Watch For Noncompetes And Other Restrictive Covenants In Stock Grant Agreements
Your stock grant agreement can have a provision that will not only claw back your gains if you leave to work for a competitor but also restrain you from taking a job at that company. These types of provisions, called restrictive covenants, can lurk in grant agreements for stock options, restricted stock, and performance shares. They are separate from your employment agreement.
Until recently, courts have been treating restrictive covenants in a predictable pattern, according to attorney Michael Melbinger, a retired former head of the Employee Benefits and Compensation practice at Winston & Strawn. Courts have been more likely to enforce a restrictive covenant, especially a noncompete, if the remedy for breach is merely loss of compensation. Courts have been less likely to enforce a provision that prevents you from earning a living in your profession. When the provision gives you a choice of (a) working for a competitor and forfeiting equity or (b) keeping the compensation but not competing, most courts will enforce the provision. This is called the employee-choice doctrine.
Game-Changing Court Case
However, in Newell Rubbermaid v. Storm (Del. Ch. March 27, 2014), the respected Delaware Court of Chancery went beyond the employee-choice doctrine and, in doing so, changed experts' views on these provisions. The court granted the plaintiff company a temporary restraining order against the defendant, a former employee, for actions that appeared to violate the noncompete, nonsolicitation, and confidentiality covenants of the company's RSU agreement with the employee. The RSU agreement, to which the defendant assented and which the company sought to enforce, was a so-called "clickwrap" agreement. This is an online agreement that requires webpage visitors to affirmatively assent to the terms of a contract by clicking an "accept" button to proceed, along with a checkbox for confirming the statement "I have read and agree to the terms of the grant agreement." (Compare this to the "browse-wrap" concept, by which the use of the website implies assent to an agreement.)
The Delaware court concurred with the plaintiff that the defendant had assented to the restriction under the agreement by accepting the award through a third-party website, and the court enforced the noncompete even though the grants had already been forfeited. It reached this conclusion even though the former employee merely clicked to indicate acceptance of the agreement as a whole and did not acknowledge/click on any specific provision confirming that she had read or agreed to the restrictive covenant.
In ADP v. Lynch and Halpin, the US 3rd Circuit Court of Appeals reached a similar judgment in relation to online agreements. In the company's procedures, employees had to check boxes to confirm that they had reviewed the documents, which included the plan, the award agreement, and the noncompete. The first page of the grant agreement also specifically told employees that acceptance of the award depended on their agreeing to the noncompete. The court found that the employees had checked the box affirming that they had read these documents. It dismissed as irrelevant their contention that they did not recall doing so and had not been adequately informed about the consequences of accepting the grants.
A legal alert from McGuireWoods includes a discussion of an unpublished case, MeadWestvaco Corp. v. Bates, No. CL13-1589 (Va. 12th Cir. Ct. Aug. 1, 2013), in which a court similarly enforced restrictive covenants in equity award documents that an employee acknowledged online. However, the equity award documents in this case did not include language identifying temporary injunctive relief as a potential remedy for a breach. Forfeiture of the equity compensation was the only result mentioned, but the court still granted injunctive relief. To reach that result, the court applied the "inevitable disclosure doctrine" used in most states. This allows the company to enjoin an employee who has knowledge of a trade secret from working for a direct competitor when the employee will inevitably have to use or disclose those trade secrets in that new job. Similarly, in Cameron International Corp v. Guillory (September 2014), the Texas Court of Appeals granted temporary relief enjoining a former employee (Mr. Guillory) from violating the noncompete provision in a restricted stock agreement also accepted online.
How Common Are These Provisions?
Willis Towers Watson's 2013 LTI Policies and Practices Survey shows that restrictive covenants in equity award agreements are more common than many people may realize. In a blog commentary at his firm's website, Mr. Melbinger reports the following from the survey:
- About one third of the surveyed companies have put restrictive covenants in recent stock grants, and usage is not related to company size.
- Noncompetition, nonsolicitation, and nondisparagement are the most common restrictions.
- These restrictions apply to everyone getting an award, not just to certain executives.
- A clawback of realized gains is the most common consequence of a violation.
The NASPP's 2019 Domestic Stock Plan Design Survey found that stock plans at 72% of the responding companies have clawback provisions (up from 60% in 2013). At 39% of these companies, clawbacks are triggered by the violation of a noncompete.
At the website of the SEC, you can see an example of a stock grant agreement that includes a restrictive covenant (see Section 2.2). Another example is in the details of grants made in 2015 to executives at General Motors (see the section "Restrictive Covenants").
Your stock grants come with strings attached, as explained in an article elsewhere on this website that discusses court cases involving noncompetition clauses and other restrictive covenants. Courts may enforce all remedies in a stock grant agreement. This includes remedies that go beyond simply the forfeiture of the stock award, such as a restraining order preventing you from working for a competitor.
Alert: Look at each of your stock grant agreements for noncompete provisions that not only cause the forfeiture of unvested grants and claw back vested grants (and proceeds) but also restrain you from being employed by a competitor.
Newell Rubbermaid v. Storm and other recent cases present many lessons for employees. You must read your whole grant agreement and understand all of its terms, even if you have little ability to negotiate changes. In addition, do not ignore new grant agreements on the assumption that these are always going to be the same. For the employee in Newell Rubbermaid v. Storm, the noncompete provision appeared suddenly in the most recent grant agreement. By clicking "accept" in an online agreement, you may be agreeing not only to terms related to your stock grant but also to terms that affect your post-employment obligations to your company. For more details on the related lessons for employees, see Mike Melbinger's blog commentary on this topic.
Bruce Brumberg is co-founder and Editor-in-Chief of myStockOptions.com.