Once employed, ADP’s sales staff could earn stock awards by meeting certain sales targets. But to receive an award, the employee had to sign a third agreement, a Restrictive Covenant Agreement, which imposed still more post-employment restrictions on the employee. Among other things, the Restrictive Covenant Agreement essentially prohibited the employee for two years after termination from soliciting all current and prospective ADP customers, whether or not the employee was “involved or exposed” to the customer while employed by ADP. The Restrictive Covenant Agreement also contained a geographic restriction, which essentially prohibited the employee from competing against ADP in the same geographic area where the employee worked for ADP.

Two ADP employees voluntarily terminated their employment with ADP and began working for an ADP competitor. ADP sought an injunction enforcing the more onerous restrictions of the Restrictive Covenant Agreement; the employees apparently were in compliance with the less onerous restrictions of the Sales Representative and Non-Disclosure Agreements.

The District Court denied the injunction, finding that ADP was not likely to prove that the restrictions in the Restrictive Covenant Agreement were designed to protect ADP’s legitimate interests of protecting its customer relationships and proprietary information. Those interests, the District Court found, were already protected by the restrictions contained in the Sales Representative and Non-Disclosure Agreements. Thus, the District Court concluded that the Restrictive Covenant Agreement was an unjustified, and therefore unenforceable, restraint on competition.

The Third Circuit disagreed, reasoning that ADP’s high-performing sales personnel pose a greater threat to ADP’s customer relationships than lower-performing sales personnel do and that ADP therefore had a legitimate interest in imposing more onerous restrictions on the high-performing employees. The Court also remarked that ADP’s two-tiered approach imposed less restraint on competition than a single-tiered approach that imposed the heightened restraints of the Restrictive Covenant Agreement on all ADP sales staff.

The Third Circuit did acknowledge, however, that the restraints in the Restrictive Covenant Agreement may impose an undue burden on the former employees. But the appropriate judicial response, according to the Court, is not to strike the agreement down entirely, but instead to blue line the agreement to make it reasonable and not excessively burdensome. In fact, ADP conceded that the Restrictive Covenant Agreement’s non-solicitation should be modified so that it is limited to customers about whom the employees gained knowledge during their employment with ADP. The Court thus remanded the matter to the District Court to blue line the Restrictive Covenant Agreement.

Christopher Walsh, a Director in the Gibbons Commercial & Criminal Litigation Department, authored this post.
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