9.3 Non-compete and non-solicitation agreements

Non-compete and non-solicitation agreements are crucial tools employers use to protect their business interests. These contracts limit an employee's ability to work for competitors or solicit clients after leaving a company.

Courts carefully scrutinize these agreements to ensure they're reasonable in scope and duration. Employers must balance protecting their interests with allowing fair competition and employee mobility. Recent trends show increased scrutiny of overly broad restrictions.

Types of restrictive covenants

• Restrictive covenants are contractual provisions that limit an employee's ability to compete with their employer during or after their employment
• These agreements are designed to protect the employer's legitimate business interests, such as confidential information, customer relationships, and investment in employee training
• The three main types of restrictive covenants are non-compete agreements, non-solicitation agreements, and non-disclosure agreements

Non-compete agreements

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• Prohibit employees from working for a competitor or starting a competing business within a specified geographic area and time period after leaving their current employer
• Employers use non-compete agreements to prevent former employees from using knowledge and skills gained during their employment to benefit a competitor
• Examples:
  • A salesperson is prohibited from working for a competing company within a 50-mile radius for one year after leaving their current employer
  • A software developer is barred from starting a competing software company for two years after termination of employment

Non-solicitation agreements

• Prevent employees from soliciting their former employer's customers or clients for a specified period after leaving the company
• These agreements also often prohibit former employees from recruiting or hiring their former colleagues
• Examples:
  • A financial advisor is prohibited from contacting or providing services to their former employer's clients for 18 months after leaving the firm
  • A recruiting manager is barred from hiring any of their former employer's staff for one year after termination

Non-disclosure agreements

• Prohibit employees from disclosing confidential information, such as trade secrets, customer lists, and proprietary business practices, to third parties during and after their employment
• These agreements help maintain the confidentiality of sensitive information that provides a competitive advantage to the employer
• Examples:
  • An engineer is prohibited from disclosing technical specifications and designs of their former employer's products to a new employer
  • A marketing manager is barred from sharing their former company's marketing strategies and customer data with a competitor

Legitimate business interests

• For a restrictive covenant to be enforceable, the employer must demonstrate that the agreement serves to protect a legitimate business interest
• Courts generally recognize three main categories of legitimate business interests: protection of trade secrets, preservation of customer relationships, and investment in employee training
• The employer bears the burden of proving that the restrictive covenant is necessary to safeguard these interests

Protection of trade secrets

• Trade secrets are valuable, confidential information that provides a company with a competitive advantage, such as formulas, manufacturing processes, and business strategies
• Employers have a legitimate interest in preventing former employees from disclosing trade secrets to competitors or using them to start a competing business
• Example: A pharmaceutical company requires employees to sign non-disclosure agreements to protect the confidentiality of its drug formulas and research data

Preservation of customer relationships

• Employers often invest significant time and resources in developing and maintaining customer relationships
• Restrictive covenants can help prevent former employees from exploiting these relationships for the benefit of a competitor
• Example: A sales representative is prohibited from soliciting their former employer's customers for a specified period after leaving the company to protect the employer's investment in building those customer relationships

Investment in employee training

• Employers may provide extensive training and professional development opportunities to their employees, which can be costly and time-consuming
• Restrictive covenants can help protect an employer's investment in employee training by preventing former employees from using those skills and knowledge to benefit a competitor
• Example: A consulting firm requires employees to sign non-compete agreements to protect its investment in providing specialized training and certifications to its consultants

Reasonableness of restrictions

• For a restrictive covenant to be enforceable, the scope and duration of the restrictions must be reasonable and not unduly burdensome on the employee
• Courts consider three main factors when assessing the reasonableness of a restrictive covenant: geographic scope, duration of restrictions, and scope of prohibited activities
• If a restrictive covenant is found to be unreasonable, courts may either refuse to enforce the agreement or modify its terms to make it reasonable

Geographic scope

• The geographic scope of a restrictive covenant must be limited to the area where the employer operates or where the employee provided services
• Overly broad geographic restrictions, such as worldwide or nationwide prohibitions, are more likely to be found unreasonable
• Example: A court may find a non-compete agreement that prohibits an employee from working for a competitor anywhere in the United States to be unreasonable if the employer only operates in a few states

Duration of restrictions

• The duration of a restrictive covenant must be limited to the time necessary to protect the employer's legitimate business interests
• Overly long durations, such as lifetime bans or restrictions lasting several years, are more likely to be found unreasonable
• Example: A court may find a non-solicitation agreement that prohibits a former employee from contacting the employer's clients for five years after termination to be unreasonable and modify the duration to one year

Scope of prohibited activities

• The scope of activities prohibited by a restrictive covenant must be narrowly tailored to protect the employer's legitimate business interests
• Overly broad restrictions, such as prohibiting an employee from working in any capacity for a competitor, are more likely to be found unreasonable
• Example: A court may find a non-compete agreement that prohibits a software developer from working in any role for a competing software company to be unreasonable and modify the restriction to only prohibit work on competing products

Consideration for agreements

• For a restrictive covenant to be enforceable, the employee must receive something of value, known as consideration, in exchange for agreeing to the restrictions
• Consideration can take the form of initial employment, continued employment, or additional benefits for existing employees
• The adequacy of consideration is often a point of contention in disputes over the enforceability of restrictive covenants

Initial employment as consideration

• In many states, an offer of employment is sufficient consideration for a restrictive covenant signed at the beginning of the employment relationship
• Courts reason that the employee is receiving the benefit of a job opportunity in exchange for agreeing to the restrictions
• Example: A new hire signs a non-compete agreement as a condition of accepting a job offer, and the job itself serves as consideration for the agreement

Additional benefits for existing employees

• For existing employees, continued employment alone may not be sufficient consideration for a new restrictive covenant
• Employers may need to provide additional benefits, such as a promotion, raise, or bonus, to support the enforceability of the agreement
• Example: An employer offers a long-term employee a significant salary increase in exchange for signing a non-solicitation agreement, and the raise serves as consideration for the agreement

Enforceability of agreements

• The enforceability of restrictive covenants varies by state, with some states having more stringent requirements or limitations than others
• Courts may use different approaches, such as the blue pencil doctrine or reformation, to address overly broad or unreasonable provisions in restrictive covenants
• Employers must be aware of state-specific enforceability standards when drafting and seeking to enforce restrictive covenants

Blue pencil doctrine

• Under the blue pencil doctrine, courts may strike out overly broad or unreasonable provisions in a restrictive covenant while leaving the remainder of the agreement intact
• This approach allows courts to enforce the reasonable portions of the agreement without invalidating the entire covenant
• Example: A court may use the blue pencil doctrine to strike out an overly broad geographic restriction in a non-compete agreement while enforcing the remaining provisions

Reformation of overly broad provisions

• Some courts may reform or rewrite overly broad or unreasonable provisions in a restrictive covenant to make them enforceable
• This approach involves modifying the terms of the agreement to be reasonable rather than simply striking out the offending provisions
• Example: A court may reform an overly long duration in a non-solicitation agreement from five years to one year to make the agreement enforceable

State-specific enforceability standards

• Some states have enacted laws that limit the enforceability of restrictive covenants or impose specific requirements for their validity
• For example, California generally prohibits non-compete agreements, while other states may require additional consideration or have specific limitations on the duration or scope of restrictions
• Example: An employer seeking to enforce a non-compete agreement in California may face significant challenges due to the state's strict limitations on the enforceability of such agreements

Consequences of breach

• When an employee violates a restrictive covenant, the employer may seek various remedies to protect its interests and enforce the agreement
• Common remedies for breach of a restrictive covenant include injunctive relief, liquidated damages provisions, and recovery of attorney's fees
• The availability and scope of remedies may depend on the specific terms of the agreement and applicable state laws

Injunctive relief

• Injunctive relief is a court order that prohibits the employee from engaging in the prohibited conduct or requires them to take specific actions to comply with the agreement
• Employers often seek injunctive relief to prevent further harm to their business interests, such as the disclosure of trade secrets or the solicitation of customers
• Example: An employer may seek an injunction to prohibit a former employee from working for a competitor in violation of a non-compete agreement

Liquidated damages provisions

• Liquidated damages provisions specify a predetermined amount of money that the employee must pay to the employer in the event of a breach
• These provisions can help employers recover damages without having to prove actual harm, but they must be reasonable and not function as a penalty
• Example: A non-solicitation agreement may include a liquidated damages clause requiring the employee to pay $10,000 to the employer for each client solicited in violation of the agreement

Recovery of attorney's fees

• Some restrictive covenants include provisions that require the breaching employee to pay the employer's attorney's fees incurred in enforcing the agreement
• These provisions can help deter violations and ensure that employers can afford to enforce their rights under the agreement
• Example: A non-disclosure agreement may state that the employee is responsible for paying the employer's attorney's fees if the employer prevails in a legal action to enforce the agreement

Defenses to enforcement

• Employees may raise various defenses when an employer seeks to enforce a restrictive covenant
• Common defenses include undue hardship on the employee, lack of legitimate business interest, and unconscionability of terms
• The success of these defenses depends on the specific facts of the case and the applicable state laws

Undue hardship on employee

• Employees may argue that enforcing the restrictive covenant would cause them undue hardship, such as difficulty finding new employment or providing for their family
• Courts may consider factors such as the employee's age, education, skills, and financial circumstances when evaluating this defense
• Example: An employee may argue that enforcing a non-compete agreement would cause undue hardship because it would effectively prevent them from working in their chosen profession for an extended period

Lack of legitimate business interest

• Employees may challenge the enforceability of a restrictive covenant by arguing that the employer lacks a legitimate business interest justifying the restrictions
• This defense requires the employee to show that the agreement is not necessary to protect the employer's trade secrets, customer relationships, or investment in training
• Example: An employee may argue that a non-solicitation agreement is unenforceable because the employer's customers are readily ascertainable from public sources and not protected as a legitimate business interest

Unconscionability of terms

• Employees may argue that the terms of the restrictive covenant are unconscionable, meaning they are so unfair or one-sided that they shock the conscience
• Factors that may support an unconscionability defense include a significant disparity in bargaining power, lack of meaningful choice, or terms that are grossly favorable to the employer
• Example: An employee may argue that a non-compete agreement with a ten-year duration and worldwide geographic scope is unconscionable because it effectively prevents them from working in their field for an unreasonable period

Drafting enforceable agreements

• To increase the likelihood that a restrictive covenant will be enforced, employers must carefully draft the agreement to comply with legal requirements and best practices
• Key considerations in drafting enforceable agreements include clarity of language, tailoring to specific needs, and compliance with state laws
• Employers should work with experienced legal counsel to ensure their restrictive covenants are properly drafted and enforceable

Clarity of language

• Restrictive covenants should be written in clear, unambiguous language that is easily understandable by the employee
• Vague or overly broad language can lead to challenges to the enforceability of the agreement or disputes over its interpretation
• Example: Instead of prohibiting an employee from working for "any competitor," a non-compete agreement should specifically define the prohibited competitors or industries

Tailoring to specific needs

• Restrictive covenants should be tailored to the specific needs and circumstances of the employer and employee
• One-size-fits-all agreements are more likely to be found unreasonable or unenforceable because they may not be necessary to protect the employer's legitimate interests
• Example: A non-solicitation agreement for a salesperson should focus on prohibiting the solicitation of the employer's customers, rather than including a broad prohibition on soliciting any potential customers

Compliance with state laws

• Employers must ensure that their restrictive covenants comply with the specific laws and regulations of the states where they operate
• This may involve including state-specific language, adhering to limitations on the scope or duration of restrictions, or providing additional consideration as required by state law
• Example: An employer drafting a non-compete agreement for employees in multiple states should ensure that the agreement complies with the specific requirements of each state, such as providing garden leave pay in Massachusetts or adhering to the 18-month maximum duration in Oregon

Recent trends and developments

• The legal landscape surrounding restrictive covenants is constantly evolving, with courts and legislatures responding to changing business practices and public policy concerns
• Recent trends and developments include increased scrutiny by courts, legislative efforts to limit enforceability, and the impact of remote work on restrictions
• Employers must stay informed about these changes and adapt their practices accordingly to ensure the enforceability of their restrictive covenants

Increased scrutiny by courts

• In recent years, courts have shown a greater willingness to scrutinize restrictive covenants and invalidate agreements that are overly broad or unreasonable
• This trend reflects a growing concern about the potential negative impact of restrictive covenants on employee mobility and competition
• Example: In 2021, the Illinois Supreme Court invalidated a non-compete agreement that prohibited an employee from working for any competitor worldwide, finding the geographic scope unreasonable

Legislative efforts to limit enforceability

• Some states have enacted or proposed legislation to limit the enforceability of restrictive covenants, particularly for low-wage or entry-level employees
• These efforts aim to protect workers from unfair restrictions on their ability to find new employment or advance their careers
• Example: In 2020, Washington D.C. passed the Ban on Non-Compete Agreements Amendment Act, which prohibits the use of non-compete agreements for employees earning less than $150,000 per year

Impact of remote work on restrictions

• The rise of remote work, accelerated by the COVID-19 pandemic, has created new challenges for the enforcement of restrictive covenants
• With employees increasingly working from home or other remote locations, traditional geographic restrictions may be less relevant or effective
• Example: An employer seeking to enforce a non-compete agreement with a 50-mile radius restriction may face challenges if the employee can perform their work remotely from anywhere in the country