NJ Appeals Court Takes “Blue Pencil” to Restrictive Covenant

NJ Appeals Court Takes “Blue Pencil” to Restrictive Covenant

If your restrictive covenant agreement is too broad, the court may take out its “blue pencil” and modify its terms. In a recent decision involving non-solicitation and non-compete provisions imposed on ADP, LLC employees, the Appellate Division of the New Jersey Superior Court offered guidance regarding what it will consider to be overly broad. Its ruling is in line with an earlier decision by the U.S. Court of Appeals for the Third Circuit that also called for blue penciling ADP’s overbroad restrictive covenants.

ADP’s Restrictive Covenant Agreements

High-performing ADP employees who meet their sales targets are eligible to participate in a stock-option award program. However, they must first sign a Restrictive Covenant Agreement (RCA). The RCA contains a non-solicitation provision (Non-Solicitation Provision) that prohibits employees—for a period of one year following their termination (voluntary or involuntary)— from soliciting any ADP clients to whom ADP “provides,” “has provided” or “reasonably expects” to provide business within the two-year period following the employee’s termination from ADP. The RCA also prohibits the solicitation of all prospective ADP clients. In addition, the RCA prevents former employees from soliciting ADP’s “Business Partners,” which is defined to include “referral partners” in addition to “marketing partners.”

The RCA also contains a non-compete provision. For a period of one year following their termination, employees will not “participate in any manner with a Competing Business anywhere in the Territory where doing so will require [them] to [either] provide the same or substantially similar services to a Competing Business as those which [they] provided to ADP while employed,” or “use or disclose ADP’s Confidential Information or trade secrets.” The term “Territory” is defined as the “geographic area” where the employee worked or had contact with ADP clients in the two years prior to her termination.

The defendants in the consolidated appeal are all former employees of ADP who, shortly after voluntarily leaving ADP, began working at Ultimate Software Group (Ultimate), a direct competitor of ADP. In the resulting litigation, ADP has sought to enforce its RCAs, with varying success at the trial court level.

Appellate Division’s Decision

The Appellate Division first held that because ADP presented evidence of a legitimate business interest to support the imposition of the covenant’s restrictions, the RCA is not entirely unenforceable. However, it further held that the RCA’s non-solicitation and non-compete provisions are overly broad and require blue-penciling to “ensure they reasonably guard ADP’s interest in protecting its customer relationships without imposing an undue hardship on its former employees.”

With regard to the Non-Solicitation Provision, the Appellate Division held that ADP may only prohibit its employees, upon separation from the company, from soliciting any of ADP’s actual clients with whom the former employee was directly involved or who the employee knows to be ADP’s client. As to the solicitation of prospective clients, it found it unreasonable and onerous to restrict defendants from soliciting clients unknown to defendants while at ADP.

“We find this unreasonable. That restrictive language is untenable as an ADP employee could not possibly know all of ADP’s actual clients. Therefore, it is necessary to blue-pencil the RCA to achieve the balance of protecting ADP’s interests against the hardship it imposes on former employees,” Judge Heidi Currier wrote. She further explained:

Due to the breadth of ADP’s worldwide reach, any company defendants approach might be a potential ‘prospective’ ADP client. We cannot envision any practical manner in which defendants could conduct business without offending this provision. That is an unreasonable burden and undue hardship, and therefore subject to blue-penciling.

As modified by the court, when working for a competitor, a former employee is only prohibited from soliciting a prospective ADP client if the employee gained knowledge of the potential client while at ADP and directly or indirectly, solicits that client after leaving.

With regard to the non-compete provision, the Appellate Division found it reasonable for ADP to restrict its former employees, for a reasonable time, from providing services to a competing business in the same geographical territory in which the employee operated while at ADP. It reversed a trial court decision in which the judge relaxed the covenant’s restriction by blue-penciling the geographical limitation in these clauses to also include a market segment.

“We cannot discern any rationale in the record to blue-pencil a market segment component into the RCA. There is no evidence that the specialized training, information, or strategic client skills defendants obtained at ADP differed according to the number of employees in the companies they serviced,” judge Currier wrote. “The customer relationships ADP seeks to protect are the same, regardless of how many employees the client might have.”

Key Takeaway for NJ Businesses

The Appellate Division’s decision provides further confirmation that New Jersey employers may rely on non-competes, non-disclosure agreements and other restrictive covenant agreements to protect legitimate business interests. However, it also makes clear that courts can modify agreements that are overly broad and not narrowly tailored to protect such interests.

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Robert Levy, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.