Non-Compete Agreements: Finding the Right Balance

Sue Schloemer

Jul 18, 2016

Arm wrestling

Non-compete agreements have long been a staple of executive employment contracts. Today, however, they’re becoming increasingly common even in lower-level jobs. According to the Wall Street Journal, a steady rise in litigation over non-competes “largely reflects the increased usage of non-compete arrangements among lower-level staffers, along with employees’ greater mobility and access to sensitive information.”

state_law_rulesIt might seem like overkill to require a non-compete agreement with employees below the executive level. However, an individual’s ability to damage your business by going to work for a competitor will grow over time — assuming the employee gains responsibility and knowledge that could help a competitor. If you don’t secure a non-compete agreement at the beginning of an employment relationship, you’ll probably need to jump through an extra hoop to make it legally enforceable later on.

State Law Rules

State law governs non-compete agreements, and some of the rules vary from one state to the next. In an extreme case, California generally doesn’t recognize the validity of these agreements at all.

Federal courts may also sometimes get involved. One federal court recently weighed in on a case and upheld a common principle — the need for an employee to receive “consideration” (some form of compensation) in exchange for accepting a non-compete agreement.

Ordinarily, being offered a job is deemed to be adequate consideration in itself. However, if an employee has already been working for a while, simply being allowed to keep the job might not be deemed adequate consideration. That’s how the U.S. District Court in Hawaii came down on the issue in the case of The Standard Register Co. v. Keala (No. 14-00291 JMS-RLP).

“Numerous courts have held that where an employee has already been hired, continued at-will employment, standing alone, is insufficient consideration for a non-competition agreement,” the court held, and denied the employer’s request for a temporary restraining order against former employees.

Is the Agreement Enforceable?

One possibility for “consideration” in that situation might have been a bonus or a promotion. However, courts aren’t always predictable in what they’ll uphold. Here are other key facets of a non-compete agreement that courts examine:

  • Does it protect a legitimate business interest? For example, let’s say you claim that an employee possesses sensitive information which could harm you if it fell into a competitor’s hands. Unless there’s evidence that you made a real effort to protect the secrecy of that information, a court may decide your stated business interest isn’t legitimate.
  • What is the duration of the agreement? Courts are sympathetic to the idea that people need to earn a living. Therefore, they often frown on agreements that restrict former employees for periods longer than, for example, six months. But “reasonable” limits vary by circumstances and courts.
  • What are the geographic parameters? A court will try to determine reasonableness here based on the size of your market. If you don’t have many competitors beyond a certain distance, such as a 10-mile radius, you wouldn’t be able to justify an agreement based on a 50-mile radius. Again, there’s considerable variability in this parameter.
  • What activity is prohibited? The broader the scope of the prohibition, the less likely the agreement is to be enforceable. The most “reasonable” restriction in the eyes of the majority of courts is against soliciting your customers.

Red Pencil, Blue Pencil

If a court reviews a non-compete agreement and finds fault with it, there are three possible outcomes — depending on the state. The most restrictive standard is known as the “red pencil” rule. It requires the invalidation of an entire agreement even if only one provision is flawed. Nebraska takes the position, and South Carolina, Virginia and Wisconsin generally do as well.

Under the less draconian “blue pencil” standard, courts are allowed to invalidate specific provisions of an agreement, while leaving other ones standing. Arizona, Connecticut, Indiana, Maryland, Montana and North Carolina generally take that approach.

The best scenario is “reformation,” which is permitted in approximately 30 states. This is where the court can actually rewrite the agreement to allow it to be as faithful as possible to the employer’s original intent, but only to the extent permissible by law. That way, you might win a partial victory if you’re still allowed to restrict the former employee’s activities, even if not as thoroughly as you’d hoped.

Not all states fall into such tidy categories, and their positions evolve. Wherever you’re located, you will need to consult with a qualified attorney to draft a non-compete agreement that will hold up to local scrutiny.

Also, many job applicants will take a dim view of a requirement to sign this type of contract. With that in mind, you’ll need to balance your eagerness to hire a particular applicant with the consideration you’re willing to offer to make the agreement more palatable. Otherwise, the non-compete agreement could be a deal breaker. Consult your legal adviser for more information.

About The Author

Sue enjoys helping clients succeed. Her breadth and depth of accounting knowledge combined with over 25 years of…

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