LEGAL GUIDE
Written by attorney Lawrence J. Sherman | Jul 27, 2010

The Realities of Agreements Not to Compete

Employers commonly place limitations that prevent professional, executive, and skilled employees from taking subsequent jobs with their customers/clients and/or potential and actual competitors. These restrictions may be included in an employment contract or separate agreement, or in a company manual.

These restrictions are commonly called “non-compete" agreements and are matters of increasing concern for highly mobile and valuable employees in the workforce. Three separate, but related, concerns are raised by these agreements,

  1. Will these restrictions hold up in court?

  2. Does the mere threat of needing to defend in potentially expensive litigation constitute an independent risk or deterrent to entering into a new employment or business relationship?

  3. What is the likely exposure on the part of the employee or his/her new employer if the agreement is enforced by a court?

Before addressing these questions, the basic legal principles that apply to these agreements are discussed briefly, followed by a discussion of each of these important concerns.

The Basics

A growing number of employers are demanding that newly hired and/or current employees sign non-compete agreements that contain binding promises that the employee will not work for a competitor and/or solicit its customers/clients. Other employers require an employee to sign such an agreement as a condition of receiving severance benefits.

The courts and society at large recognize that employers have legitimate concerns whenever an employee has access to sensitive business information or trade secrets. A trade secret includes knowledge or information that would give the employee or his/her new employer a competitive advantage because the information is not generally known and/or readily available to others who might benefit from access to the information. This valuable proprietary information includes, but is not limited to, customer lists or compilations, formulas, devices, methods, techniques or processes of doing business and/or computer programs or other materials that incorporate such knowledge or information. Indeed, the concept of proprietary information generally includes all information that the employer has made reasonable efforts to keep secret from every outside party except those individuals who need to know or use the information within or on behalf of the business organization.

Employees with access to proprietary information or trade secrets routinely leave the organization either because they quit, are fired, or are laid off. No matter the reason for termination, the former employer still has reason to be concerned that the former employee will use information gained on the job for his/her own personal advantage. Examples include a former employee opening a competing business or going to work for a customer/client or direct competitor.

Enforceability of Non-Compete Agreements

Non-compete agreements or covenants not to compete, as they are sometimes called, almost invariably bring into play significant competing interests. This anomaly arises because our legal system places a high value both on the employer’s right to protect its business and on the individual employee’s ability to earn a living. This balancing of competing interests, in turn, creates uncertainty as to whether and to what extent these provisions will be enforced by a court if litigation ensues.

As a general rule, a court will decline, in whole or in part, to enforce a covenant not to compete if it is found to be unreasonable in its duration and geographic scope or reach. While there is variation from state to state, a non-compete provision is likely to be held unreasonable where:

  1. The provision covers too wide a geographic area, usually measured in square miles from the headquarters or sales territory of the employer seeking to enforce the agreement;

  2. The provision is too broad in the types of prohibited business activities; and/or

  3. The provision is too long in its duration.

The biggest and most frequently contested issue arising with non-compete agreements involves the duration that an employer can restrict a former employee from competing in a similar business. While there are no clear-cut answers on what will not pass judicial scrutiny, case law and/or statutory guidance exists in every state and is often calibrated to the nature and scope of the business involved. A two year period is generally, but not uniformly, regarded as the outside limit of a valid non-compete agreement, provided that it does not unduly limit activities and/or geographic scope.

If the matter proceeds to litigation, a non-compete agreement may be found unreasonable because (a) the restriction does not serve any valid business purpose; (b) the protected information had not been kept private; or (c) the information is not particularly sensitive. The courts are more likely to enforce restrictive agreements against high-level managers or professional and technical employees who truly have access to inside or unique information since these former employees are in a position to hurt their former employer in tangible or significant ways. If truly secret information has been taken and used by a former employee, the courts may even impose restrictions on the former employee even if he/she did not sign a non-compete agreement based on common law principles governing breach of fiduciary duties and/or unfair trade practices.

How Much of a Deterrent is an Arguably Legal Restriction?

Even if an employee receives a solid job offer, he/she may find the offer disappear or, worse yet, be suddenly fired once his/her former employer threatens suit and/or secures an interim court order forbidding the employee from working until the case is resolved. This potential obstacle poses a very real problem for any new employer if it hires the employee with knowledge of the non-compete agreement or if it continues his/her employment after gaining knowledge of the existence of the restriction through a legal demand letter or legal papers generated by the former employer.

As a result, any individual who has signed a non-compete agreement that arguably covers his/her new employment may face serious difficulty in finding a new job or going into business on his/her own. When initially faced with signing a non-compete agreement, the individual should try to negotiate away some of the fine print by raising some common sense arguments that seek to appeal to considerations of basic fairness and common decency.

Discussed below are a few simple tips, many of which are more likely to succeed with the assistance of an experienced employment lawyer.

  1. If presented with a non-compete agreement, the individual can ask or demand to have the clause worded so that it takes effect only if he/she leaves the job voluntarily. This limited restriction will make far less daunting efforts by the employee to find a new job if he/she is later fired or laid off.

  2. If presented with a non-compete agreement, the individual can ask or demand to have the clause worded so that it takes effect only if he/she leaves the job voluntarily. This limited restriction will make far less daunting efforts by the employee to find a new job if he/she is later fired or laid off.

  3. Specific wording in the agreement may invite unnecessary problems. It may be wise to ask to remove broad or general language, while stating a willingness to agree to the inclusion in its place of specific language tailored to the actual business setting. For example, many employers will include general and voluminous restrictions drafted by inside or outside lawyers when they really only fear competition from one or two specific employers whose names could easily be listed in the agreement.

  4. If an employee is promoted to a new job that carries with it a request to sign a non-compete agreement, he/she should try to negotiate a severance arrangement that provides an equivalent benefit or protection that reflects the added difficulty of seeking new employment. There is also a downside – namely, the mere fact that you may try or succeed in getting some relief will almost certainly prevent the individual from later claiming that he/she was forced to accept the clause if litigation ensues.

How Much Exposure May Exist If the Agreement Is Enforced?

An almost inevitable consequence of any threat or action by a former employer to enforce a “non-compete" agreement is the need to retain a lawyer to respond to a demand letter from and/or to defend against litigation instituted by a former employer. Defense costs are not capable of being estimated in advance because it is hard to predict how any problem will play out in court over time. The one element of certainty is that full-fledged litigation can be very expensive.

Exposure to a court award of damages to the former employer based on lost profits represents another potentially adverse consequence. While the former employer always has the burden of proving lost profits, which are generally disfavored by the courts in this circumstance, such damages can be considerable in magnitude if awarded. In rare cases, the former employer may also successfully demand that the employee pay back salaries previously earned after he/she breached the non-compete provision or a related duty of loyalty and/or good faith.

Finally, and most commonly, a court can issue an order restraining the employee from taking the job or continuing to work in violation of the non-compete agreement for its full duration or a reasonable duration if the court has the power to modify or “redline" the agreement.

Conclusion

Quite obviously, “non-compete" agreements not only raise many and varied legal questions, but also can have a potentially severe impact on employees and employers alike. Irrespective of the context, an employee must be proactive whenever a prospective and/or current employer seeks to impose these restrictions. Even so, the alternatives are quite limited.

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