NON-COMPETITION AGREEMENTS†
Linda S. Woolf
I.
Introduction
Non-competition agreements (or restrictive covenants)
have become increasingly important tools in preventing former employees from
utilizing or disclosing proprietary and confidential information once the
employment relationship ends. A
non-compete provision is an agreement between an employee and his or her
employer whereby the employee contracts not to compete with the employer
following termination of the employment relationship. These agreements generally prevent the
employee from engaging in the same business/profession, soliciting the
company’s customers and revealing the company’s confidential information for
the benefit of the former employee or the benefit of a new employer. Although most (but not all) jurisdictions
recognize reasonable covenants not to compete, a multitude of statutory and
common laws provide various restraints on their validity and enforcement. As such, it is critical to consult applicable
state statutes and decisions, since the agreements may be prohibited (e.g.,
II.
Enforceability
of Non-Compete Agreements
Most jurisdictions recognize and
enforce reasonable covenants not to
compete. A covenant is reasonable if the following criteria are
met: (a) the agreement protects a legitimate business interest of the employer;
(b) the agreement is reasonably limited in duration and geography so as to not
impose undue hardship upon the former employee; and (c) the agreement does not
violate public policy. Several
jurisdictions also require the agreement to be supported by additional
consideration in the form of a benefit to the employee.
A. Legitimate Business Interests
A restrictive covenant is
reasonable and enforceable when it protects some legitimate interest of the
employer beyond the mere interest in protecting the employer from
competition. Those extended legitimate
interests generally assume some version of the criteria noted below.
1. Trade Secrets and Confidential
Information
An employer has a legitimate
business interest in keeping former employees from using its trade or business
secrets or other confidential information in competition against it. Even in the absence of a demonstrable trade
secret, the employee may be enjoined from using confidential information
obtained during his employment under certain circumstances.[1]
2. Customer Relationships and Specialized Training
An employer is entitled to protect
its customer relationships or the knowledge that its employees gained solely by
reason of their employment with the company.[2] Furthermore, although an employer does not
have a protectable interest in the general
knowledge and skill of an employee, some courts will enforce non-compete
agreements if the employer’s services are unique.[3]
B. Scope, Geography and Duration
A non-compete agreement should be limited by type of activity, geographical area and duration. The extent to which the agreement is limited is crucial in determining the reasonableness of the agreement. If (1) the agreement proscribes activities more extensive than necessary; (2) the agreement covers a geographical area more extensive than necessary to protect the interests of the business; or (3) the agreement lasts longer than is required to protect those interests, the agreement will be deemed unreasonable and unenforceable. Thus, employers can protect their interests, but they must narrowly tailor restrictive covenants as to scope,[4] geography and duration.[5]
C. Public Policy
Courts generally will not enforce
restrictive covenants that contravene public policy.[6] Restrictive covenants affecting attorneys,
for example, are generally unenforceable as a violation of professional conduct
codes.[7] In addition, non-compete agreements with
health care professionals are sometimes rigorously scrutinized out of concern
that the public will be deprived of a qualified practitioner if such an
agreement is enforced.[8] Courts have even found that where an
agreement is ambiguous, subjecting the employee to uncertainty offends public
policy.[9]
D. Consideration
Several jurisdictions also
require that any non-compete agreement be supported by additional consideration in the form of a benefit to the
employee. The type of consideration can
be important and varies with each state.
In most states, signing a non-compete agreement at the inception of
one’s employment is valuable consideration sufficient to support a covenant not
to compete.[10] After the employment relationship begins, an employer can
provide consideration for signing a non-compete agreement by providing new
responsibilities, a cash payment or other benefit.[11] While continued employment is sufficient
consideration in some courts,[12]
it is insufficient consideration in others.[13]
III.
Non-Competition
Agreements in Connection with the
While covenants not to compete in
employment contracts are generally not favored by the law, a lesser degree of
scrutiny is applied to covenants that are ancillary to the sale of a business.[14] The rationale behind this distinction when
analyzing covenants not to compete focuses on the different nature of each
contract. A contract of employment
inherently involves parties of unequal bargaining power, whereas a contract for
the sale of a business is far more likely to be entered by parties of equal
footing.[15] As a result, a covenant entered into as part
of the sale of a business generally can be drafted more broadly than one
entered into as part of an employment contract.[16]
A. Enforcement
Whether the terms of the non-compete
agreement are reasonable typically turns on the specific facts of each
transaction.[17]
1.
whether
the covenant is broader than necessary for the protection of the covenantee in
some legitimate interest;
2.
the
effect of the covenant upon the covenantor; and
3.
the
effect of the covenant upon the public interest.[18]
Of primary importance are the
questions whether the covenant not to compete is reasonable to the covenantee
and whether it is reasonable as to time, space and activity.[19]
Four factors
are considered in determining whether the protection afforded a covenantee in a
territorial restraint covenant ancillary to the sale of a business is
reasonable under the circumstances. These factors can be listed as follows:
1. the
type of business sold;
2. the
effect of including territory into which the transferring business did not
extend,
3. the
extent of the purchaser’s original business, and
4. the
period of restraint.[20]
The most important of these factors
is the type or nature of the business purchased. For this purpose, businesses are categorized
in three ways: businesses involving (1) services, (2) distribution of goods,
and (3) the production, manufacturing, or processing of goods.[21] In regard to duration, courts typically will
examine the amount of the purchase price to determine reasonableness.[22]
B. Assignability of Non-Competition Clauses
Divested
businesses frequently are parties to pre-existing employment contracts
containing non-compete provisions.
Jurisdictions are split, however, on whether employment contracts
containing covenants not to compete are assignable to the new owner in the
event of a sale of the business.[23] The majority of these states have concluded
that the restrictive covenants are not assignable.[24] Some of these jurisdictions have based their
decisions on a finding that the employment contracts are personal to the
parties and may not be assigned.[25] Other jurisdictions have concluded that
employment contracts involve personal services and are not assignable without
the parties’ consent.[26]
Several
other jurisdictions have taken a less restrictive view; these generally allow
non-competition agreements to be assigned absent specific language in the
agreement prohibiting such assignment.[27] The decision in AutoMed Techs., Inc. v. Eller reasoned that the identity of the
party enforcing a restrictive covenant should make “very little” difference to
the employee.[28] Furthermore, because courts only enforce
covenants to the extent that they are reasonable and necessary to protect an
employer’s legitimate interests, an employee will not be prejudiced by having
the contract assigned to a successor business.[29]
In situations where an employee
consents to assignment, an issue may arise regarding whether the purchase and
sale of the business goodwill should be interpreted to include the purchase and
sale of an employment agreement with a non-compete clause when that employment
agreement is not explicitly included in the list of purchased assets. In
IV.
Enforcing
the Agreement
A. Burden of Proof
The party seeking to enforce the non-compete agreement
bears the burden of proving its reasonableness by clear and convincing
evidence.[32]
B. Judicial Enforcement
Courts take one of three positions when approaching
covenants not to compete: (1) an agreement that is overly broad and
unreasonable in scope, duration and/or geography will not be enforced;[33]
(2) an overly broad agreement can be “blue-penciled” by deleting the offending
provisions and enforcing the remaining contract;[34]
or (3) an overly broad agreement can be redrafted or revised to provide
reasonable protection to an employer’s legitimate business interest.[35]
C. Remedies
Upon a breach of the agreement, the
non-breaching party is entitled to money damages and/or injunctive relief. Generally, courts prescribe relief under one
or more of the theories noted below.
1.
Injunctive Relief
An
employer may seek injunctive relief to enforce the terms of the restrictive
covenant. For example, an employer may
seek to prevent the former employee’s solicitation of customers or key
employees, or to prevent disclosure of trade secrets or other confidential
information. Ordinarily, injunctive
relief may be granted only upon a showing that: (1) the plaintiff's remedies at
law are inadequate, causing irreparable harm pending resolution of the
substantive action; (2) the plaintiff has a reasonable likelihood of success at
trial; (3) the plaintiff's threatened injury outweighs the potential harm to
the defendant resulting from the injunction sought, and (4) the injunction will
serve the public interest.[36] An employer may be entitled to preliminary
injunctive relief where it can demonstrate that it is likely to suffer
irreparable harm if such relief is not granted before a decision on the merits
can be rendered.[37] Injunctive relief may be denied, on the other
hand, where the former employer fails to demonstrate that such relief is
necessary to protect its legitimate business interest.[38]
2.
Actual Damages
Although it
may be impossible to ascertain an exact amount of lost profits resulting from
the breach of a non-compete covenant, an award of damages is not precluded.
Rather, the plaintiff must provide evidence that establishes damages with a
fair degree of probability.[39]
3. Liquidated Damages
A liquidated damages clause in an employment contract
is governed by the same rules that prevail under other contracts.[40] In order to recover liquidated damages under
a contract, “(1) injury caused by the
breach must be difficult or impossible of estimation in fact and not merely
contended by the contract; (2) the parties must intend to provide for damages;
(3) and the sum stipulated must be a reasonable pre-estimate of the probable
loss.”[41]
4. Other Theories of Relief upon Breach
Beyond injunctive relief and damages,
there are other theories of relief that may be sought upon breach. These
include:
(a) Uniform Trade Secret Act (USTA);
(b) Unfair Competition and Deceptive
(c) Breach of Fiduciary Duty;
(d) Intentional Interference with
Contractual Relations, or
(e) Conspiracy.
D. Possible Defenses to Enforcement
An employer’s material breach of the employee’s
employment contract may provide a defense to enforcement.[42] Failure to provide sufficient consideration
also may provide a defense to enforcement of a restrictive covenant.[43] In addition, enforcement may be challenged if
the agreement is unreasonable in light of its scope, geography or duration, as
previously discussed. Standard contract
defenses such as fraud or promissory estoppel also may apply.
V.
Conclusion
Employers must take proactive measures to protect
company information. Careful attention to statutory and common law is required
when drafting non-compete agreements.
Although such agreements may not provide full protection from disclosure
of company information, non-compete agreements can be extremely effective in
protecting the proprietary and confidential information of a business when
drafted properly.
ENDNOTES
† Submitted by the author on behalf of
the FDCC Employment Litigation and Civil Rights Section.
[1] PADCO
Advisory, Inc. v. Omdahl, 179 F. Supp. 2d 600 (D.
[2] Smith
v. HBT, Inc., 445 S.E.2d 315 (Ga. Ct. App. 1994) (employer has an interest in
the customer relationships its former employee established and/or nurtured
while employed); Cohoon v. Financial Plans & Strategies, Inc., 760 N.E.2d
190 (Ind. Ct. App. 2001) (employer had a legitimate, protectable interest in
good will of its clients and “past” clients with whom employee had direct
contact during last twelve months of his employment); Rogers v. Runfola &
Assocs. Inc., 565 N.E.2d 540 (Ohio 1991) (legitimate business interest exists
to keep employees from disclosing internal information and client relationships
developed at employer’s expense); Farr Assocs., Inc. v. Baskin, 530 S.E.2d 878
(N.C. Ct. App. 2000) (protection of customer relationships against
misappropriation by a departing employee is a legitimate interest of an employer);
but see Prof’l Bus. Servs.
[3] Willis
of New York, Inc. v. DeFelice, 750 N.Y.S.2d 39 (App. Div. 2002) (insurance
brokerage firm was entitled to enforce restrictive covenants against its former
high-level employee to prevent the employee from soliciting firm's clients
after employee joined firm's competitor because employee's services were
unique); Vantage Tech., L.L.C. v. Cross, 17 S.W.3d 637 (Tenn. Ct. App. 1999)
(an employer may have a protected interest in the unique knowledge and skill
that an employee receives through special training by his employer, at least
when such training is present along with other factors tending to show a
protected interest).
[4] See, e.g., Howard Johnson & Co. v.
Feinstein, 609 N.E.2d 930 (Ill. App. Ct. 1993) (agreement’s activity restraint
was carefully tailored and narrowly drawn to meet parties’ interests); cf. Modern Environments, Inc. v.
Stinnett, 561 S.E. 2d 694 (
[5] See, e.g., Cardiovascular Surgical
Specialists v. Mammana, 61 P.3d 210 (Okla. 2002) (non-compete clause precluding
surgeon from practicing cardiovascular and thoracic surgery within twenty-mile
radius of former practice was overbroad and unenforceable where closest
hospital outside twenty-mile radius was 100 miles away from location of former
practice); Hopper v. All Pet Animal
Clinic, Inc., 861 P.2d 531 (
[6] See Dowd & Dowd, Ltd. v. Gleason,
693 N.E.2d 358 (
[7] See, e.g., id.; Jacob v. Norris,
McLaughlin & Marcus, 607 A.2d 142 (N.J. 1992).
[8] Valley
Medical Specialists v. Farber, 982 P.2d 1277 (Ariz. 1999); but cf. Cardiovascular Surgical Specialists v. Mammana, 61 P.3d 210
(Okla. 2002) (upholding non-compete clause precluding surgeon from soliciting
patients of former practice for one year, except where patient affirmatively
requested surgeon to continue providing his or her medical services).
[9] Power
Dist. Inc. v. Emergency Power Eng’g, 569 F. Supp. 54 (E.D. Va. 1983).
[10] See, e.g., Farr Assocs., Inc. v. Baskin,
530 S.E.2d 878 (N.C. Ct. App. 2000).
[11] See, e.g., Davis & Warde, Inc. v.
Tripodi, 616 A.2d 1384 (Pa. Super.
[12] Coastal
Unilube, Inc. v. Smith, 598 So. 2d 200 (Fla. Dist. Ct. App. 1992); Leatherman
v. Mgmt. Advisors, Inc., 448 N.E.2d 1048 (
[13] Lyle
R. Jager Agency v. Steward, 625 N.E.2d 397 (Ill. App. Ct. 1997); Milner Airco,
Inc. v. Morris, 433 S.E.2d 811 (N.C. App. 1993).
[14] Habif,
Arogeti & Wynne, P.C. v. Baggett, 498 S.E.2d 346 (Ga. Ct. App. 1998).
[15] Watson
v. Waffle House, 324 S.E.2d 175 (
[16] Gale
Indus. v. O’Hearn, 570 S.E.2d 661 (Ga. Ct. App. 2002); Rent-A-Center v. Canyon
Television & Appliance Rental, 944 F.2d 597 (9th Cir. 1991); H&R Block
v. Lovelace, 493 P.2d 205, 210 (
[17] Rent-A-Center
v. Canyon Television & Appliance Rental, 944 F.2d 597 (9th Cir. 1991).
[18] Fogle
v. Shah, 539 N.E.2d 500 (Ind. Ct. App. 1989).
[19]
[20]
[21]
[22] Bowen
v. Carlsbad Ins. & Real Estate, 724 P.2d 223, 225 (N.M. 1986) (citing
Bonneau v. Meaney, 178 N.E.2d 577, 579 (
[23] Hess
v. Gebhard & Co., 808 A.2d 912 (
[24]
[25] Id. (citing Sisco v. Empiregas, Inc.,
237 So. 2d 463 (Ala. 1970) (stating that covenants not to compete are personal
to the performance of the company and the employee and are not assignable,
particularly as they involve a relationship of personal confidence between the
two parties); Smith, Bell & Hauck, Inc. v. Cullins, 183 A.2d 528 (Vt.
1962)).
[26]
[27] Artomick
Int’l., Inc. v. Koch, 759 N.E.2d 385 (Ohio Ct. App. 2001); see also AutoMed Techs., Inc. v. Eller, 160 F. Supp. 2d 915, 924
(N.D. Ill. 2001) (“without any Illinois precedent holding that restrictive
covenants may never be assigned without consent, we are unwilling to anticipate
new public policy restrictions on contract rights.”).
[28] AutoMed
Techs., Inc. v. Eller, 160 F. Supp. 2d 915, 924 (N.D.
[29]
[30] 55
P.3d 429 (N.M. Ct. App. 2002).
[31]
[32] Raimonde
v. Van Vlerah, 325 N.E.2d 544 (
[33] Presto-X-Co.
v. Beller, 568 N.W.2d 235 (
[34] Commercial
Bankers Life Ins. Co. of Am. v. Smith,
516 N.E.2d 110 (Ind. Ct. App. 1987).
[35] Raimonde
v. Van Vlerah, 325 N.E.2d 544 (
[36] See, e.g., Washel v. Bryant, 770 N.E.2d
902 (
[37] Shred-It,
USA, Inc. v Mobile Data Shred, Inc., 202 F. Supp. 2d 228 (S.D.N.Y. 2000).
[38] See PADCO Advisory, Inc. v. Omdahl, 179
F. Supp. 2d 600 (D. Md. 2002) (denying permanent injunction enjoining former
employee from misappropriating confidential customer database where evidence
showed that former employee did not physically take tangible records, customer
list was constantly changed, and employee’s memory of list contents two years
after he left would not qualify as trade secret).
[39] Prairie
Eye Center, Ltd. v.
[40] See Habif, Arogeti & Wynne, P.C. v.
Baggett, 498 S.E.2d 346 (Ga. Ct. App. 1998).
[41] Capricorn
Sys., Inc. v. Pednekar, 546 S.E.2d 554 (Ga. Ct. App. 2001).
[42] Ward
v. Am. Mut. Liab. Ins. Co., 443 N.E.2d 1342 (Mass. Ct. App. 1983).
[43] McCandless
v. Carpenter, 848 P.2d 444 (Idaho Ct. App. 1993).
(Author’s bio)
Linda Woolf
is a partner and founding member of the