Non-compete agreements: legal arguments and implications

Non-Competition Agreements

The use of non-competition agreements as a part of the modern employment contract is increasing as businesses are becoming more sensitive to competition and proprietary issues. Formerly such agreements were used only in high levels of the corporate ladder and highly technical industries but today they are being used at all levels of business. Unfortunately, many businesses fail to take the time to ensure that their non-compete agreements are properly drafted and, as a result, such agreements tend to be the source of considerable and lengthy litigation. In most jurisdictions, the requirements for an enforceable non-compete agreement are governed by statute and businesses engaging in multi-state operations must be cognizant that the provisions may be different from state to state. Despite these differences there are similarities that appear in nearly all enforceable non-compete agreements. First, all non-compete agreements must be reasonable and cannot be overreaching and must be framed as to protect the reasonable business interest of the employer. It is the latter term that provides the basis for most litigation regarding non-competition agreements.

Non-compete agreements were common and accepted under the British common law but they were enforced begrudgingly by the courts. Historically, non-compete agreements were considered per se invalid on the basis that they caused undue personal hardship and public injury. Under the common law the only real requirement was that the terms such as length and jurisdictional limits of the agreement were reasonable and the courts applied what became known as the "rule of reason. In time, the individual states began to enact statutes that chronicled different statutory elements which said states felt should be included in non-compete agreements (Cal.Business Code). Many states have, from time to time, prohibited non-compete agreements but, in recent years, such agreements have become universally available as a business mechanism but subject to the special nuances of each state's statutory requirements (Malsberger, 1996).

The purpose of the non-compete agreements is to allow an employer to protect the one of his most valuable assets: his business' goodwill. Through the application of the terms of a non-compete agreement, an employer can prevent a former employee from capitalizing on that goodwill by directing competing with his former employer. Similarly, the non-compete agreement also prevents a former employee from using confidential information that he may have garnered while being employed. In order for information to be considered to be confidential, however, the employer must be able to demonstrate that a reasonable effort was made by the employer to keep such information confidential and that the confidential information gives the employer a competitive advantage.

Employers that utilize non-compete agreements generally do so at the beginning of an employee's employment but, interestingly, they do not take effect until, and unless, the employment arrangement has terminated. The primary purposes that employers use non-compete agreements are to protect their business' goodwill and to protect confidential information but most believe that this agreements are used to prevent former employees from competing directly with the employer. Although this is the legal effect of many non-compete agreements, this is prohibition area that the courts scrutinize closely. The right of everyone to make a living is held sacred by the courts and non-compete agreements that have such purpose as its primary goal are likely to be held invalid by the courts.

Non-compete agreements must also be supported by consideration. This means that the employee must receive something valuable in order for the non-compete agreement to be enforceable. Ordinarily, as long as the agreement is signed at the time of the initial hiring the courts have held that the promise of employment is sufficient consideration, however, if the employee is asked to sign such an agreement after beginning his employment the employer must supply additional consideration if the agreement is to be considered enforceable. The nature of this additional consideration must be examined on a case by case basis but the mere offering of continued employment is not sufficient.

Reasonableness is the universal condition in all non-compete agreements and this reasonableness is determined by applying a balancing test between the need to protect the employer's business interest against the burden placed on the employee by the enforcement of the terms of the agreement. In determining reasonableness, scope and duration are significant factors (Pivateau, 2008). Courts generally examine both of these terms carefully and are not reluctant to exercise their discretion if they find that the terms are unreasonable. Under such circumstances Courts may either limit the terms of the agreement or void the agreement in its entirety.

Non-compete agreements are intended to protect the reasonable competitive business interest of the employer. This means far more than merely protecting an employer from direct competition from its former employee. The Courts have held that employers do not have the right to prevent former employees from competing with their former employees when they are merely using their own skills or knowledge but employers do have the right to prevent former employees from taking existing customers; using confidential information; and protecting the employer's investment in any specialized training.

From the standpoint of the employer non-compete agreements are legitimate as they serve to provide the employer with some protection for having provided the employee with the opportunity to develop his or her skills, knowledge and reputation within the comforts of being employed. The non-compete agreement serve to protect the employer's investment in the employee by discouraging the employee from leaving. In return the employee enjoys the comfort of continuous employment.

The non-compete agreement can, however, create tensions between the employer and employee. For instance, an unscrupulous employer can leverage such agreement to force his employee to remain in his employ knowing that the employee will not be able to actively compete against him. Depending on the scope and duration of the non-compete agreement, many employees would not be able to remain unemployed during the specified restrictions of the non-compete agreement and this often has a chilling effect on the employee.

The enforceability of non-compete agreements is often difficult (Handler, 1982). As already noted, the Courts scrutinize these agreements heavily. Against this background, it is imperative that employers who utilize non-compete agreements do so in a consistent and timely manner. An employer who fails to treat all non-compete agreements equally among all former employees who have signed such an agreement faces the chance that the court may not enforce the isolated cases where he finally decides to seek enforcement. The logic behind this approach by the courts is that in order for a non-compete agreement to withstand scrutiny as being reasonable the employer must demonstrate that the agreement satisfy a legitimate business purpose. By not enforcing a non-compete agreement against all former employees a serious question is raised as to the agreement's satisfying a legitimate business purpose.

The fact that the courts scrutinize these agreements so heavily also results in their interpreting as narrowly as possible. In most cases, they construe the terms of the agreement in favor of the employee. The two factors that the courts rely upon most frequently in finding that a non-compete agreement is unreasonable and, therefore, unenforceable are: 1) the restraint is greater than necessary to protect the employer's business interest; 2) the employer's business interest is outweighed by the hardship to the employee. Using these standards, courts look at all the circumstances in making a determination on the enforceability of the agreement.

One of the techniques used by the courts in reviewing non-compete agreements is identified as the "Blue Pencil" doctrine. Using this doctrine the court decides to enforce the substance of the agreement but crosses out the provisions that it considers to be unreasonable. The use of this doctrine does not allow the court to change or alter any material term of the agreement. The court is only eliminating an isolated term or two that it finds to be particularly unreasonable. Blue penciling has a number of critics who argue that such approach encourages employers to include terms in non-compete agreements that are overly broad or clearly unenforceable in an effort to intimidate employees who, having signed a non-compete agreement, fear the enforcement of such terms.

In order to avoid having a non-compete agreement from being declared unreasonable and, therefore, unenforceable employers are best to consider incorporating step-down provisions in their agreements. The advantage of step-down provisions is that it provides the court reviewing the agreement with alternative scope and duration terms that they might find more acceptable.

The fact that non-compete agreements are highly scrutinized inures to the benefit of employees attempting to attack its terms but litigation can be expensive and time consuming. The best approach for any employee attempting to avoid the restrictions of a non-compete agreement is to negotiate a settlement short of actual litigation but in the event that this is not possible the remedies available for an employee include injunctive relief and money damages. Injunctive relief is a more expedient remedy but is more appropriately sought by the employer attempting to keep its ex-employee from openly competing while the litigation is pending. In limited situations, an employee might attempt to obtain injunctive relief but it would be available only where the employer has somehow already prohibited the employee from otherwise working.

Money damages would be available for both sides of the litigation depending upon who prevails on the underlying issues. Unfortunately, litigation costs can be expensive and result in neither party benefiting in pursuing the matter to that end.

The fact that lawyers are specifically prohibited from participating in non-compete agreements is telling as to the utility of such documents. Although lawyers actively participate in the preparation of such documents for other professionals and employees, the ethical guidelines published by the American Bar Association states: "A lawyer shall not participate in offering or making: (a) a partnership or employment agreement that restricts the right of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement (American Bar Association, 2004: Rule 5.6)."

Interestingly, the reasons offered for this position by the ABA, and supported by the courts, are that such restrictions interfere with clients' choice of counsel and the attorney-client relationship and are, therefore, considered a violation of public policy but the same rationale has not been applied universally to other employment situations.

In recent years there has been more and more concern expressed by the courts that question the basic fairness of non-compete arguments. Some courts have raised the question as to the moral right of employers to impose such conditions on their employees. One court explained this concern by stating: "The average, individual employee has little but his labor to sell or to use to make a living. He is often in urgent need of selling it and in no position to object to boiler plate restrictive covenants placed before him to sign. To him, the right to work and support his family is the most important right he possesses (Arthur Murray Dance Studios of Cleveland v. Witter, 1952: 703-04)."

Non-compete agreements serve a valuable function for employers but they interfere substantially with an employee's right to work and they also interfere, at least in the case of professional relationships, with the public's right to do business with whomever they wish. Enforcement of non-compete agreements can result in former employees having to move substantial distances in order to continue practice their trade or profession and also require potential clients, customers, and patients having to do the same in order to maintain their business relationship with the employee. In this sense, non-compete agreements serve as a restraint of trade and place a major burden on both the former employee and the consumer.