Understanding Restrictive Covenants and Current Challenges to Noncompetes

by Isaac Mamaysky, 3/12/25

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Restrictive covenants are contractual provisions designed to protect an employer’s business interests by limiting what an employee can do during and after employment. While an employee’s obligation not to compete with an employer is a matter of common law fiduciary duty during the employment relationship, this duty generally ends at the conclusion of employment. To extend these obligations beyond the termination of employment, many employers – especially in the financial services space – include various restrictive covenants in their executive employment agreements, operating agreements, and other corporate documents.

Key types of restrictive covenants

While there are other restrictive covenants, five especially common types often appear in employment agreements:

Noncompete agreements: These agreements restrict an employee from working for a competitor or starting a competing business for a specified period and within a defined geographic area after leaving the employer. They safeguard trade secrets, protect customer relationships, and prevent unfair competition.
Nonsolicitation agreements: Nonsolicitation clauses bar former employees from soliciting their previous employer’s clients and/or other employees for a set period of time. The aim is to preserve existing business relationships and maintain workforce stability – employers don’t want former employees poaching clients or colleagues after they leave.
Confidentiality agreements: Confidentiality agreements require employees to maintain the confidentiality of proprietary information both during and after employment. These agreements are used to protect trade secrets, client data, business strategies, and other critical information from competitors and public disclosure.
Assignment of inventions: An assignment-of-inventions clause provides that any invention or creation developed by an employee during their tenure is the property of the employer. This ensures that any intellectual property developed during the course of employment, using the employer’s resources or under the employer’s direction, remains under the employer’s ownership and control.
Nondisparagement clauses: Nondisparagement clauses serve to protect an employer’s reputation by prohibiting current and former employees from making negative or damaging statements about the company.

In practice, these and other restrictive covenants often appear together in employment contracts to form a comprehensive framework for protecting an employer’s interests. Note that these provisions – and especially the confidentiality and nondisparagement clauses – are typically limited by contract to allow disclosures and statements that are protected by law or constitute protected whistleblowing; without such limitations, the clauses would be overbroad and unenforceable.

A closer look at noncompete agreements

Noncompete agreements have historically been enforceable when carefully drafted. However, a growing body of critics argue that noncompetes hinder employees from finding new jobs and starting their own businesses, which ultimately harms employees and stifles economic activity.

Likewise, noncompete agreements can sometimes tie an employee to unfavorable working conditions, especially if they are not fully aware of the long-term implications at the time of signing. Based on these and other public policy considerations, noncompetes are currently under significant scrutiny and attack on several bases:

First, the Federal Trade Commission (FTC) has issued a rule that bans most new noncompetes, arguing that they are an unfair method of competition. Although this rule is currently stayed by court order, the stay is being appealed and reflects a growing governmental push to limit these provisions.

Second, some states have imposed strict limitations on the application of noncompete agreements to employees working in those states. As a matter of common law, most states limit the geographic and temporal scope of noncompetes, while other states have entirely banned them by statute.

Notably, both the FTC rule and the laws of certain especially-strict states exempt noncompetes that are tied to the sale of a business. Noncompetes tied to a business sale, such as the purchase of an advisor’s book of business by a new employer, are more commonly enforceable and subject to a lesser degree of scrutiny than noncompetes used in the regular course of an employment relationship.

Third, the National Labor Relations Board (NLRB) previously took the position that noncompetes may violate the National Labor Relations Act (NLRA). However, the NLRB landscape shifted in February 2025, when the new acting general counsel rescinded two memoranda from the former general counsel that opposed noncompetes. Together, they took the position that noncompetes and forfeiture-for-competition clauses (explained below) violate the NLRA.

With the memoranda now rescinded, employers have more leeway to enforce restrictive covenants. However, some legal uncertainties remain due to differing administrative law judge opinions regarding the legality of noncompetes under the NLRA.

Finally, antitrust laws are increasingly being used to challenge noncompetes. Both the Department of Justice (DoJ) and the FTC have established guidelines addressing business practices that impair worker mobility and competition in the marketplace. Despite the current stay of the FTC’s noncompete ban, the updated guidelines indicate that regulators may pursue legal action against noncompete provisions that are deemed to inhibit competition by restricting worker mobility. In practice, this means the agencies may launch investigations or initiate enforcement proceedings against such agreements on an individual basis, whether through individual FTC actions or DOJ prosecutions.

The Restatement of Employment Law and Enforceability

According to the Restatement of Employment Law (2015), which is intended to reflect the common approach to noncompetes among most states, several conditions must be met for a restrictive covenant to be enforceable:

Reasonableness. The covenant must be reasonably tailored in scope, geography, and duration. Typically, noncompete agreements are limited to one or two years, with three years representing the longer end of the spectrum.
Protectable interests. Employers must demonstrate that the restrictive covenant serves a legitimate interest – such as protecting trade secrets, preserving customer relationships, or safeguarding investments made in an employee’s professional reputation. For example, if an employer has invested heavily in building an employee’s public image as the “face” of a product or service, then the employer has a valid interest in limiting that employee’s ability to immediately leverage their reputation for a competitor.
Grounds for nonenforcement. Restrictive covenants may not be enforced if, for instance, the employee was discharged in a manner that makes enforcement inequitable, if the employer acted in bad faith, or if there is a significant public need for the employee’s specialized skills that outweighs the employer’s interests.

Simply put, the longstanding common law regarding noncompetes indicates that they must be carefully drafted, limited in scope, intended to protect legitimate interests, and used in good faith. Employers should also be aware that, even when noncompetes meet these requirements, courts may refuse to enforce them because of various considerations regarding fairness and public policy.

‘Blue pencil’ states

As already mentioned, some states prohibit overbroad restrictive covenants and require that they be reasonable in scope and limited in geography and duration. To reform otherwise-unenforceable restrictive covenants, courts in so-called blue pencil states can make edits so the clauses are sufficiently limited and otherwise modified to be enforceable under state law.

In other words, with permission typically granted by contract, a court in a blue pencil state can adjust unenforceable terms in a restrictive covenant, rather than invalidating the entire clause. However, this option is not available in every state.

Differentiating noncompetes and nonsolicits

Bear in mind, a noncompete and nonsolicit are not the same thing. Noncompetes directly prevent an employee from working for competitors, while nonsolicits focus on preventing the poaching of clients and employees after an employee leaves.

Under current regulatory trends, noncompetes face potential bans, but nonsolicits typically continue to be enforceable as long as they are limited in geographic scope and duration, and as long as they are not so broad that they effectively function as a noncompete. The issue for employers is that nonsolicits are far from flawless instruments.

Even assuming a nonsolicit is enforceable, there is persuasive precedent standing for the principle that clients cannot be restricted from choosing their financial advisers and other service providers. Likewise, financial professionals may have a fiduciary obligation to inform clients that they are leaving to a new firm. Taken together, this means that an adviser may be allowed to inform clients of their departure, as long as they do not solicit those clients in the process. And if an informed client then chooses to follow the adviser to their new firm, then the prior employer may have little recourse despite the existence of a nonsolicit.

Other protective clauses

If an employer is especially concerned about the enforceability of a noncompete or where state law is especially strict, one common alternative is called a “garden leave provision.” Unlike noncompetes, garden leaves require an employee to remain on the employer’s payroll for a specified period after employment ends, often while being relieved of day-to-day duties.

This mechanism helps protect confidential information and client relationships without restricting future employment opportunities. The rationale is that, by the time the garden leave elapses, clients have identified other service providers within the existing employer, memories have faded, and clients are less likely to join the departed employee at their new venture.

Another related concept is the forfeiture-for-competition clause. Some employment contracts stipulate that, if an employee competes with their former employer, they will forfeit bonuses or other benefits. However, such provisions must navigate complex legal terrain. For example, if the benefits are vested or considered earned compensation, withholding them might run afoul of ERISA or state wage payment laws.

Courts are divided on these clauses: Some view them as less restrictive than noncompete agreements because they do not outright prevent competition, while others see them as equivalent in their practical impact. Like many issues surrounding noncompetes, this becomes a question of state law.

Liquidated damages

Many employment contracts now incorporate liquidated damages provisions as a clear and predictable remedy for breaches of restrictive covenants. Such clauses stipulate a predetermined monetary amount that an employee must pay if they violate the terms of the agreement, thereby providing a quantifiable consequence for noncompliance. The enforceability of these provisions typically hinges on whether the agreed-upon sum reasonably approximates the anticipated harm to the employer, rather than serving as a punitive penalty.

In addition to liquidated damages, courts may also award injunctive relief or other equitable remedies to protect the employer’s legitimate interests. Much like restrictive covenants themselves, limitations and restrictions on liquidated damages provisions often depend on state law.

The future of restrictive covenants

For the moment, noncompetes play a prominent role in the financial services space, but the regulatory landscape is evolving. With significant challenges from the FTC, antitrust litigation, the NLRB, and state statutory and common law, noncompetes may have a more limited role in the future than they do today. While making predictions, I should also note that noncompetes will likely remain widely applied in connection with business sales, which is a usage that is protected by some otherwise-strict state laws and also by the currently-stayed FTC rule.

As challenges in other contexts mount, the laws surrounding nonsolicits, confidentiality agreements, garden leaves, and other restrictive covenants remain largely intact. These clauses are being used as additional, and sometimes alternative, mechanisms to protect employer interests without running afoul of emerging legal standards concerning noncompetes.

While restrictive covenants serve an important role, their enforceability hinges on their scope, the dictates of state law and, ultimately, public policy considerations regarding balancing employer business interests with employee rights to pursue their careers. As legal challenges continue to reshape this area, employers should draft carefully while watching the evolving standards and regulatory developments.

Isaac Mamaysky is Partner at Potomac Law Group PLLC, where he started the Investment Advisers, Asset Managers, and Private Funds practice. Isaac is also a cofounder and the Chief Compliance Officer of QuantStreet Capital, an RIA that focuses on quantitative asset allocation through SMAs and model portfolios.

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