Non-Compete Provisions in CEO Contracts

The following post comes to us from Michael S. Katzke, a founding partner of Katzke & Morgenbesser LLP, and is based on a Katzke & Morgenbesser publication by Mr. Katzke and Henry I. Morgenbesser.

In negotiating the terms of a CEO employment arrangement, arguably the most important term for the board of directors of the employer is the non-competition (or non-compete) provision. A recent study by three business and law school professors (Bishara, N., Martin, K, and Thomas, R., When Do CEOs Have Covenants Not to Compete in Their Employment Contracts? (October 18, 2012) Ross School of Business) has found that, in spite of concerns by commentators that CEOs often have bargaining leverage over employers, there has been a significant upward trend over time in the use of non-compete provisions in new and restated CEO contracts. The study found usage of non-competes peaked in 2008 (89%) and in 2010 was at approximately 79%, up from 60-65% in the early 1990s.

In our practice, we often spend a great deal of time negotiating the appropriateness of including a non-compete in the employment agreements of CEOs and other senior executives and, if so included, the specific terms of the provision. The three key components of the non-compete are the duration, geographic scope and parameters of the prohibited activities. Obviously, the post-employment duration of the non-compete is a major consideration and, for better or worse, is often intertwined with the length or amount of severance to be paid upon a severance termination event. The geographic limitation is often fairly straightforward and, for the most part, based upon where the company is conducting its business and where its primary customers are located.

The more nuanced and complex negotiation, whether on behalf of the company or the executive, is the scope or breadth of the non-compete. From the company’s perspective, we have seen good external candidates threaten to walk away when the company insists upon a provision which could be considered unreasonable due to its scope being broader than the actual protection needed against a departed executive’s competitive activities. From the viewpoint of the executive, he or she does not want the possibility of being forced to remain completely on the sidelines post-employment due to a provision which is needlessly broad.

A non-compete containing an excessively long duration or an overly broad geographic scope or coverage of prohibited businesses may be ultimately determined by a court to be unenforceable. Nevertheless, when representing executives we are loath to advise them to accept such provisions merely on the basis that all or a portion of the non-compete is likely not to be enforceable. We believe that an overly broad provision (whether reasonable or not) may have a chilling effect on employment opportunities by potentially scaring off future employers, including those whose businesses are not truly competitive with the business of the executive’s former employer.

In that regard, a few of the modifications or clarifications that we have used in recent years to broker a reasonable non-compete provision include permitting the executive to:

  • own passive interests in private entities (in addition to public company ownership) with certain percentage and value limitations
  • to invest in a private equity or hedge fund which invests in or maintains a competing business so long as the executive does not provide advice or other services to such fund or portfolio business
  • provide services to a portfolio company of a private equity or hedge fund which invests in or maintains a competing business so long as the portfolio company itself is not engaged in the competing business
  • provide services to a division or subsidiary of a competing business so long as the division or subsidiary is not engaged in a competing business (provided the executive does not provide advice or other services to the competing business)
  • provide services directly to a competing business if the size (or location or market) of the competitor or its core business makes it not really a competitor of the former employer
  • be employed by or provide services to potentially competitive entities other than those specifically listed in the non-compete covenant
  • more specific to the financial services sector, continue to be employed in such sector in areas that are not competitive with the executive’s functions at the former employer (note that this provision often will first get worked out upon an executive’s departure from his or her employer)

While we do not discount the importance to an employer of a viable non-compete provision, we believe that the employer and the executive should be able to agree upon a provision that is protective of the employer’s business while, at the same time, not being so unreasonably broad that the executive is precluded from obtaining subsequent employment with an employer whose business activities do not threaten the business of the former employer.

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