Why It’s Important to Bake Restrictive Covenants into Food and Beverage Industry Agreements
Recipes, ingredients, formulas, and processes are sometimes kept secret for generations in the food and beverage industry, and protecting these secrets can be essential to a company’s survival.
Threats to trade secrets are not only limited to high-tech companies and defense contractors, nor is trade secret misappropriation solely the provenance of hackers and hostile foreign actors. Indeed, most misappropriation is carried out by employees and business partners, either intentionally or because of a basic lack of understanding of one’s obligations. But once a secret is out, it is no longer a secret, even if the disclosure was not malicious or intentional.
Likewise, customer and vendor relationships are paramount in the food and beverage industry, and a brand or a relationship that took years to cultivate can be destroyed in an instant. One relatively simple way for companies in this industry to protect their trade secrets and goodwill is to include restrictive covenants in their agreements with employees, franchisees, distributors, vendors and other business partners.
Types of Restrictive Covenants
The most common types of restrictive covenants are confidentiality/non-disclosure agreements (NDAs), non-competition agreements (non-competes), and non-solicitation agreements (non-solicits). NDAs require the signatory to maintain the confidentiality of sensitive information and to not use or disclose it without express consent. Non-competes prohibit the signatory from working for or on behalf of a competitor for a certain amount of time in a specific geographic area. Non-solicits prohibit the signatory from soliciting certain customers or business partners for a specific amount of time.
While not traditionally considered restrictive covenants, exclusivity agreements, which require one or both parties to work exclusively on behalf of the other, are an another important tool for companies in the food and beverage industry to consider. Sometimes exclusivity agreements are manifested as “in-term” non-competes, which restrict competition during the term of an agreement and are generally not subject to the same legal strictures as “post-term” non-competes, which restrict conduct after the relationship ends.
Restrictive Covenants Must Protect Legitimate Business Interests
Regardless of the context, restrictive covenants must all meet certain basic threshold criteria to be enforceable. First, they must protect a legitimate business interest. Broadly speaking, legitimate business interests include trade secrets and confidential information, as well as goodwill. Preventing ordinary competition is not a legitimate business interest.
Examples of confidential information and trade secrets in the food and beverage industry include recipes, ingredients, formulas, processes, profit margins, strategic growth and/or marketing plans, terms of exclusive vendor relationships, customer lists and preferences, and cost of goods sold, among other things. Indeed, the quintessential example of a trade secret is the recipe for Coca-Cola, perhaps the most closely guarded secret in the world. Another example is KFC’s fried chicken recipe. Coca-Cola and KFC would not be the companies they are today, if they even continued to exist, had their recipes been disclosed. And had either of these companies been able to patent these recipes, they would have lost that protection long ago (and would have been required to disclose the recipes in patent filings).
Recent allegations of trade secret misappropriation in the food and beverage industry include a co-packaging partner departing with a Dijon mustard recipe or a business partner pilfering a pasta recipe. It doesn’t matter whether you are a major soft drink company or a craft brewery, a nationwide fast-food franchise or a mom and pop restaurant, all companies have information that their existence depends upon remaining a secret.
Another protectable interest is goodwill. Goodwill is an amorphous term, however, that can be difficult to define, in particular outside of the employment context, where it typically refers to customer relationships. For instance, where a salesperson is assigned certain customers or is provided with leads or resources to build a book of business and is the primary contact person for those customers, the employer may be able to enforce restrictive covenants in the event the salesperson leaves to join a competitor and attempts to poach the customers. In other contexts, goodwill can also include reputation, brand loyalty, investment in a franchise, and even, in certain states, the integrity of the franchise or distribution system or network.
Restrictive Covenant Must be Reasonable in Scope
Even where there is a protectable interest, a restrictive covenant is only enforceable where it is narrowly tailored to protect that interest. The reasonableness of a restrictive covenant is an incredibly fact-intensive inquiry that depends on numerous factors, including the nature of the industry, which state’s law governs the covenant, the economy, and even the effectiveness of the lawyers representing the parties. However, there are some general rules that can be drawn from precedents, which provide helpful guideposts for a company considering the use of restrictive covenants.
The intersection of geography and conduct prohibitions will be particularly important to any court’s enforceability analysis. For example, a sales representative who sells high-end cheeses on behalf of a particular fromager to boutique grocery stores in the Northeast, or a wine distributor who distributes a particular vineyard’s wines exclusively to liquor stores in the South, may be prohibited from selling competing products to the same or similar customers in the same geographic area following their terminations, but likely can’t be prohibited from doing so in another geographic area or to other types of establishments (such as restaurants or wine bars) in the same geographic areas.
Variations under state law are critically important to understand what a noncompete can and can’t achieve. Companies should be aware, however, that some states, including California, do not permit non-competes under most circumstances, and non-solicits are generally permissible only where there is evidence of trade secret misappropriation.
What Type of Restrictive Covenant is Most Appropriate?
As noted above, there are different types of restrictive covenants that companies can utilize depending on the circumstances, with no one-size-fits-all solution. As a baseline, regardless of the circumstances, companies should impose strict NDAs. And so long as the information being protected is, in fact, confidential, there should be little difficulty enforcing such agreements in most circumstances. But that is the bare minimum.
In addition to NDAs, companies in the food and beverage industry should consider whether to require their own employees to sign non-competes or non-solicits. Depending on the employee’s level and role, he or she may have access to some of the company’s most sensitive information. And certain employees, most often sales people or customer relationship managers, serve as the “face” of the company’s brand. In either case, if the employee leaves and joins a competitor, he or she can do substantial harm to a former employer if he or she were to use or disclose confidential information or trade secrets, or solicit key customers. But again, non-competes and non-solicits are not a one-size-fits all. Senior executives, product developers (which could be an engineer, a chemist, or even a brewmaster or chef), sales people, and rank-and-file employees (who may not be customer facing and often do not have insight into the company’s most secret information) do not all require the same restrictions. For some types of employees, NDAs may be sufficient. Some states, such as Maine, Washington and New Hampshire flatly prohibit low-wage workers from signing non-competes. Even for the higher level and customer-facing employees, thoughtful consideration should be given to whether non-solicits are sufficient to protect the company’s interests, or whether non-competes are necessary.
Similar consideration should be given to franchisees, which are likewise provided with certain confidential information and are almost certainly the face of many franchisors’ brands. Examples of confidential information and trade secrets in the franchise context will vary among industries, and perhaps even between companies within an industry, but may include profit margins, strategic growth and/or marketing plans, terms of exclusive vendor relationships and cost of goods sold.
As for vendors, NDAs and non-solicits should be considered. Where a restaurant sources its ingredients and at what prices are often highly guarded secrets that the vendors of those agreements will be privy to. This can be just as true for something as seemingly benign and common as tomatoes or olives as it can be for ingredients that are much harder to source, such as certain types of truffles or hops. For many of the same reasons, exclusivity agreements are also utilized in some vendor agreements.
Similarly, distributors and other business partners are often privy to confidential information concerning the identities of key customers, as well as those customers’ ordering history and projections, pricing or discounts they receive, product preferences and the like.
Food and beverage companies should confirm that their franchisees, vendors, and distributors utilize appropriate restrictive covenants with their employees as well. It’s not just the company that serves as franchisee, vendor or distributor that can cause harm — so too can its employees. Food and beverage companies should understand whether and how franchisees, vendors and distributors have chosen to mitigate that risk internally. Provided companies comply with relevant franchise, antitrust, employment and other laws, requirements for such can be built into agreements with business partners, and can be strengthened with indemnity provisions.
Erik Weibust, Alison Eggers and Anne Dunne are Boston-based attorneys at the global law firm Seyfarth.