Non-competition agreements are restrictive contracts between employers and employees that 1) prohibit workers from revealing proprietary information about the company to competitors or other outsiders, or 2) forbid workers from themselves competing with their ex-employer for a certain period of time after leaving the company. Non-competition agreements often appear as clauses within a larger employment agreement. Such agreements are a tool that small business owners may use to try and ensure that key personnel do not walk off with company secrets or clients in order to start their own competing business or join an existing competitor in the area. Non-competition agreements have significant deterrent value in many situations, but they may also alienate some potential employees. It is important that their application within a firm is seen to be fair and equitable. Most firms that employe non-competition agreements do so to safeguard sensitive proprietary company information. Sensitive proprietary company information may cover any aspect of a business's operation, including production formulas, processes, and methods; business and marketing plans; pricing strategies; salary structure; customer lists, contracts; intellectual property; and computer systems.
These agreements are also called confidentiality or nondisclosure agreements or, simply, non-compete agreements, and they typically define confidential information, identify ownership rights, and detail employee obligations to ensure that confidentiality is maintained. But there are definite limits on the scope and duration of such covenants. Employers generally cannot use non-compete agreements to keep employees from practicing their trade or profession indefinitely. This is particularly true if the former employees were experienced in the specified occupation before they were hired. But while employees generally have every right to make use of skills and experiences gained in one company when they set off on the next stage of their lives, it is illegal for them to make off with trade secrets of their former place of employment.
Nonetheless, business owners do not always win court cases against ex-employees who pilfer in this area. In some cases, they lose for the simple reason that the business owner never identified the company's confidential or trade secret information. An ex-employee does not have the right to steal company confidential information or trade secrets that are identified as such. However, the ownership of information developed through company procedures must clearly differentiate between what belongs to the employee and what belongs to the company.
More often, however, courts throw out non-competition agreements out of concerns that such clauses constitute restraints of trade or that they force prospective employees to choose between signing or continuing their job search elsewhere. In deciding whether to enforce a non-compete agreement, courts generally focus on two things. First, whether the covenant is ancillary to a valid employment contract. Second, whether the agreement imposes reasonable restrictions in terms of time and geography.
Enforcing Non-Competition Agreements
Non-competition covenants are usually enforced by the courts if they are reasonable with respect to time and place and do not unreasonably restrict the former employee's right to employment. Of course, different parties have different conceptions of what constitutes a "reasonable" restriction. Legal experts contend that the courts are far more likely to side with the business owner if he or she does not go overboard on imposing restrictions in the following areas:
- Nature of prohibition—Restrictive covenants often are shaped with an eye toward the type of position that was held by the employee. Companies are more likely to target high-level managers or executives for stringent non-compete measures than programmers, writers, architects or other staffers with specialized skills who have less overall knowledge of the company.
- Duration of agreement—Non-competition agreements are less likely to be enforced if they go beyond one year or so. In addition, according to Susan Gaylord Willis in an aricle in HRMagazine, businesses should consider establishing relatively short timeframes if the agreement stipulates a wide geographical scope "because the courts are unlikely to sustain a provision that leaves former employees with no way to earn a living in the field in which they are most experienced."
- Geographic area—It is generally recognized that small business owners have a right to request competition protection from ex-employees in the immediate area in which they operate. Agreements, however, that attempt to forbid ex-workers from setting up a similar business in some distant geographic area or region are likely to be overturned unless the company conducts business in a multi-state area or nationally.
- Restrictions on Solicitation—Who is the employee prohibited from soliciting? This is a question the answer to which should be covered. Is it customers whom the employee personally acquired or any of the company's customers? The narrower the restriction, the more likely a court will enforce it.
- Restrictions on contacting other employees—The courts generally consider it unfair competition for one company to induce employees of another company who have acquired unique technical skills and secret knowledge during their employment to terminate their employment and use their skills and knowledge for the benefit of the competing firm. In such a case the plaintiff company could seek an injunction to prevent its former employees and the competing company from using the proprietary information.
Business owners should keep in mind, however, that attitudes toward non-competition agreements vary considerably from jurisdiction to jurisdiction. No federal statutes exist to regulate these types of agreements with former employees, unless the restrictions violate existing anti-discrimination laws. Instead, each state has its own unique state contract laws. Some courts adhere to a "blue pencil" rule, meaning that they have the authority to edit unduly restrictive agreements so that the scope and/or duration of the agreement is lessened without throwing out the entire contract. Jurisdictions without such options in place, however, typically uphold the agreement in its entirety or strike it down entirely, leaving the employee free to pursue any course he/she wants. Consequently, it is important, when drawing up non-compete agreements, to be sure and investigate the related laws prevalent in the state (or states) in which the company conducts its business.
One way in which the business owner can minimize the danger of having a non-compete agreement overturned in court is to create unique non-competition agreements for each employee affected. A company that performs services locally, such as a diaper service or a carpet cleaning company, may need protection against pirating of customers in its area of operation. In that case, the company would want a covenant that would be of long duration, maybe two years, but limited geographically to the city, county, or metropolitan area. On the other hand, a company in a fast-moving field that sells nationally or internationally, like a software publisher, may prefer a worldwide non-compete of shorter duration. With fast-moving businesses, the chances are the any proprietary information gleaned from the employer would be public knowledge and/or obsolete within six months, and its disclosure after that would no longer pose a threat.
Although a useful tool in securing trade secrets, the non-compete agreement or clause may also complicate the development of loyalty with key employees. Many, when asked to sign such an agreement will feel like the less affluent partner in a couple planning to marry when the richer partner brings up the subject of a prenuptial agreement. Very small businesses have few employees and it is important that each one feel that he or she is a part of the whole, and that the loyalty that they offer is reciprocated.
As Jeffrey Gitomer explains rather colorfully in an article he wrote for Long Island Business News, "This single clause alienates and threatens every single salesperson in a manner that they begin their term of employment with a negative feeling toward the employer. 'This guy doesn't trust me and I haven't even stepped foot inside his building.' This feeling of animosity deepens when some form of employment termination occurs. Other lawyers begin huddling as to the enforceability of the non-compete clause and business once again reduces itself to the low-life challenge, 'My lawyer can beat up your lawyer.'"
Small business owners must judge for themselves, and on a case-by-case basis, the value that having non-compete agreements has for their operations.
see also Employment Contracts
Fellman, David. "Non-Compete Agreements: Can protect your business." Wide-Format Imaging. November, 2005.
Gitomer, Jeffrey. "When You Leave, Hands Off Former Employers Clients." Long Island Business News. 11 April 2003.
Orr, Joel N. "The Employment Contract." Computer-Aided Engineering. May 2000.
Sidime, Aissitou. "Non-Compete Agreements Are Not Ironclad." San Antonio Express-News. 21 November 2005.
Willis, Susan Gaylord. "Protect Your Firm Against Former Employees' Actions." HRMagazine. August 1997.
Hillstrom, Northern Lights
updated by Magee, ECDI
A non-compete agreement, or a covenant not to compete is a contract in which one party agrees not to compete with another party in exchange for payment of some consideration. Non-compete agreements are most commonly found in employment contracts, particularly with management or sales employees; in agreements among shareholders or partners of a business; in contracts for the sale of a business; and in agreements for the funding of a business. Non-compete agreements are difficult to enforce, and must be carefully drafted to conform to the regulations of the state in which the agreement is to be performed.
NON-COMPETE AGREEMENTS IN EMPLOYMENT CONTRACTS
In an employment setting, a non-compete agreement is a contract between an employer and an employee, which prevents the employee from working for a competing company and from divulging to third parties, including new employers, the confidential business and proprietary information, trade secrets, customer lists, and technical and manufacturing processes of the contracting employer. A non-compete agreement must seek to protect a company's legitimate business interests and property. Without such an agreement, employees can leave a company, and subject to state protection against misappropriating a company's trade secrets and federal intellectual property statutes, freely compete with their former employers.
With some exceptions, most states recognize non-compete agreements or restrictive covenants in employment contracts, either through specific provision in a state statute or through the state courts' application of a common law “rule of reason” analysis. The rule of reason analysis weighs the company's interest in protecting its
proprietary and confidential information in a geographic area for a period of time against the employee's need to have a way in which to earn a living. However, the specific provisions and types of non-compete agreements that the state will recognize varies among the states, and quite often a non-compete agreement which is found valid in one state is determined by the courts in another state to be unenforceable because, for example, it is too broad in scope or time.
Courts are generally not eager to broadly enforce such agreements because they may restrict an individual's ability to earn a living. Courts will also not enforce agreements that are merely broad-based attempts to prevent all competition. As a result, non-compete agreements must be drafted with care to conform with each state's requirements for a valid non-compete agreement.
Non-compete agreements in and of themselves do not change the nature of the employment relationship. If it is an at-will relationship, either party can terminate the relationship at any time, and the drafter of a non-compete agreement must be careful, in the attempt to restrict competition, that there is not instead a promise made that the employee will have a job with the employer for life.
One question regarding the at-will employment relationship when a non-compete agreement is in place is whether an employer can discharge an employee for refusing to sign a non-compete agreement, even if that agreement is deemed to be unreasonable. There is concern that such a discharge violates the public policy exception to employment-at-will; the non-compete agreement may have negative societal effects on the freedom of employees to seek or change jobs and limits to technological advancements. Whether a court will deem a discharge as a violation of public policy depends on the nature of that state's public policy exception and the nature of the state's laws regarding non-compete agreements.
Non-Compete Agreements and State Laws . The legality and enforceability of the non-compete agreement varies by state. Scott Westcott provides a rough guide to non-compete agreements in “The Legal Landscape.” Non-compete agreements are the least enforceable in California, where (under section 16600 of the California Business & Professions Code) it states that, subject to statutory exceptions, any contract that restricts a person from engaging in gainful employment is void. Georgia and Wisconsin are less strict but if one item in an agreement is deemed unenforceable, the entire agreement is considered void. Non-compete agreements are rarely enforced in Colorado or Oregon. In fact, Oregon passed additional legislation to restrict non-compete agreements in January 2008.
The majority of states will enforce non-compete agreements if they are narrowly defined to protect intellectual property of customer relationships. Some states will revise a non-compete agreement by scratching out the terms that are not enforceable. Among the states that are reluctant to enforce non-compete agreements are New York, Massachusetts, and Illinois. Florida, Texas, Michigan, and New Jersey are more likely to enforce a non-compete agreement.
There are some common provisions in non-compete agreements that are required in all the states that have enforced such agreements. All contractual provisions that seek to restrict competition must be in writing. An oral contract between an employer and an employee, under which the employee promised to not work for a competing company, is not enforceable. As with any contract, there must be “valuable consideration” for the non-compete agreement. The definition of what is sufficient to constitute valuable consideration differs by locale, but generally if the non-compete provisions are part of the employment contract at the time of hire, being hired itself has been held to be sufficient consideration for a contract preventing competition if the employment relationship ends. If a non-compete agreement is presented to an employee after employment has commenced, there must be some payment, or at least the promise of a raise or promotion, to the employee in order for the agreement to be found to be based on sufficient consideration. While an employer could claim that continued employment itself was sufficient consideration and that the employee would have been fired if he or she had not signed the contract, such arguments are not favored by courts.
Most importantly, the provisions of the non-compete agreement regarding the geographic territory which the agreement covers, the areas of competition which the agreement protects, and the length of the time period of non-competition must be restricted. No court will enforce a contract that attempts to prevent an employee from ever working again. Accordingly, a non-compete agreement should include in very specific terms the interests which the employer wishes to protect from competition, such as technology, research and development efforts, customer lists, pricing information, suppliers, prospective customers and projects, the company's strategic planning efforts, and other confidential and proprietary business information. Companies commonly refer to these interests as “trade secrets.”
Courts are most willing to set aside non-compete agreements, or at least modify them, on the issues of the length of the period of non-competition, and the geographic area which it covers. The basis for the time and geographic restrictions is that they must be “reasonable.” This determination differs from state to state, and within
a state, from industry to industry. For instance, geographic restrictions tend to be broader on non-compete agreements regarding Internet commerce because web businesses often sell to customers worldwide. Anyone attempting to enforce a non-compete agreement must be aware that the agreement will not be looked upon with favor if the amount of time it extends or the geographic area it covers is too broad, based on the type of business, the location of the customer base, and the job duties of the employee restrained by the non-compete agreement. Recent court rulings indicate that the following time periods are likely to be upheld: up to five years for agreements regarding trade secrets, up to three years for agreements regarding sale of a business, and up to six months for other types of agreements (e.g., use of client lists).
NON-COMPETE PROVISIONS IN SHAREHOLDER/PARTNER, FUNDING, OR SALE OF A BUSINESS AGREEMENTS
Agreements among shareholders of or partners in privately held companies often contain non-compete provisions. These protect each of the parties to the agreement from competitive activities of another that would damage the business, since each of the shareholders or partners has access to the company's trade secrets and confidential and proprietary information. Similarly, in agreements to provide funds to a business, particularly where the funding is provided by a venture capital source, there regularly appear non-compete provisions. The funding source includes these provisions because it wants to ensure the likelihood of the business's success by preventing competition by the owners or key managers of the business.
In a sale of a business, the former owners are often restrained from setting up a new business within some geographic area that will compete with the business they just sold, for a specified period of time, again so that the business which was sold can have a chance to survive without competition from those who have information about the company's strengths and weaknesses. There is usually a separately negotiated payment for the non-compete provisions in a sale of a business agreement, and often the sold business will retain the former owners as consultants during the pendency of the non-compete period. Courts are more willing to enforce these types of non-compete agreements, as opposed to those in employment contracts, since the parties have received something of value—an ownership interest, proceeds of a sale, or funding—that is more than just continued employment.
A non-solicitation contract, which is similar to an agreement not to compete, prevents one party to the contract from seeking business from clients of the other party to the contract. These kinds of contracts can also restrict one party from recruiting for hire people who work for the other party.
SEE ALSO Employment Law and Compliance; Entrepreneurship
———.“10 Mistakes to Avoid in Non-Compete Agreements.” HR Focus 79, no. 10: 2.
Garrison, Michael J., and Charles D. Stevens. “Sign This Agreement Not to Compete or You're Fired! Noncompete Agreements and the Public Policy Exception to Employment at Will.” Employee Responsibilities and Rights Journal 15, no. 3 (2003): 103–126.
Shaefer, Enrico. “What Every Employee Should Know About Non-Compete-Non-Solicitation Contracts.” Ezinearticles.com, 16 June 2008. Available from: http://ezinearticles.com/?What-Every-Employee-Should-Know-About-Non-Compete-Non-Solicitation-Contract&id=442997.
Steinberger, Jeffrey. “Are Non-Compete Agreements Valid?” Entrepreneur, 2007. Available from: http://www.entrepreneur.com/management/legalcenter/legalissuescolumnistjeffreysteinberger/article179190.html.
Westcott, Scott. “The Legal Landscape.” Inc.com, February, 2008. Available from: http://www.inc.com/magazine/20080201/the-legal-landscape.html.
Wirtz, David. “Tip the Scales on Non-compete Agreements.” HRMagazine, 47, no. 11 (2002): 107–115.
A contract limiting a party from competing with a business after termination of employment or completion of a business sale.
Found in some business contracts, noncompete agreements are designed to protect a business owner's investment by restricting potential competition. Generally, businesses pursue these agreements in two instances: when hiring new employees, or when purchasing an established business. The noncompete agreement is a form of restrictive covenant, a clause that adds limitations to the employment or sale contract. These agreements protect the business by restricting the other party from performing similar work for a specific period of time within a certain geographical area. First used in the nineteenth century, and common today in certain professions, noncompete agreements sometimes have an uncertain legal status. Courts do not always uphold them. Generally, courts evaluate such clauses for their reasonableness to determine whether they constitute an unfair restraint on trade.
The rationale behind noncompete agreements is an employer's self-interest. Typically, companies invest heavily in the training of their employees. Similarly, they have an interest in protecting their customer base, trade secrets, and other information vital to their success. The noncompete agreement is a form of protection against losses. The company does not wish to invest in an employee only to see the employee take the skills acquired, or the company's customers, to another employer. Thus, when hiring a new employee, the company may make her sign a noncompete agreement as part of a condition of employment. Likewise, the prospective purchaser of an established business may only buy it if the current owner is willing to sign a noncompete agreement.
In practice, such agreements are very specific in several respects. Usually the agreement will define a length of time, geographic radius in miles, and type of activity in which the employee promises to refrain from working after leaving her or his job. This is often the case in businesses that depend on an established group of customers. A hair salon, for example, may require its stylists to agree not to compete against it in neighboring hair salons. Noncompete agreements are also well established in fields where an individual is associated with a product or service. High-profile positions in the media typically require them. A television anchorwoman, for example, will typically be contractually bound not to work for a competing news channel in the same market for a period of time following the termination of her contract.
In legal challenges courts use a standard of reasonableness in deciding whether to uphold a noncompete agreement. Most states use a three-part test: the agreement must be reasonable in terms of length of time, size of geographical territory included, and the business's necessity for the agreement. Covenants restricting the sellers of businesses typically receive a lower level of scrutiny, whereas restrictions on the behavior of former employees are closely scrutinized.
Courts are primarily concerned with preventing unfair restraints on trade. In a free market, most businesses cannot reasonably assert a need to restrict competition. Many states will evaluate each separate part of an agreement using the so-called blue pencil doctrine of severability, under which certain parts of the agreement can be upheld as enforceable and others can be found unenforceable. A few states, however, throw out an entire agreement if any part of it is found to be an unfair restraint on trade.
Jordan, Thomas E. 1990. "The Application of Contract Law to Georgia Noncompete Agreements: Have We Been Overlooking Something Obvious?" Mercer Law Review 41 (winter).