Non-Compete Contracts: Uses and Abuses

Non-compete agreements are becoming increasingly popular with employers. These restrictive devices are intended to limit employees and former employees from working for a competitor or from divulging trade secrets or other proprietary data.

Contrary to common misperceptions, courts generally uphold these non-compete clauses if they comply with acceptable standards. Some states - notably California and, to a lesser extent, New York - impose substantial restrictions. In California, they generally are not enforceable at all. In New York, their enforceability is quite limited.

But in most states, reasonable agreements are enforced by the courts through orders that prohibit employees from engaging in conduct that violates non-competes. Employers also can be held liable if they hire someone who violates an agreement with a previous employer by sharing secrets or by taking a job at their company. In some cases, employers can recover damages from both the former employees and their new employers who collaborate with them in the transgressions.

Most non-compete agreements are entered into with little, if any, negotiation between the employer and the employee. They usually are signed at the outset of an employment relationship. The employee has very little bargaining power and generally is not too concerned about limitations on future employability when beginning a new job. Consequently, employers generally present these non-compete agreements on a take-it-or-leave-it basis, and most employees have little ability or motivation to decline to sign them or to negotiate less onerous terms.

But when an employee decides to leave a job, the non-compete agreement may be a significant impediment to future employment or may prevent employees from becoming self-employed. Although the laws differ from state to state, general principles apply to non-compete contracts in most jurisdictions. Here are some considerations to keep in mind:

• Rule of Reasonableness: In order to be valid, a non-compete agreement must be reasonable. Courts recognize that employers have a legitimate interest in protecting the time, investment, and other resources they have invested in employees, but that interest must be balanced against employees' job mobility in a free enterprise system. Courts generally will scrutinize non-compete agreements carefully to make sure that they are geared to protect the reasonable business interests of an employer without unduly limiting an employee's other work opportunities. Therefore, these arrangements must usually be tailored narrowly to restrict truly competitive activities without forbidding an employee from working in the same industry or profession in a way that is not competitive.
• Independent Consideration: In many states, a non-compete agreement is valid if entered into at any time after an employment relationship begins. But in some states, courts will not enforce non-compete agreements unless the employee gets what is termed "independent consideration" - in other words, if they get something in exchange for signing the agreement. If this principle applies in your state, a non-compete agreement will be valid only if it is signed at the time employment commences, or at a later date if the employer gives you some additional benefits such as increase in salary, promotion, or other items of value.
• Duration: In order to assure that these contracts are not too stifling, courts will generally require that they only last for a limited amount of time. The duration depends upon a number of circumstances, including how long it will take to train another employee to take over the position being vacated. Generally, non-compete agreements one or two years in length will be valid, and longer time periods may be suspect. Courts generally will permit longer non-compete periods in connection with a sale of a business when a new buyer insists that the old owner refrain from competing for a prescribed period of time. In these situations, courts reason that the parties should be permitted to negotiate whatever time frame they want since the exchange is less coercive than it is in an employer-employee relationship.
• Distance: In addition to duration, a non-compete agreement often must have reasonable geographic limits. In today's global economy, the distance factor is less significant than it has been in the past. But if an employer has a particular market area, courts may refuse to enforce non-compete agreements that extend beyond that. For instance, a cosmetology business that draws most of its customers from a radius of 10 or 15 miles probably couldn't limit a former employee from working in the cosmetology business outside of that market area.
• Blue Pencil Rule: Many courts follow the "blue pencil" rule, which means if an agreement is too restrictive, the courts can modify it and then enforce it. But in some states, the "blue pencil" rule is prohibited, and courts must either uphold non-compete agreements as drafted or invalidate them entirely.
• New Employer Liability: In many states, employers who lose an employee to a competitor in violation of a non-compete agreement can sue the new employer, as well as the old employee. In these states, employers are reluctant to hire away employees who have non-compete agreements. The best approach for employees in these states is to let their prospective new employer know about the non-compete so that the employer is not later "surprised" with a lawsuit by the old employer. The new employer may decide that the non-compete agreement is invalid, or may be willing to assist the employee, including payment of legal expenses, in the event of a lawsuit by the former employer.

While employees usually have little bargaining power when confronted with non-compete agreements, there are a number of steps they can take to minimize the impact of these restrictive devices. They should keep these principles in mind and check the laws of the state in which they reside or work if they are asked to enter into a non-compete agreement or if they seek to leave their job, work for a competitor, or begin their own business after they have already signed such an agreement.

Marshall Tanick is a partner with Mansfield Tanick & Cohen, a Minneapolis law firm that provides legal services to individuals, families, businesses and organizations nationwide.