5 things you need to know about non-compete agreements
Whether you call it a non-compete agreement or a covenant not to compete, there is no denying there is a lot of confusion out there regarding this particular type of contract. What are they? What do they mean for employers and employees? And, are they even enforceable?
So, before you enter into a non-compete agreement — either as an employer or employee — there are several things you need to know.
1. What, exactly, are non-compete agreements?
Non-compete agreements are contracts between an employer and an employee that are typically signed at the start of their business relationship. Essentially, a non-compete agreement prohibits the employee from competing with the business directly or indirectly for a specific duration of time after their employment has ended.
While the contents of the non-complete may vary from company to company, they may attempt to prohibit the employee from things such as:
- Working for a competitor company or competing individual
- Starting a company that offers the same products or services
- Developing competing products or providing competing services
- Recruiting former colleagues to join their new business, although this can also be done through a non-solicitation agreement
However, just because an employer may want to prevent an employee from competing against them, it isn't always that easy. In fact, there are very specific rules regarding the enforceability of non-compete agreements, which can vary from location to location.
2. When are non-compete agreements enforceable?
Almost every state has a slightly different approach when it comes to the enforceability of non-compete agreements. In fact, some states view non-competes as overly restrictive on competition — meaning they are only enforceable in certain circumstances or not at all.
However, in states where non-compete agreements are allowed, there are several factors courts often look to when determining if a specific non-compete is enforceable, including:
- Is the non-compete agreement needed to protect an employer's legitimate businesses interest, such as confidential business information?
- Does the non-compete agreement have a reasonable time limitation?
- Is the non-compete agreement limited to a specific geographic location (city, county, region, etc.)?
- Is the non-compete agreement support by "consideration," which means the employee receives some benefit — like a new job, more compensation, or stock options — for agreeing not to work for a competitor?
One thing to remember, though, is that just because you may happen to live in a state that permits non-compete agreements doesn't mean that every non-compete will be enforceable. Indeed, not meeting any of the factors above may be enough to invalidate a non-compete agreement even in states the generally enforce them.
3. What types of business interests can a non-compete protect?
One of the most important factors courts will often look at when determining the validity of a non-compete agreement is whether it actually protects a legitimate business interest of the employer. If it doesn't, there really isn't any reason to stop the employee from competing against a former employer.
Some common legitimate business interests include, but are not limited to:
- Trade secrets
- Confidential business or professional information
- Company relationships with specific customers and clients, either existing or prospective
- Specialized training
4. What is considered a reasonable geographical area and time limit?
As mentioned above, a valid non-compete agreement should include a geographical area limitation. This simply means that a former employee cannot compete with the employer within that specific location. For example, some non-compete agreements will define the geographic restriction by a radius around the company's headquarters. Others may limit the non-compete agreement to specific cities in which the employer does business.
As a general rule, the broader the geographical area, the less likely the non-compete is enforceable. For instance, an employer will have a much stronger argument if a non-compete is limited to a single city versus an entire state. That doesn't mean the latter isn't possible to enforce under certain circumstances, but it's going to be a lot harder for the employer to justify.
As for a time limit on a non-compete agreement, most employers see between six months and two years as a reasonable non-compete time frame, with one year being quite common. However, the time frame depends on the industry and type of career path the individual has. But the longer the duration of the non-compete period, the more likely a court will deem it unenforceable.
5. How does President Biden's Order on Promoting Competition affect non-competes?
According to the Executive Order on Promoting Competition in the American Economy, President Biden has requested that the Federal Trade Commission set limits on the use of non-compete clauses:
"To address agreements that may unduly limit workers' ability to change jobs, the Chair of the FTC is encouraged to consider working with the rest of the Commission to exercise the FTC's statutory rulemaking authority under the Federal Trade Commission Act to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility."
While this executive order has not changed the current laws, it's likely that non-competes will be facing extra scrutiny moving forward in some jurisdictions.
If you would like to stay up-to-date on the laws surrounding non-compete agreements, sign up for a free trial to Practical Law today.
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