Enforceability of Restrictive Covenants in Arizona

Non-Compete Agreement. A non-compete agreement is a representation from the employee to employer that the employee will not compete with the employer’s business for a set period of time and within a certain geographical location upon termination. See id. (“A covenant not to compete precludes former employees from working in the same business as the employers for certain time periods in specified areas.”). For example, a non-compete agreement might provide that upon conclusion of the employment relationship, the employee will not engage in the same industry as the employer within a geographical range of ten miles of the employer’s principal place of business for one year.

Non-Solicitation Agreement. A non-solicitation agreement (sometimes referred to as a “hands off” or “anti-piracy” agreement) is a representation by an employee to not solicit the customers of his former employer for a set period of time after the employment affiliation ends. See id. (observing that non-solicitation agreements “restrict[] the terminated employee from soliciting customers of his former employer”); Alpha Tax Servs., Inc. v. Stuart, 158 Ariz. 169, 171 (Ct. App. 1988) (“This type of agreement, which has been called an antipiracy or hands-off agreement, is less restrictive than a covenant not to compete and is designed to prevent former employees from using information learned during their employment to divert or to steal customers from the former employer.”)

“Solicitation” is often expressly defined in the agreement itself. If no contractual definition is provided, the term’s general meaning is “the act or an instance of requesting or seeking to obtain something.” Black’s Law Dictionary (10th ed. 2014). Thus, to “solicit” a former customer means to interact with the customer in a manner that would encourage him or her to leave the former employer and engage the employee. Merely notifying former customers of the employee’s new employment, such as advertisements or e-mail announcements, is permitted as long as the notification does not include a solicitation. See Alpha Tax Servs., Inc., 158 Ariz. at 171.

In general, “[t]he validity of a restrictive covenant is determined by its reasonableness.” Phx. Orthopedic Surgeons, Ltd. v. Peairs, 164 Ariz. 54, 60 (Ct. App. 1989). A restrictive covenant will be considered “reasonable” when the restraint (1) does not exceed that necessary to protect the employer’s legitimate interest, (2) would not cause undue hardship to the employee, and (3) would not cause harm to the public interest. See id. at 59; Valley Med. Specialists v. Farber, 194 Ariz. 363, 369 (1999) (en banc).

Accordingly, “[r]estrictive covenants which tend to prevent an employee from pursuing a similar vocation after termination of employment are disfavored” and will be “strictly construed” against the employer. Amex Distrib. Co., Inc. v. Mascari, 150 Ariz. 510, 514 (Ct. App. 1986). Likewise, “[a] restrictive covenant is not enforceable to prevent a former employee from using his skills and talents he learns on the job in his new job.” Bryceland v. Northey, 160 Ariz. 213, 217 (Ct. App. 1989) (citing Lessner Dental Labs., Inc. v. Kidney, 16 Ariz. App. 159, 162 (1971)).

Ultimately, the determination of reasonableness is a fact-intensive inquiry, with results that vary widely depending on the totality of the circumstances. See Id. at 216 (“Each case hinges on its own particular facts.” (citing Gann v. Morris, 122 Ariz. 517, 518 (Ct. App. 1979))). Accordingly, “what is reasonable depends on the whole subject matter of the contract, the kind and character of the business, its location, the purpose to be accomplished by the restriction, and all the circumstances which show the intention of the parties.” Fearnow v. Ridenour, Swenson, Cleere & Evans, P.C., 213 Ariz. 24, 26 (2006) (citation omitted).

Careful drafting of these provisions and covenants is therefore imperative for enforcement. Nonetheless, employers should remember that Arizona follows the “blue pencil rule” and “will blue pencil restrictive covenants, eliminating grammatically severable, unreasonable provisions[.]” Fearnow, 213 Ariz. at 32 (citing Valley Med. Specialists, 194 Ariz. at 372). Thus, including too much specificity in a restrictive covenant may prevent a court from eliminating a clause it finds unreasonable.

Non-Compete Agreements. As indicated above, when determining the validity of non-compete agreements, courts will balance the interests of the business in protecting its legitimate interests with an individual’s right to engage in the work in which he is trained. The two primary considerations in the reasonableness inquiry are the covenant’s limitations regarding time and geography. See, e.g., Orca Commc’ns Unlimited, LLC v. Noder, 233 Ariz. 411, 417 (Ct. App. 2013) (“A restriction on a former employee’s right to compete against a former employer is enforceable, but only if the restriction is limited in time and in geography.”); Valley Med. Specialists, 194 Ariz. at 370 (“A restraint’s scope is defined by its duration and geographic area.”).

Due to the fact-intensive nature of the reasonableness analysis, courts have found a variety of non-compete agreements to be reasonable. For example, one Arizona federal court determined that a one-year duration of a covenant not to compete within a twenty-five-mile radius of the employer was reasonable where a wealth management employee left the employer (a bank) to start his own firm. See Compass Bank v. Hartley, 430 F. Supp. 2d 973, 981 (D. Ariz. 2006).

Another court held that a provision prohibiting competition for five years within a twelve-mile radius of a veterinarian’s former employer was reasonable. Lassen, 86 Ariz. at 328. Moreover, the Arizona Supreme Court upheld a covenant by an employee disc jockey not to become employed by or associated with, in any capacity, any radio station within fifty miles of Phoenix for the period of one year from the date of termination of employment. See Titus v. Superior Court, Maricopa Cty., 91 Ariz. 18, 22–23 (1962).

Courts have also found a variety of non-compete agreements to be unreasonable and unenforceable. See, e.g., Valley Med. Specialists, 194 Ariz. at 365 (finding unreasonable a covenant between physicians forbidding competition within a five-mile radius of any medical office owned by the former employer for three years); Lessner Dental Labs., Inc. v. Kidney, 16 Ariz. App. 159, 162 (1971) (holding that restrictive covenant prohibiting dental technician for period of two years following termination of her employment with dental laboratory from entering into business of repairing, adjusting, creating, or selling dental prosthetics and related devices within county was overly broad and would not be enforced by injunction).

What these cases show is the reality that a full review of the particular facts is necessary before drafting or attempting to enforce a non-compete agreement.

Non-Solicitation Agreements. Although Arizona courts have recognized that a non-solicitation agreement is “less restrictive than a covenant not to compete” due to its narrower scope, Olliver/Pilcher Ins., Inc. v. Daniels, 148 Ariz. 530, 531 (1986), the “test of validity” remains “one of reasonableness,” Fearnow, 213 Ariz. at 26 (citing id. at 532). A non-solicitation agreement will therefore be enforceable if it is “no broader than necessary to protect the employer’s legitimate business interest.” Hilb, Rogal & Hamilton Co., 190 Ariz. at 216.

In this regard, employers have a legitimate interest in restraining former employees “from appropriating valuable trade information and customer relationships” acquired during employment. Bryceland, 160 Ariz. at 216 (citing Restatement (Second) of Contracts § 188, cmt. b (1981)). And, as a result, employers are permitted to protect this interest, see Valley Med. Specialists, 194 Ariz. at 370 (noting that an employer’s clientele is “an asset of value which has been acquired by virtue of effort and expenditures over a period of time, and which should be protected as a form of property” (citation omitted)), though the protection must be curbed to “those customers to whom the employee represented the employer’s goodwill,” Amex Distrib. Co., 150 Ariz. at 518.

Furthermore, an employer’s interest in customer relationships may be guarded “for as long as may be necessary to replace the employee and give the replacement a chance to show that he can do the job.” Bryceland, 160 Ariz. at 216 (citing id.). As to what amount of time is reasonable, Arizona courts have explained:

Amex Distrib. Co., Inc., 150 Ariz. at 518 (citation omitted); see, e.g., Hartley, 430 F. Supp. 2d at 980 (noting that courts routinely uphold one-year restrictive covenants in financial services industry but concluding that “two years is unreasonable” (citations omitted)); Bryceland, 160 Ariz. at 217 (holding a two-year restriction on solicitation invalid because “the evidence showed that it took approximately fourteen weeks for adequate schooling and on-the-job training of new personnel to handle the duties of a deejay”).

Notably, although employers have a recognized interest in retaining current clients, non-solicitation agreements cannot extend to former or prospective clients. See Orca Commc’ns Unlimited, LLC, 233 Ariz. at 418 (“[A]n employer has no protectable interest in persons or entities as customers when the employer has no business ties to them.”); Hilb, Rogal & Hamilton Co., 190 Ariz. at 216 (holding that employer had no protectable interest in a former client’s account); Bryceland, 160 Ariz. at 217 (noting without deciding, that “the restriction against employment by any ‘potential customer or client’ of [the employer] may be overly broad”). Thus, if a non-solicitation agreement is drafted too broadly with respect to protection of an employer’s clients, it likely will be invalid.

If a former employee breaches a restrictive covenant, what can the employer do?

An employer has a few options if it learns that its former employee is violating a restrictive covenant: (1) petition a court for a temporary restraining order (“TRO”) and/or preliminary injunction, (2) seek entry of a permanent injunction, and (3) assert a claim for damages.

Temporary Restraining Order/Preliminary Injunction. The first and possibly most efficient option available to an employer is to seek a TRO against the employee to prevent further violation of the restrictive covenant for a temporary period. While the employee was already contractually-prohibited from engaging in the conduct, obtaining a TRO provides an additional deterrent as any subsequent violation would subject the employee to contempt of court proceedings.

To obtain a preliminary injunction, the moving party must follow the procedures outlined in Arizona Rule of Civil Procedure 65 and establish (1) a strong likelihood of success on the merits, (2) the possibility of irreparable injury not remediable by damages if the requested relief is not granted, (3) a balance of hardships favoring that party, and (4) public policy favoring a grant of the injunction. See Shoen v. Shoen, 167 Ariz. 58, 63 (Ct. App. 1990) (citation omitted); Winter v. Natural Res. Defense Council, Inc., 555 U.S. 7, 20 (2008) (stating that a TRO may be granted if the movant “establishes that he is likely to succeed on the merits, that he is likely to suffer irreparable harm in the absence of preliminary relief, that the balance of equities tips in his favor, and that an injunction is in the public interest”).

The court may use a “sliding scale” approach when evaluating this standard. See Ariz. Ass’n of Providers for Persons with Disabilities v. State, 223 Ariz. 6, 12 (Ct. App. 2009). As such, the court may grant the request for injunction when the movant proves either: (1) probable success on the merits and the possibility of irreparable injury or (2) the presence of serious questions on the merits and that the balance of hardships tips sharply in the movant’s favor. See id.

With respect to irreparable harm, courts are in general agreement that an investment firm can show irreparable harm from the loss of investment clients to a former employee. Many courts have held that the losses resulting from such harm are difficult to quantify, particularly when the firm has invested considerable effort in cultivating and growing the goodwill and business of the clients. See, e.g., Thrivent Fin. for Lutherans v. Hutchinson, 906 F. Supp. 2d 897, 907 (D. Neb. 2012) (“[T]he amount of damages resulting from the solicitation of Thrivent’s clients and use of its Confidential Business information would be difficult, if not impossible, to ascertain with any degree of certainty.”); Fid. Brokerage Servs. LLC v. Clemens, 2013 WL 5936671, at *10 (E. D. Tenn. Nov.4, 2013) (“While the Court agrees that the loss of fees earned from the customers who transfer their accounts can ultimately be calculated and compensated as money damages if Fidelity prevails on the merits, it does appear to the Court that certain elements of Fidelity’s claimed damages in the form of loss of customer referrals and loss of goodwill are very difficult to calculate, or even adequately prove.”); Hilliard v. Clark, 2007 WL 2589956, at *9 (W.D. Mich. Aug. 31, 2007) (“[T]here was no way to calculate how much the various client portfolios might have grown if they were not transferred, what assets the clients may have earned, inherited or won over time, or what potential referrals transferring clients might have made.”).

However, when monetary damages can be reasonably calculated and cover the movant’s full harm suffered, the monetary damages provide an adequate remedy at law. See IB Prop. Holdings, LLC v. Rancho Del Mar Apartments Ltd. P’ship, 228 Ariz. 61, 65 (Ct. App. 2011).

Permanent Injunction. Because non-compete and non-solicitation covenants are required to have reasonable time-frames, the use of the phrase “permanent injunction” is somewhat contradictory. However, the employer can seek a permanent injunction enforcing the applicable covenant until the end of the contractual period.

Claim for Damages. An employer may also bring a claim for damages. The amount of damages available can run the gamut due to the specific violation and the terms of the restrictive covenant, but in general, as long as the employee’s breach harmed the employer, the employer has a cause of action against the employee for damages, see Home Indem. Co. v. Bush, 20 Ariz. App. 355, 360 (1973), and likely attorneys’ fees, see Ariz. Rev. Stat. § 12-341.01.