What are noncompete agreements?

Covenants not to compete, or noncompete agreements, are separate agreements or clauses in an employment contract that prohibit an employee from working in a related business in a particular geographic area for a certain length of time after the employee leaves the organization.

Noncompete agreements can be valuable in protecting a organization's clients or any confidential or technical information the organization may have. But, because noncompete agreements restrict an individual's choice of employment, they are subject to critical legal review in most states. Some states have specific statutes regulating these agreements; some ban them entirely. Even in those states where noncompete agreements are not governed by state statute, the courts will closely scrutinize these agreements. Generally, these agreements will be upheld only if their restrictions are reasonably necessary to protect a organization's legitimate interests.

What is a noncompete agreement? A noncompete agreement can be a clause in an employment contract or an entirely separate agreement between an organization and its employee that prohibits the employee from competing against the organization after he or she leaves the organization. Noncompete agreements are used either to prevent an employee from using the organization's confidential information after he no longer works for the organization or to prevent a former employee from soliciting or otherwise exploiting the organization's long-term customer relations. Either one or both of these interests may be at stake when an employee leaves a organization.

The problem with using noncompete agreements is that they often are not enforceable. The organization must first demonstrate that it has a "protectable interest" --usually defined as either confidential information or long-standing customer relations --before a court will consider enforcing the agreement. And even if the organization has a protectable interest, the agreement must be carefully drafted, limited both in time and in geographic area protected.

Some organizations have tried to go even farther in seeking to prevent former employees from working for competitors. They have argued that a simple confidentiality agreement should be interpreted like a noncompete agreement. Under this approach, an employer argues that a former employee who later worked for a competitor inevitably would disclose the former employer's trade secrets. Taking this approach, employers have tried to argue that former employees could be restricted from working for competitors even if no written noncompete agreement ever existed.

Part of another agreement. To be considered valid, a noncompete agreement must be a part of another agreement between the employer and employee, for example, a formal employment agreement.

How can a organization demonstrate that it has a "protectable interest?" Only the employer's legitimate "protectable interests" can be protected by a noncompete covenant. Since "protectable interest" usually means either confidential information or long-standing customer relations, a organization must demonstrate either one or both of these interests. Customer lists and other customer information are also examples of business interests found to be protectable.

Limited in time and geographic scope. If the organization has a protectable interest, courts will generally examine the nature of the restrictions in the noncompete agreement to see if they are reasonably related to what the organization seeks to protect. Two of the major restrictions affecting the validity of these agreements are time and geographic scope. If the geographic area in which the employee is restricted from competing is too broad or the time period during which the employee must refrain from competing is too long, a court will not enforce the agreement. The scope of activities prohibited may also be examined.

Balancing of interests. Courts will balance the organization's interests against possible harm to the employee based on restricting his or her employment opportunities. For example, the geographic area must bear a reasonable relationship to the interests the organization seeks to protect. Instead of sweeping prohibitions, such as the former employee cannot compete within 50 miles or cannot work for a direct competitor, companies are using more specific clauses which prohibit a former employee from soliciting customers with whom he or she dealt when employed by the organization. These customer-specific noncompete agreements have been better received by the courts --primarily because they protect a organization's interests yet leave the employee free to practice his or her profession or occupation by soliciting anyone other than those customers with whom he or she dealt while working for the organization

Consistent use of agreements. One thing courts will examine is whether similarly situated employees were required to sign these agreements. Courts do not look favorably on the selective use of these agreements. If some of the sales representatives in an organization's sales division are required to sign an agreement and others are not, it is unlikely that the agreement would be upheld. A court would reason that if an organization requires only some of its sales staff to sign the agreement, the organization would not have a truly protectable interest, whether the interest is customer relations or confidential information.

Similarly, companies should avoid selectively enforcing these agreements. If an organization chooses to enforce its noncompete agreements, it should do so uniformly --otherwise, a court might find that the organization really had no protectable interest at stake. Uniformly enforcing these agreements does not mean that the organization must take every former employee to court. It does mean, however, that an organization should examine each case and document the reasons for not taking legal action.

Sufficient consideration. Another variable courts will examine is whether or not there was "consideration" given for the agreement. Contract principles require that the employee be given something in exchange for his agreement to refrain from competing later on. Most courts have held that just giving the employee a job is sufficient consideration. The problem arises when an employee is asked to sign a noncompete after he or she has been employed for some time. If the employee already had the job, the issue becomes whether there was any consideration given in exchange for the employee signing the noncompete agreement.

Of course, an employer can avoid these problems by requiring employees to sign the agreement as soon as they are hired. That way, the job itself is the consideration. The exception to this is when an employee changes positions in the organization. An organization might want an employee to sign a noncompete agreement when the employee goes from a position that did not involve contact with customers to a position that does involve such contact. In this kind of situation, the new position would serve as the consideration.

Some states treat noncompete agreements more favorably than other states. An employer who does business in more than one state can choose which state's law will apply by specifying in the agreement that it is governed by the law of a particular state. Employers need to consider those states they're located in and determine which state's laws would treat them most favorably. Employers can have a great deal of latitude in this regard.

Sample noncompete agreements can be found at 28,325.