A non-compete agreement, as the name implies, is an agreement that restricts one party (usually an employee) from competing with another party (usually an employer). Surprisingly, it doesn’t take much to make a non-compete agreement unenforceable. That is because legislators in every state have recognized important public policy reasons for restricting the power of these agreements. This article summarizes the key terms in non-compete agreements and the kind of language that will make them unenforceable.
For a non-compete agreement to be enforceable, the restrictions it imposes need to be “reasonable” in light of the legitimate business interests of the party seeking to enforce it. The general idea here is that courts don’t want to enforce any non-compete agreements that impose too great of a restriction on competition or that would make it too difficult for the restricted party to find employment after terminating the business relationship with the other party.
Now, say a company is primarily in the business of selling gourmet sandwiches, a non-compete agreement might state that an employee is prevented from working for any gourmet sandwich companies within any city where the employer operates during the term of employment and for two years following the employee’s departure. The geographic restriction here is the prohibition from working for a competitor in any city in which the employer operates. Alternatively, the agreements might say the employee is prohibited from working for a competitor within a certain radius, say five miles, of any of the employer’s sandwich shops.
Generally, the larger the geographic area that the employee is restricted from working, the greater chance that a court might rule that the restriction is overly broad and unenforceable.
So if this agreement sought to restrict the employee from working for another sandwich shop in any state in which the employer operated, it would likely be ruled as overly broad.
The employer doesn’t need to prevent the employee from working in cities it doesn’t operate in to stop the employee from competing with it.
Similarly, how long the employee is being restricted is also important. The longer the agreement seeks to prohibit competition, the more likely it will be ruled as unenforceable. In our example, the employee was prohibited from directly competing while employed and for a period of two years after the employee left the company. A period of six months to three years is the typical period seen in non-compete agreements that is generally enforced.
If the employee were prevented from competing for five or ten years following his or her departure, it would likely be seen as an unnecessarily long time to restrict the employee in order to protect the employer’s interests.
It is also necessary to be specific about the type of companies or the industry in which the employee is prevented from working. In our example, the employee couldn’t work for any other “gourmet sandwich companies.” This restriction is narrowly tailored to the employer’s industry and the market in which it competes. If the non-compete agreement had sought to prevent the employee from working for any “restaurants or companies that sell food,” a court would likely deem it an overly broad restriction. This would prevent the employee from working for too many types of companies that don’t directly compete with the employer, including places like coffee shops, five-star restaurants, and convenience stores.
What “business interests” are we talking about here? What exactly do courts allow employers to prohibit with these agreements? Departing employees pose several special dangers to former employers. For instance, the business contacts and relationships gained while working for the employer could be usurped. The employer doesn’t want to let the employee go to work for another competitor and steal all those contacts away. This helps explain why something like a 10-year non-compete agreement in this context wouldn’t make sense to a court.
When an employee leaves and stops speaking with the contacts he or she gained through the employer, those contacts will likely forget about that particular employee rather quickly. If the employee goes to work for a competitor after a few years, those old contacts should be fair game for the former employee to try to win over through legitimate competitive efforts.
Beyond business contacts, non-compete agreements may also seek to prohibit employees from competing from using confidential information and trade secrets gained while working for an employer.
Whereas non-disclosure agreements focus on preventing the disclosure of confidential information or trade secrets, non-compete agreements mainly focus on preventing unfair competition using such information or secrets, although in practice there is often a lot of overlap between the two agreements.
Another important point here is that the types of restrictions imposed depend on the situation, and every situation is different. What is seen as reasonable in one context might not be in another. For instance, if the employer operated in a very small industry, with few competitors, then a court probably wouldn’t enforce a wide geographic restriction or a long temporal restriction because it would make it virtually impossible for the former employee to find employment within the same industry. Courts don’t want to enforce agreements that make it too difficult for people to work and make a living in the industries in which they have experience.
Furthermore, the employee’s position in the company is often relevant. It would make sense to restrict a manager or executive employee from competition since they likely have acquired important contacts and information through the employer. However, if the employee just made the sandwiches or ran the register for the sandwich shop, there isn’t much risk of the employee unfairly competing after leaving the employer. It would be very difficult to get a court to enforce any non-compete agreement in that situation unless it was tailored to be quite narrowly restrictive.
As with all contracts, there needs to be mutual consideration or inducement for each party to sign. So what is the employee receiving in exchange for his or her promise not to compete? If it’s a new employee, then the consideration is the employee’s actual employment with the company.
However, if the employee has already been working for the employer when the employer asks him or her to sign the agreement, then the employer needs to offer additional consideration. This could be any type of perk, such as:
What is important is that whatever is offered is more than just token consideration. Telling the employee to agree or take a hike just won’t cut it.
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