Third Circuit Confirms Courts’ Authority to Salvage Over Broad Restrictive Covenants

Kevin M. Passerini

On April 26, 2019, the U.S. Court of Appeals for the Third Circuit weighed in on a pair of district court rulings which had denied ADP, LLC’s requests for preliminary injunctive relief against two former employees who ADP alleged had violated post-employment restrictive covenants. In ADP, LLC v. Rafferty, et al., the Court unanimously reversed the rulings and remanded to the district courts with instructions to “blue pencil the agreements and reconsider the four-factor preliminary injunction standard” as it relates to the former employees’ non-competition and customer non-solicitation obligations. The Third Circuit’s opinion restates what has long been the law in New Jersey and clarifies for anyone still in doubt that “New Jersey has evolved from invalidating overbroad restrictive covenants outright to presumptively ‘compress[ing] or reduc[ing]’ their scope ‘so as to render the covenant reasonable’” (alterations in original; citations omitted).

What is “blue penciling”?

“Blue penciling” is most commonly used to refer to courts’ narrowing and, in essence, reformation of arguably over broad restrictive covenants to align with the scope permitted under applicable law—or, as the Third Circuit explained, “any tailoring of a restrictive covenant.” In other jurisdictions, blue penciling refers merely to the striking of over broad provisions of a restrictive covenant and enforcement of the remainder. Ultimately, blue penciling is supported because it serves to honor the parties’ expectations that certain obligations will apply after the termination of employment. But blue penciling also provides employers with an opportunity to implement—at least in good faith—broader restrictions than may ultimately be enforced by a court. Tactically, some companies may opt for the finality and predictability of narrowly drawn restrictions, while others may prefer the deterrent effect of a broader restriction and hedging in the event the law becomes more favorable in the future, hopeful they may be able to avail themselves of courts’ blue penciling authority if they’ve later been determined to have overreached.

What is the main takeaway from this ruling?

The Third Circuit’s re-affirmation of blue penciling under New Jersey law should not come as a surprise to anyone, and the main takeaway is that companies should ensure that agreements subject to New Jersey law expressly recognize that the restrictive covenants in it are severable and are to be reformed by any court of competent jurisdiction if found to be invalid or unenforceable in whole or in part.

Another key aspect of the Third Circuit’s opinion is its characterization of New Jersey law as “presumptively” favoring blue penciling of over broad restrictive covenants. The panel’s use of that term and its mandate that the lower courts blue pencil the agreements at issue on remand suggest that blue penciling may not be entirely discretionary under New Jersey law. Its rationale seems to be based, in part, on how cases have been decided since the New Jersey Supreme Court’s opinion in Solari Industries, Inc. v. Malady, 264 A.2d 53 (N.J. 1970), which, for the first time, permitted partial enforcement of restrictive covenants. In the aftermath of that seminal ruling, the Third Circuit explains, “courts have strived, if possible, to salvage restrictive covenants, construing the opinion’s three-part test as rarely justifying the total invalidation of a restrictive covenant.” Time will tell whether courts in other matters will view the ruling as requiring blue penciling or as merely nudging courts to exercise their discretion.

We will follow up separately on another intriguing portion of the Court’s rationale that has the potential to influence not only how courts evaluate the breadth of restrictive covenants and their ties to legitimate business interests but also how and when companies choose to implement them. Stay tuned for that. In the interim, if you have any questions about the impact of this ruling on your contracting practices or your recruitment and hiring practices, or about whether your agreements are appropriately structured to maximize the benefits of New Jersey’s blue penciling law, please contact a member of our team.

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