Small businesses are increasingly using non-compete agreements to reduce the impact of the loss of their greatest assets: employees and the knowledge they possess.
The term non-compete is the common term for several different types of agreements more properly known collectively as restrictive covenants. It is absolutely critical that these agreements be drafted correctly to ensure that they are enforceable.
Non-compete agreements prevent the departing employees from using the experience and knowledge learned while on the job from starting their own business in direct competition. A non-compete agreement may also protect a business from the damage caused by departing employees leaving their business to work for competitors, vendors or others generally within a specific geographic region and for a specific time period.
Properly drafted restrictive covenants can give a small business the ability to obtain an injunction to block a former employee from going to work for a prime competitor, recover attorney fees in the event the employee breaches the agreement and even allow the business to recover damages from the competitor who hires or retains the employee in violation of the agreement. However, poorly drafted or pro forma agreements can, at best, fail to provide adequate protection and, at worst, create additional legal problems for the employer.
The law governing restrictive covenants generally attempts to balance two conflicting and competing interests. On one hand, they seek to protect the legitimate business interests of employers in protecting confidential information, which can include everything from customer contacts to pricing and other trade secrets. On the other hand, the law also attempts to balance the legitimate right of employees to take their skills into the marketplace and sell them to the highest bidder. These laws vary from state to state, and differences in state law can be substantial. The law also is evolving as businesses increasingly require certain employees to sign them as a condition of employment.
Proper drafting of restrictive covenants requires careful examination of the facts of the employee’s job duties and the nature of the business or industry. Few types of contracts are more reliant on the specific facts than restrictive covenants. Slight changes in the facts can render the agreement unenforceable in whole or in part. An agreement that may be valid and enforceable in one industry or region may be unenforceable in a different industry in the same region or the same industry but in a different region.
Types of Restrictive Covenants
The primary types of restrictive covenants are non-compete, non-disclosure, non-solicitation and a category that has developed more recently, sometimes referred to as anti-raiding agreements.
- Non-compete agreements prevent the departing employee from starting their own business in direct competition or working for competitors, vendors or others generally within a specific geographic region and for a specific time period.
- Non-disclosure agreements prevent the departing worker from disclosing any confidential information. Non-disclosure agreements generally do not require time or geographic restrictions, or if such provisions are required, they are much broader than those enforceable in non-compete agreements.
- Non-solicitation agreements prevent the departing employee from soliciting customers or business away from the former employer.
- Anti-raiding agreements prevent a departing employee from attempting to hire other employees away from the previous employer. This scenario most commonly occurs when the departing employee is starting their own business or accepts employment with a subsequent employer in which they have hiring authority.
Validity of Contracts
Restrictive covenants cannot, and should not, be drafted in such a way as to act as a restraint on free competition in the marketplace. Courts will apply a number of factors in evaluating the validity of such agreements. Generally recognized protectable interests of the employer include customer contacts and trade secrets. The definition of “trade secret” is far broader and protects much more information than what many small business owners realize, including such areas as pricing.
Because restrictive covenants are actually contracts, the usual requirements for any valid contract apply, including the necessity of valid consideration for imposing the restrictions on the employee. This is easily done when the restrictive covenant is required as a hiring condition because the consideration is the employment itself. Consideration can be a bit trickier when the employer seeks to impose a restrictive covenant on an existing employee.
One final note of caution: because the use of restrictive covenants has become so prevalent in recent years, employers need to be wary of the possibility that an applicant for employment might be covered by such an agreement. If the prospective employer could be considered a competitor under the agreement, hiring the employee in violation of the agreement could expose the prospective employer to damage claims for interference with the agreement.