What Makes Non-Compete Agreements Enforceable?

Non-compete agreements, clauses, or contracts come in many forms, but they all share the same basic function: restricting or delaying one party’s ability to compete with the other. In the context of employment, a non-compete agreement usually means that an employee agrees not to work for the employer’s competitors in the same market or geographical area for a certain amount of time after leaving (typically one to two years). This post will examine the reasons non-compete agreements are often unenforceable, then review the factors that can help keep them in compliance with state law, at least in some states.

The Basics

From an employer’s perspective, non-compete contracts serve to lower the risk of a former employee sharing trade secrets and strategic resources such as client lists with competitors. The employer essentially lays claim to not only an employee’s work, but their expertise and “inside knowledge” as well.

From an employee’s perspective, however, non-compete agreements can be burdensome, and courts have generally acknowledged that they tend to limit a person’s ability to pursue a career and livelihood. They also restrict marketplace competition, resulting in lower wages and causing professional skills to leave the labor market.

Non-Compete Agreements Are Often Unenforceable

Although the principle behind non-compete agreements is sound—preventing former employees from sharing trade secrets with competitors—the provisions are often phrased so broadly that the employee is left with very few options. Especially since internet business touches so many industries, the “market” of a given industry is often global. Because non-compete agreements are so restrictive, they are often unenforceable.

Different states have developed different answers to this problem. In California and Oklahoma, for instance, non-competes are effectively illegal except in the case of selling a business. Other states will usually enforce trade secret protections, but not work restrictions. In all cases, enforceability depends on whether the court considers the non-compete clause to be reasonable. An agreement that is enforceable will usually be quite limited in both geography and time.

Defining Reasonability

The following factors shape legal precedent across states and determine the enforceability of a non-compete agreement.

The context of the agreement is important to its enforceability. A non-compete agreement must be supplemental to another enforceable contract, such as an employment contract or a contract for the sale of a business.

In order to enforce a non-compete agreement, an employer generally must demonstrate that the clause is necessary to guard legitimate, protectable interests. States tend to define protectable interests differently, but categories include trade secrets and client or customer information. Some states have broader definitions; Missouri, for instance, considers “protection from unfair competition” to be a protectable interest.

The scope of the restricted activity will affect a non-compete agreement’s enforceability. A vaguely formulated restraint will be much more difficult to enforce than one that is specifically defined, especially if it is also very broad and tends to prevent the employee from working in his or her field. As with other factors, states have different interpretations of what is specific enough. Limiting competition in a broad geographic scope (the country) or for a long time (5 years) is much more likely unenforceable than a very narrow scope (10 miles) or short period of times (6 months).

As with any contractual obligation, a non-compete agreement is only valid and enforceable if one can prove consideration or benefit. In other words, the other party must receive a benefit from the contract. Many states (but not Washington, Pennsylvania, and Texas) have determined that continued employment constitutes sufficient consideration. Thus, if an employee obtained employment in exchange for signing the non-compete agreement, consideration is established.

A final factor is a state’s approach to judicial modification. Some states (e.g. Oregon and New York) allow judges to amend and reformulate a faulty non-compete clause until it is valid and enforceable. Other states (e.g. Rhode Island and North Carolina) allow a court to remove certain words or phrases until the clause can be considered enforceable, but the court cannot add anything to the contract; in this way, an overreach or error in a non-compete agreement is not fatal to its operation. In other states (e.g. Nebraska), however, a non-compete clause that does not meet all requirements is considered void in its entirety. A state’s approach to judicial modification has strategic importance when drafting a non-compete contract.

There is no simple answer to whether non-compete clauses are enforceable. They must be carefully worded to comply with the policies of your state. Seek legal counsel to determine what interests are considered protectable and legitimate in your state, and to make sure your non-compete agreement is not too broad.

_________________________________________

Featured Image by Rebecca Sidebotham.