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Are Stock Option Agreements The Modern Agreements Not To Compete?

On Behalf of | Aug 30, 2011 | Non-compete Agreements

Non-compete agreements, also known as “covenants not to compete,” previously were part of any typical employment and/or compensation agreement between companies and their executives. While most executives may not know the exact legality of non-competition agreements, most realize their potential ramifications and seek advice from a qualified employment law attorney prior to signing them. The same is not always true of executives presented with a stock option agreement; however, it should be.

Here’s a typical scenario where non-compete agreements wind up in Court: An executive obtains employment with a corporation (company “A”) as a regional vice president of marketing. At the beginning of his or her employment with this company, the executive signs a non-compete agreement as part of a compensation and/or employment contract. Over a period of 15 years, the executive works diligently creating a rather impressive name for himself or herself. Company “A” decides to restructure its work force and wants the executive to relocate to a different market out of state. The executive is reluctant because of familial and community obligations. The executive, having established a remarkable reputation over the 15 year period, decides to take other employment and sign up with Company “B.” There is a dispute as to whether Company “B” is considered a competitor of Company “A.” The case ends up in litigation over the enforceability of the executive’s non-competition agreement executed with Company “A.”

In this scenario, counsel and the courts will scrutinize the enforceability of the non-competition agreement pursuant to the traditional approach established through case law decisions over the years. In Ohio, agreements that restrict competition by an ex-employee have generally been held to be valid if they contain reasonable geographical and temporal restrictions. Such an agreement does not violate public policy if it is reasonably necessary for the protection of the employer’s business, and not unreasonably restrictive upon the rights of the employee.

The problem is that if Company “A” has ever dealt with this scenario before, it has since hired competent employment counsel to draft their covenants not to compete, increasing the likelihood they will be valid and enforceable. This means that the executive is stuck and cannot work for Company “B.” Recognizing this, employment lawyers have been finding more creative ways to invalidate and/or work around these types of covenants. Usually, talented employment attorneys can find a middle ground or some compromise that allows the employee to change employment while still protecting Company “A’s” business. Rarely does either company or the employee want to take a “scorched earth” approach to the litigation expending thousands of dollars on litigation.

In recent years, companies have found a new tool.  Companies have begun utilizing stock option agreements to restrict employees from competing against a former employer rather than traditional covenants not to compete. These new type of agreements are not subject to court review under the same traditional approach as non-compete agreements. This removes much of the employee’s bargaining power.

For instance, in the above scenario, Company “A” may have avoided invalidation under the traditional non-compete agreement test by merely including a provision in the executive’s stock option agreement that requires the executive to repay all profits (including gains on profits) the executive received from exercising stock options granted to him or her during the executive’s employment with Company “A.” This agreement would be in effect if the ex-employee decides to work for a competitor of Company “A” for a set amount of time after their employment with the first company ended, typically one year. There is no uniform judicial review of these agreements yet; however, they do not appear to be subject to the traditional geographical and temporal restrictions as they are not traditional covenant’s not to compete. Technically these agreements do not restrict an ex-employee from working for a competitor, rather, they merely require the ex-employee to repay profits made from their former company’s stock options granted to them during their employment.

If you are an executive with a long-term employment history with a reputable company, you may have a stock agreement that has brought you significant income as part of your compensation package. This may cause you to think twice before deciding to leave your company in order to avoid having to repay thousands of dollars in previously executed stock options. Moral of the story, just because you have not signed a non-compete agreement does not mean you do not have to think twice about leaving your existing employer.

Before you decide to leave your current employer, you should contact an experienced employment attorney with Mowery Youell & Galeano, Ltd.

By: Nicholas W. Yaeger