How Effective Are Non-competition Agreements?
Originally published: 07.01.07 by Mike Coyne
Three factors determine whether and to what extent you'll be protected.
You hire the best service technicians that you can find. You provide them with more and better training than any of your competitors provide to their people. You emphasize customer relations, salesmanship, and the importance of developing good relationships with your customers. Then, just as you are about to reap the rewards of your investment in your employees, a couple of your best technician sannounce that they are leaving to open their own shop. How could you have protected yourself from this outcome?
Many business owners believe that non-competition agreements are the answer. However, whether and to what extent a non-competition agreement can protect your business depends upon a number of circumstances. Here's what you need to know about non-competition agreements.
- The enforceability of non-competition agreements is a state-law matter. If you are in California,you are out of luck. In California, non-competition agreements generally are invalid, except in connection with the sale of the business. Many states, however, such as Ohio, are fairly liberal in enforcing such agreements.
- If you are in a state in which non-competition agreements are not illegal, whether and to what extent a court will enforce a non-competition agreement generally depends on three factors: the presence of consideration, the existence of a protectable interest, and the reasonableness of the non-competition terms
- The requirement of "consideration" means that an employee must receive something of value in exchange for his or her promise not to compete. If an employee signs a non-competition agreement before beginning work with an employer, the promise of the job probably is sufficient consideration for the agreement. If you ask an employee to sign a non-competition agreement after employment has already begun, then you may have to provide additional consideration, such as a bonus or promise of a promotion. (However, some state courts hold that continued employment is sufficient consideration to allow for enforcement of a noncompetition agreement.)
- The need for a "protectable interest" means that an employer must have an interest to protect. Generally, the courts acknowledge that an employer has a legitimate interest in protecting its relations with its customers and in preventing a former employee from taking advantage of relationships or information acquired in the course of employment. There are circumstances, however, where an employer will not be able to show a protectable interest. For example, consider an employer that has retail-sale locations located in two cities about 30 miles apart. If the employer closes its retail outlet in one of the two cities, it likely will not be permitted to enforce a non-competition agreement in the city in which the retail outlet was closed. This is because the employer no longer has a protectable interest in that city.
- Perhaps the most important factor considered by courts is the "reasonableness" of the restrictions placed on the employee. As a practical matter, the courts will consider three factors: the length of time that a restriction is in place, the geographical area in which competition is prohibited, and the nature of the activities that are prohibited by the non-competition agreement. In our experience, courts generally are unwilling to enforce non-competition agreements that are intended to be in place for more than 12 months, unless an employer can demonstrate that a longer term is absolutely necessary to protectits interests. Likewise, courts will enforce a geographical restriction only to the extent that the restriction is reasonably necessary to protect the employer. If a geographical restriction is written in a fashion that appears to be intended to "punish" a former employee, the courts likely will throw it out. In some states, rather than completely invalidate a geographical restriction or time restriction, the court will use its discretion to reduce the size of the geographical restriction or duration of the agreement.
If you think you need non-competition agreements to protect your business, you'll need toget some legal help and follow these guidelines:
- Draft a non-competition agreement as narrowly as possible. Make the time and geographical restrictions the minimum necessary to protect yourself. Include language that demonstrates the need for protection.
- Consider other contractual provisions that can help protect your business. For example, a non-solicitation provision that prohibits your former employees from contacting your customers for a specified period of time may be more effective than a non competition agreement in protecting your business relationships.
- Consider a contractual provision that prohibits your former employees from hiring any of your current employees for some period of time after termination of employment.
- Include a confidentiality provision in your employment contracts that specifically prohibits employees from taking customer lists and other business property upon termination of employment.
- Don't require all of your employees to sign non-competition agreements. The agreements are most important for employees who have sufficient information about your business and sufficient skills to set up a competing business.
Michael P. Coyne is a founding partner of the law firm, Waldheger Coyne, located in Cleveland, Ohio.For more information on the firm, visit www.healthlaw.com, or call 440-835-0600.
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