What Is a Non-Compete Agreement?

Simply put, a non-compete agreement is a written undertaking by an employee not to engage in certain competitive activities following employment, which may include or be limited to the non-solicitation of specific customers.

While a non-compete agreement is considered to be a restraint on free competition, it is lawful if it meets certain requirements. Unfortunately, these requirements vary from state to state, making it more difficult for companies that operate in multiple states and want to use a "one size fits all" agreement. Nonetheless, there are certain common requirements for such agreements to be enforceable.

What Is Generally Required for a Non-Compete Agreement to be Lawful?

Although laws vary from state to state, whether a non-compete is enforceable usually depends on the answers to the following questions:

1. Is the agreement in writing and signed by the employee?

2. Did the employee receive sufficient consideration for signing the agreement?

3. Is the time period of the restriction reasonable?

4. Is the restricted territory in the agreement reasonable?

5. Is the restriction well defined and limited to the protection of a legitimate business interest?

Sometimes employers overreach with their non-compete agreements by making them broader than necessary to protect legitimate business interests. For example, an employer who wants to prevent an employee from calling on the customers the employee contacted while employed may not need an agreement restricting the employee from calling on all customers of the company. Because courts generally view non-competes with disfavor and construe them strictly against the employer, employers should be careful to avoid creating restrictions are greater than the specific need at issue.

Factors to Consider When Drafting a Non-Compete Agreement

To prepare a non-compete agreement that is likely to be enforced by the courts and that will serve to protect customer relationships, companies should consider the following factors:

* State Law Variation - One of the most challenging aspects of drafting and implementing non-competes is the state law variation. Each state has different rules and standards by which they judge the enforceability of restrictive covenants. One "form" non-compete will not work in every state. Be sure to understand the legal nuances of state non-compete law before drafting.

* Changes in the Law - Even in those states where non-competes are enforceable, the interpretation of the law on non-competes continues to evolve. Agreements that were enforceable ten years ago may not be enforceable today, so relying on an old form or failing to update an agreement may prove to be risky.

* The Written Document - Be sure to reduce the agreement to writing and have it signed by the employee. Including the non-compete terms in a policy manual is unlikely to have much chance of success.

* The Employee´s Signature - It is important to get the employee´s signature on the document at the outset of employment. In many states, the failure to have the employee sign the agreement at the outset of employment will doom the agreement unless additional compensation or some other additional "consideration" is given to the employee.

* Type of Restriction Needed - The type of restriction utilized is one of the most important things to consider. The employer must decide what it is trying to protect, such as customer relationships or the goodwill of the company. The employer then must determine the type of restriction necessary to protect those assets, which may vary depending on the type of employee. One restriction may be needed for a salesman, while another type of restriction is needed for a CEO or President. In either case, once the type of restriction is determined, careful attention needs to be paid to the clarity of the restriction.

* Scope of the Restriction - Scope is a term that applies to both time and territory. An employer should use a time period that is long enough to protect the employer but not so long as to be unreasonable. Many courts have found restrictions between 6 months and 24 months to be safe for enforceability, provided the restricted territory is not too broad in scope. When defining the territory, effort should be made to stay focused on the employee´s scope of work for the company. Going too far beyond that scope could create a problem with enforceability.

* Don´t Overreach - Companies should look to protect legitimate business interests, not punish employees who leave. Courts generally will not enforce non-compete agreements without there being a legitimate business interest at stake. For example, if a company is not doing business in Ohio, restricting an employee from competing in every state, including Ohio, would be overreaching.

* Assignment Provisions - Assignment provisions allow employers to assign or transfer the non-compete agreement to a purchaser of the business. Although assignment provisions are not enforceable in all states, including them adds value to a company when it comes time to sell, because the purchaser buys the right to enforce the non-competes against the seller´s former employees.

* Judicial Modification - The last factor to consider when drafting a non-compete is whether a court may modify the terms of the non-compete if it is deemed overbroad. Courts take different approaches to modification. In some states, like Georgia, if one part of the non-compete is overbroad or unenforceable, the entire agreement is void and unenforceable. In other states, like North Carolina, courts will blue-pencil (i.e., strike out) the overbroad and unreasonable term(s) and enforce the remaining terms of the non-compete. Other states, like Delaware, take a more lenient approach toward modification and re-write the terms to be "reasonable" and enforce the modified non-compete. Employers can be more or less aggressive in drafting its employee non-competes once they know what modification method will be applied by the courts.

For more employee information or consultation on employee issues, contact the author, Madeline Baum.