What is a non-compete contract?
A non-compete is defined as a type of restrictive covenant that seeks to prevent an employee from joining a competitor for a set period of time after leaving a company. Covenants not to compete, like covenants not to solicit, play a meaningful role in protecting a company, but the scope and purpose of non-competitions differ depending on the industry. For example, suppliers often use non-competes to protect formulas, recipes , special manufacturing processes or business relationships with customers, while employers in the financial services industry use non-competes as a means to prevent employees who have developed a book of business from leaving, taking the book and joining a competitor. Non-competitions in the financial services context tend to cover a longer period of time and larger geographical area than the typical non-compete (which often lasts six months to a year and covers a limited area).
What’s in a non-solicitation contract?
Employers may also use non-solicitation agreements to help ensure that employees don’t "poach" the company’s clients/lead sources or other employees after they leave. Non-solicitation agreements can be widely applied depending on how they are drafted. They can, for example: Employee non-solicitation agreements have become more common in industries with a measurable referral source or client base. In the medical field, physicians often enter into non-solicitation agreements when entering into employment agreements with medical practices. A common situation resulting in litigation is where a physician enters into a non-solicitation agreement with their practice and then moves to a competing practice or establishes their own practice and they counsel patients to come to their new practice. This situation also commonly applies to physician-owned hospitals and clinics that employ physicians. These non-solicitation agreements become particularly important when a practice has spent years building a patient base through the efforts of its employed physicians. Non-solicitation agreements can also be valuable to businesses that are non-medical in nature, such as financial planning, legal services, design, consulting to name a few. Employers must be careful, however, regarding the scope of their non-solicitation agreements. For example, restricting a physician’s ability to talk to patients who have been treated within the past year and saw a certain physician employed by the practice may not be enforceable as it likely prohibits the physician from speaking to many patients not of their choosing. Therefore the physicians should instead be restricted with respect to patients they themselves saw and treated within the past year. Employers must also be careful not to violate Section 16600 of the California Business and Professions Code. Competitive-activity restrictions (which we will discuss in more detail in our next section) are likely unenforceable under California law. Non-solicitation agreements are, however, enforceable under California law.
Elements of these contracts
The essential components of a non-compete agreement generally include the specific time period during which the employee would be prohibited from engaging in competitive activity, and the geographic area where restrictions would apply. The duration of the restriction is usually tied to the time necessary for the employer to safeguard and protect its legitimate business interests and confidential information. The geographic scope is typically defined by the physical area where an employer does business (i.e., where the employee works, or worked, and where the company sells to and/or services customers). When enforceable non-compete and non-solicitation agreements are entered between a company and an employee, an effective and specific time limit is agreed upon in the document. Generally, that time limit is one year post-termination. Beyond that time period, the employer likely lacks a legitimate business interest that requires protection. For example, in Hospitality Staffing Solutions, LLC v. Eiland, 538 F. Supp. 2d 1342 (M.D. Ga. 2008), the court held that a one-year post-employment covenant not to compete in "the Scope" of the Agreement was "harsh, unduly burdensome and oppressive" because it extended in scope to a national geographic area. However, the court upheld a six-month covariance because it was more reasonable than other alternatives set forth in the contract. The geographic scope of restriction will depend on the industry, size of the company, and role of the employee. Courts frequently consider whether the employee has access to the employer’s confidential information, client contact and solicitation responsibilities, and if the location of a customer base "naturally" expands its geographic areas of concern. In Campbell Soup, 295 F.2d at 614, the trial court determined that since the employer’s manufacturing and distribution facilities were located in Lisle and Northlake, Illinois, and it processed orders from these locations, the prohibited area of competition for six months after termination reasonably included all of Illinois. An employer may want to specify an area that covers the entire United States where it conducts business. However, a geographic limitation of "worldwide" would almost certainly be unreasonable. In Campbell Soup, 295 F.2d at 617, the court determined that the one-year worldwide restriction contained in the agreement was clearly arbitrary and overbroad, and would have prohibited the employee from becoming involved in the export import business throughout the rest of the world.
Lawful enforceability of these contracts
In determining whether or not a non-compete and/or non-solicitation agreement is legally enforceable there are several factors to consider. First, it is important to keep in mind that the laws governing non-compete and non-solicitation agreements are largely state law based. This means that each jurisdiction may treat the agreements differently and any decision regarding the enforceability of an agreement must take into account the applicable law. For example, in some jurisdictions non-compete agreements are difficult to enforce unless they are entered into prior to employment with the employer or in conjunction with a sale of business. In addition, states differ widely in the restrictions they will enforce in the absence of a nonsolicitation or non-compete agreement both in terms of the duration of the restriction and the geographic scope of the restriction.
Common legal challenges to non-compete and non-solicit agreements:
Overbroad agreements – if a court deems the restrictions set forth in a non-compete or non-solicit agreement to be over broad and therefore unfair to the restrain the employee’s ability to work in the future the court will decline to enforce the agreement.
Compelling employer’s interest – In some jurisdictions a newly hired employee can unilaterally refuse to sign a non-compete agreement but if the employer has a compelling interest in requiring the new employee to sign a non-compete agreement, the employer can seek a court order requiring the new employee to sign the agreement. Some jurisdictions will even enforce the non-compete or non-solicit agreement on an interim basis prior to a full hearing on the merits of the enforceability of the agreement.
Advantages and disadvantages for employers and employees
Both non-compete and non-solicitation restrictions have their fans and detractors. In general, employers love them; employees often do not. Both sides, however, will recognize that these agreements do have pros and cons that should be understood.
Non-compete arrangements are primarily seen as a way for employers to protect and preserve their business relationships by keeping employees with access to the company’s key customer accounts from taking those accounts with them to their own new employers. Proponents and detractors from non-compete agreements alike acknowledge that a well-tailored, narrowly-drafted non-compete agreement is likely to have the intended result, which is to prevent an employee from making an "easy" transition to a new job with the customer accounts the employee serviced while at the old employer getting carried along without having to put in the time and effort to earn his or her way to those customer accounts. Detractors point out that non-compete agreements can be (and frequently are) overbroad and/or poorly drafted, covering much more territory (both geographically and duration-wise) than the employer has any legitimate interest in protecting , thereby limiting its pool of potential recruits to those who do not have any advanced age or experience.
Non-solicitation agreements also are favored by employers because, even if the former employee is allowed to work for a new employer in the same general business area and therefore is "competition," a properly drafted non-solicitation agreement can go a long way toward keeping the business relationships the former employee developed during his or her tenure with the former employer while denying those relationships to the customer’s new competition. For employees, however, non-solicitation agreements possess the sting of a reminder that customer accounts and relationships do not belong to the employee who developed them during the term of employment, but instead belong to the customer’s former employer. Moreover, non-solicitation agreements have the potential to limit both the former employer’s and the new employer’s ability to serve the customers previously serviced by the former employee, placing the former employee in the uncomfortable position of having to tell long-time customers that, while he or she may be willing to service their needs, the new employer might not be able to serve those needs because of the terms of the non-solicitation agreement.
Negotiation and amendments of these contracts
In negotiating terms or modifying an existing agreement, parties should be seek to adjust the terms of the contract in one of two ways: (1) negotiate a new term or modification or (2) assign the other party to the agreement to amend its terms. When negotiating a new term or modification to the agreement, the parties should first consider if the modification will alter the scope of the original contract. If so, a material change may be to seek a new agreement entirely. Parties should also consider if all terms are still reasonable, even if not altered. As time passes, a once reasonable restraint may no longer be reasonable. When seeking to assign the other party to the agreement to amend its terms, the party should try to get an amendment that limits the scope of the agreement. Seeking to add time to the restraint of trade in exchange for altering or removing some restrictive provision will not be viewed as fair or reasonable. In this situation, the parties should consider sending the other party a proposed amendment and request that they sign it in order to avoid a formal court application.
Examples and case law
Case studies and real-world examples of employers, employees, and former employees involved in disputes over the scope, application, and enforceability of non-compete or non-solicitation agreements help inform the analysis of these agreements.
In Hilton v. Guy, 2016 Tex. App. LEXIS 11881 (Tex.App. – Houston 2016) Hilton had been employed by Guy, a firm that provided high-end residential design and architecture services. Four years after Hilton began his employment, Guy had the opportunity to acquire a competing firm owned by another designer. Through litigation, he successfully delayed this acquisition, with the hope of acquiring the firm later. Four months later, Hilton resigned. He then opened a competing firm and solicited Hilton customers. Guy sought an injunction for the period covered by Hilton’s non-solicitation agreement. The Court of Appeals granted the injunction, noting that the non-solicitation agreement was reasonable for the eighteen months (the period of the non-solicitation agreement) beginning the day after his last day of employment.
In Kravet, Inc. v. Gorman, 2013 WL 3786719, at *1 (S.D.N.Y. July 17, 2013), Gorman worked for Kravet, one of the largest importers and distributors of residential and commercial textiles. In April 2013, he began working for Fabricut, one of Kravet’s principle competitors. Kravet believed that Gorman had taken several customer lists and price schedules with him to his new employer. It sought and obtained injunctive relief from the Court.
The main contention in Gorman was whether Kravet’s customer list constituted "confidential information." The Court explained that Kravet’s customer lists were not "trade secrets." Kravet asserted that the lists were confidential. While the Court agreed that customer lists could be confidential but not necessarily trade secrets, because someone compiled the customer lists by "spending considerable time and money contacting potential customers to determine their businesses and needs," and because the lists contained whole sheets of handwritten notes, it distinguished these customer lists from customer lists that are freely accessible to anyone who makes a purchase. Moreover, Kravet took every precaution to keep its lists confidential (i.e., limit access to listings to customer service representatives, sales associates and marketing staff).
As a result, the Court found it difficult to see how Gorman could have accessed the lists without stealing or misappropriating company property.
From these cases we can learn that the above described non-compete and non-solicit clauses in employment agreements will be valid, where they contain limited geographic scope and are narrowly tailored to protect the employer’s legitimate business interests.
Conclusion and best practices
When entering into and implementing non-compete and non-solicitation agreements, employers and employees should strive to meet the following best practices:
Employers should attempt to narrowly tailor non-compete and non-solicitation provisions to the particular employee and protected interests. The longer, wider, and more general the restrictions, the more likely a court will seek to strike down the restrictions as overbroad. Employees should carefully consider entering into non-compete and non-solicitation agreements for definite time periods (e.g., no more than one year) followed by non-compete and non-solicitation agreements for indefinite time periods. Indefinite time periods necessarily allow courts more leeway to continue to modify and create new restrictions on employee mobility . Employers should consider delineating broad territories in which employees cannot practice or solicit clients. Broad territories may counterbalance overbroad time restrictions and allow for greater enforcement in the face of challenge. Employers should place restrictions on the new employer of competitive employees. Without such a provision, former employees may have significant leeway to practice and solicit clients despite any remaining restrictions. Finally, all parties should work as closely as possible together to collaboratively craft reasonable restrictions so that they can avoid costly and protracted litigation over employment restrictions. Non-compete and non-solicitation restrictions are nothing new. Parties should be able to identify and address their interests and concerns.