Cannabis companies are served well by non-compete clauses — as long as they stay focused and don’t over-reach.
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When Bruce Linton, the co-CEO Canopy Growth — the world’s largest cannabis company — was forced out this summer, his departure raised the profile of a common business contract used extensively in today’s cannabis industry — the non-complete clause.
There’s been much speculation about where Linton will land next, given that his non-compete contractually bars him from working in Canadian markets but not in the U.S.
Non-compete contracts like Linton’s are common in business. Companies need to protect what goes on inside the walls of their boardrooms, warehouses and retail outlets. And non-compete clauses are a way to accomplish this.
But despite the legal restrictions, talented workers naturally, and often unintentionally, take with them the knowledge they acquired in one job to other jobs. And not just C-level business leaders, but talent of any kind is a valuable commodity for the ever-increasing number of cannabis start-ups and expansions taking place today.
Outside of executive offices, the need for skilled labor extends to the seasoned master growers, IT professionals and deft marketers who are crucial to a cannabis organization’s success. It also applies to the revenue-generating budtenders in the retail sector, and, on the production side, the expert lab technicians who understand how to use bleeding-edge technology to extract both high-demand cannabinoids and profits alike. All of these high-profile cannabis professionals and others like them can find themselves grappling with non-compete clauses during some part of their careers.
But just because these legal concepts are common, doesn’t mean their use is always successful. After all, courts frequently hold that non-compete clauses are unenforceable if they are too broadly applied or if they in any way stifle competition. That leaves many asking: Why should a company train its future competitors? And what can they do to protect themselves?
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There are a few specific steps companies can take to strengthen non-compete clauses so that they’re more effective. However, first, they should understand the background of these legal concepts, as well and the two major kinds of employment-related contracts faced by many in the cannabis industry today.
What are non-competes?
Though most of the general public probably recognize the phrase and the concept of the non-compete clause, the legal professionals working with these ideas also refer to them as “restrictive covenants.”
A restrictive covenant is a contract, or a clause in a contract, that prohibits someone from doing something they otherwise would be allowed to do.
Examples include a professional athlete’s contract that prohibits dangerous activities or a trader’s employment contract that bars that person from trading the same equities of which their firm trades. These restrictive covenants also are seen in contracts that prohibit someone from disseminating trade secrets or other confidential company information.
For today’s cannabis-related enterprises, two kinds of covenants are both the most common and the most important — non-compete and non-solicitation clauses.
A non-compete clause states that the individual cannot compete with the company in a designated geographic area for a period of time (such as Bruce Linton in Canadian cannabis). In a non-solicitation clause, the employee agrees not to solicit either the company’s customers or employees for a degree of time.
Are they enforceable?
Generally, courts hold that while a non-compete clause must identify a particular area in which the individual cannot compete, non-solicitation clauses typically do not require a geographic restriction because they focus on an identified set of people, such as customers, employees or both.
Adding to the complexity of these restrictive covenants is that different states have different laws affecting their legality and us. Many courts place a heavy onus on the companies seeking to use these kinds of covenants, rather than the employees who sign them.
How can companies protect themselves?
Even though many courts view non-compete clauses circumspectly, cannabis operators can still use them to protect their interests. How? Create them as you would any legally binding agreement — with legal precision and a narrow, purposeful focus.
Rather than applying a wide, expansive array of non-compete factors, companies should take care to draft restrictive covenants only to protect what is most important to the company. Organizations often mistakenly think their wide-net approach to these covenants is the best way they can protect their interests. However, blanket restrictions like these are more likely to be held unenforceable because the courts rightfully view them as obstacles to competition. And any clause designed simply to remove competition is, of course, non-enforceable.
Many restrictive covenants prohibit, for example, a former employee from competing with the company throughout the entire United States, even though the employee only worked in a specific region. Other restrictive covenants prohibit a former employee from soliciting any of the company’s employees or any of the company’s global customers, regardless of whether the former employee had any interaction with those employees or customers.
In trying to protect its interests from future risks like these and others, what should a company do?
First, it objectively should consider what it is trying to protect and tailor the clause accordingly. For example, if a company is trying to prevent a former employee from poaching its upper-level executives, then the non-solicitation clause should be narrowly tailored to only prevent solicitation of those upper-level executives. If a company wants to prevent a former employee from competing in a specific region where he or she developed a client base while employed by the company, then the non-compete should be tailored to that region.
If a company drafts a restrictive covenant that covers more than necessary, it will most likely fail. Accordingly, though, you should look at the issue with the perspective of a litigator. Meaning: Look at the covenant as if you were a lawyer for the former employee. Think about what arguments you would make to attack the enforceability of this covenant.
Think about the questions you would ask. Is the geographic region larger than necessary? Is the time frame too long? Does the company really have a legitimate interest in protecting this information?
It is important to stay focused or risk courting disaster. Blanket protection invites future litigation.
How to draft an enforceable restrictive covenant
The first step is to determine what the goal of the restrictive covenant is. Be fully honest about what you seek to achieve.
Consider this scenario: Many employers want to prevent former employees from contacting former customers. This can be accomplished through either non-compete or non-solicitation clauses, depending on the specific goals.
Regardless of which type of restrictive covenant the parties decide to use, the company should identify the specific customers — by name, category or location, if possible – that the company seeks to prevent the former employee from contacting. Simply identifying all of the company’s customers generally will not be sufficient.
For example, if the employee never had contact with the customer, many courts will find that a prohibition from contacting that customer is overly broad. The reason that courts enforce prohibitions on contacting customers is that they generally find that an employee should not be able to exploit customer relationships that the employee developed while being paid by the company. Often the employee may have a closer relationship with the customer than the company does, even though the company is paying the employee to make this relationship a reality for its financial benefit.
In these cases, courts often agree that the employee should not be able to exploit this competitive advantage. But where the employee had no relationship with the customer, the fear of exploiting a competitive advantage is nil, so courts are less willing to enforce such restrictions.
In non-compete issues, the more specific a company is in defining what it wants to prevent or protect, the more it will be able to draft enforceable contracts.
While a company may not like the idea that a former employee has the right to compete with it, the practical reality is that our society and our laws favor competition. And attempting to enforce blanket prohibitions invites litigation. Instead, an honest evaluation of risks and goals will go a long way toward protecting companies while allowing people to control their careers and work more freely.