3PL Perspectives
Hillary Arrow Booth | Booth LLP
Heather C. Devine | Alexander Holburn Beaudin + Lang LLP
James T. Smith | Huffman, Usem, Crawford, Greenberg & Smith, P.A.
Non-compete agreements are generally used in employment contracts to ban former employees from going to work for, or starting, a competing business, or soliciting customers, within a certain period of time and within a certain territory. Given that non-competes limit the ability of individuals to obtain employment or start businesses, it is not difficult to understand why non-compete provisions are often the subject of disputes and require the balancing of competing polices.
Despite the uncertainty and cost of enforcement, the Economic Policy Institute estimates that somewhere between 28% and 47% of private sector workers are required to enter into non-competes. Approximately 32% of the respondents to its survey stated that all employees must sign such agreements, while others reserve non-competes for executive- and management-level employees. The data, compared to an earlier survey in 2014, indicates that the use of non-competes is growing.1
Most states allow some form of non-compete agreement, and will provide a means of enforcement. However, California, Montana, North Dakota, and Oklahoma totally ban non-compete agreements for former employees, and allow them in only limited circumstances, such as when a business interest is sold. Despite the ban on non-compete agreements in these states, they remain common as businesses still try to use them to pressure employees into not going to work for competitors. Even though these states ban non-compete agreements, they provide protections for trade secrets, and will prohibit former employees from improperly using trade secrets to compete with their former employer.2 For example, if the employer demonstrates that the former employee is using trade secret information to solicit customers, courts will permit enforcement to protect the former employer’s trade secrets.
While businesses continue to increase the use of non-competes, state legislatures continue to restrict their permitted uses. As examples, Maine, Maryland, New Hampshire, Washington, and Illinois have recently passed laws prohibiting employers from entering into non-competes with employees earning less than variously stated levels of income, generally reserving non-competes to only the higher wage-earning employees. Additionally, as of mid-2019, other states had bills pending that would also prohibit the use of non-competes with lower-wage earning employees, including Hawaii, Indiana, Missouri, New Jersey and Pennsylvania.
The majority of states will—in theory and often in practice—enforce non-compete agreements subject to certain considerations, and if reasonable. Each of these states has its own intricacies and policies for how to form a valid non-compete, what constitutes “reasonable restrictions” and what constitutes sufficient consideration to justify the agreement. While the laws of each state must be consulted, it is helpful to understand the themes applicable in most states, which highlight the difficult task of balancing the competing interests of employer and employee. Three of these themes deserve highlighting: (1) non-compete enforcing states generally require non-competes to be reasonable in their time and covered territory; (2) non-compete restrictions should be reasonably necessary to protect legitimate business interests; and (3) non-compete restrictions should not place an undue hardship on the employee, so as to remove that employee’s ability to earn a living.
While a detailed analysis is outside the scope of this article, as an example, consider the second “protection of legitimate business interest” theme—which is most often the center of litigation. To determine whether a geographic restriction is reasonable, courts will typically consider the area the employee worked, the nature of the business, the nature of the employee’s duties and responsibilities, and the employee’s knowledge of the employer’s business operation. While this task is daunting, the key principles are reasonableness and fairness to the competing interests. The larger the protection sought, the higher the scrutiny and greater the need to connect the protection to legitimate business interests.
Non-compete agreements designed to keep an employee from leaving or from working in a capacity unrelated to the capacity previously worked, will not likely be viewed favorably by the courts. In 2018, the Minnesota Court of Appeals made this point, noting the unenforceability of non-compete agreement where the evidence suggested an employer’s “motivation for the restrictive covenant was not to protect its legitimate interests in preventing unfair competition, but to protect its ‘investment’ in [the employee] by forcing him to remain with the [employer] for a long time.”
To determine whether a geographic restriction is reasonable, courts will typically consider the area the employee worked, the nature of the business, the nature of the employee’s duties and responsibilities, and the employee’s knowledge of the employer’s business operation.
Courts in states where non-competes are enforced generally fall into three categories that may be loosely labeled as reformation, blue pencil and red pencil states. The vast majority of states today are “reformation” states, meaning a court will generally attempt to equitably rewrite the agreement to be consistent with the parties’ original intent as modified by the law under a rule of reasonableness, where possible. New York and Texas are examples of reformation states. A handful of states fall in the “blue pencil” category, meaning a court may attempt to rescue a portion of the contractual provision by striking out the portion of the clause that renders it unenforceable. Connecticut and North Carolina are general examples of “blue pencil” states. It should be noted that “blue pencil” is often used to refer to an expanded version of the “reformation state” standard and some “blue pencil” states only allow modifications if the agreement authorizes such practice. Lastly, the “red pencil” label generally refers to states which have an all or nothing approach. A court in a “red pencil” state may nullify the entire non-compete agreement if one of the provisions does not comply with that state’s law. South Carolina and Wisconsin and are general examples of “red pencil” states. It is important to draft a non-compete with the knowledge of how a state will interpret and enforce it.
Canadian businesses, or those having operations in Canada, need to consider Canadian laws, and understand that many U.S. drafted non-compete agreements are unenforceable in Ontario, often because they are overly broad or punitive. Because non-compete agreements limit the ability of former employees to compete with the business by restricting where the former employee can work and by limiting what employment or work activities the departing employees can engage in, these agreements can be difficult to enforce. Generally, Canadian Courts will balance the former employee’s right to work in their field, with the policy of free and open business. To be enforceable, a non-compete agreement must be reasonable and limited in (1) geographic scope; (2) length of time the clause is valid (usually 3-6 months); and (3) the type of activities prohibited. One form of a non-compete is a non-solicit agreement that prohibits employees from soliciting customers of their former employer. When crafting these agreements, it is best to ensure that the customers who are prohibited from being approached are identified in the agreement (usually as a schedule to the employment agreement), and that the prohibition should be time limited to be enforceable as well (usually 3-6 months).
Because of the worldwide COVID-19 restrictions, valuable and talented employees may have become accustomed to working in a different environment: whether remotely, or with increased responsibilities, or perhaps more freedom. Consequently, some businesses are learning that their talent is feeling less connected to the business, and therefore more likely to leave for more lucrative opportunities, or simply a change. In the event of the loss of a key employee, it is very helpful to be able to rely upon non-compete agreements which clearly set out what will happen when the employee and business part ways. Before that happens, employers should review their employment agreements and take precautionary steps:
• Check to see if provisions regarding non-competes, restrictive covenants, non-solicitation, and protection of confidential information are included.
• Where non-competes are included, understand how broad they are, how they will work in practical terms, and determine what activities they restrict or prohibit and how.
• Verify that the agreement defines and identifies the extent of protection for confidential information. Because this is the most useful and enforceable protection in a non-compete, employers need to designate what information is confidential, and be able to readily identify it in a dispute.
• Ensure that the protection of confidential information survives the termination of the agreement.
• Determine whether the agreement provides for injunctive relief (in addition to damages) if confidential information is taken from the business, as this may enable the business to obtain urgent injunctive relief for the return, destruction, or protection of the confidential information.
References
1 See epi.org, Non-Compete Agreements, December 10, 2019.
2 A full discussion of trade secret law is beyond the scope of this article.
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