Guide to Non-Compete Agreements: Are They Right for Your Business?
By David L. Metzger and Edward M. Richters
This article is intended to provide general information only. It is not intended as legal advice or as a solution to an individual problem. You are encouraged to consult with appropriate legal counsel prior to relying on this document in whole or in part.
Businesses of all sizes are looking increasingly to non-competition agreements as a means to retaining key employees, protecting confidential information and preserving valuable customer accounts. The concept is simple. An employee agrees that, for a specified period of time after leaving the employer, he or she will not compete with or work for a competitor of the employer.
A typical agreement might prohibit Jane Doe from competing directly or indirectly with her employer, ABC Corp., or working for a competitor of ABC Corp., within any New England state, for a 12-month period following the termination of Ms. Doe’s employment with ABC Corp.
Why Have an Agreement?
At first glance, such agreements may seem to make a lot of sense. The sudden loss of a key salesperson, for example, often creates a triple whammy. First, a seasoned member of the sales team is gone, along with her in-depth knowledge of your business, your products, your pricing practices and your customers.
Second, the good will and positive customer relationships that the employee has developed over time are now gone. Third, if the salesperson has been recruited by a competitor, there exists a significant risk that she will be converting your accounts to your competitor’s while you spend considerable time recruiting and breaking in a replacement. Losing an experienced member of management or R&D to a competitor can be equally devastating.
The existence of a solid non-competition agreement can often serve to discourage employees from seriously exploring a jump to a competitor. An employee who thinks that a court may keep him from successfully landing with a new employer, may not risk the leap.
At the same time, the presence of such an agreement may dissuade competitors or their headhunters from “raiding” your staff and cherry-picking your most valuable resources. These days, one of the first questions a savvy recruiter will ask is whether a prospect has signed a non-competition agreement.
Few businesses want to become embroiled in expensive and time-consuming litigation as part of the hiring process – particularly if the agreement looks like it will stand up in court.
Enforceability of the Agreement
The critical question is–does the agreement not to compete look like it would pass judicial scrutiny? If an employee is contemplating a move, the first call is usually to an attorney for an opinion as to the probability of the agreement being enforced by a judge. Likewise, a competing employer, if serious about a potential employee, will consult with an attorney.
In evaluating a non-competition agreement, what will that attorney be looking for (and what will ultimately be evaluated by a judge)? In short–reasonableness and fairness. The interest of the employee, as well as the employer, must be protected and a restriction will be declared invalid if an employee is unreasonably prevented from pursuing his occupation and supporting his family.
Over the years, the Connecticut courts have developed a five-prong test for assessing whether an agreement not to compete is reasonably limited and fair to both the employee and the employer.
In determining the validity of an agreement, a court will consider: 1) whether the length of time that the restriction will remain in effect is reasonable; 2) whether the geographic area covered by the restriction is reasonable; 3) the overall fairness of the protection accorded to the employer; 4) the extent of the employee’s opportunity to pursue his or her occupation if the restriction is enforced; and 5) the extent of interference with the public interest.
Reasonableness of Restrictions
The two most important factors are the time restrictions and geographic scope of a non-competition agreement. For the most part, if those restrictions are found to be reasonable, the other factors will also be resolved in favor of the employer. On the other hand, if either is found to be an unreasonable restriction, the agreement as a whole will be declared invalid.
Time restrictions: An indefinite time restriction will most certainly undermine a non-competition agreement. Generally, the courts have been willing to accept a one to two year restriction without a great deal of concern.
Longer restrictions have been upheld occasionally, but may decrease the chances the agreement will be enforced. Creative drafting of separate provisions for consecutive time periods may increase enforceability, but reduce the certainty of the time restriction that may be upheld as reasonable.
Geographic restrictions:The geographic scope of a non-competition agreement is usually where an employer trips up. To be valid, the employee can only be restricted from working in areas where the employer does business or is likely to do business.
Some agreements specify certain towns, or certain states or regions where the employer does business. Others specify a radius of restriction, such as “within 50 miles of Hartford.” In either instance, overreaching can kill the agreement – even if the employee voluntarily signs it. If the 50-mile radius covers three towns where you do not do business or are unlikely to do business–the agreement may be ruled invalid.
If you declare New England off limits and Maine is not part of your customer base – the agreement may be declared unenforceable. If your restriction covers all of Connecticut, but you only do business in Hartford County and New Haven County, a court may find the entire agreement invalid.
Even if the employer can establish a broad geographic base of business, such as a regional, national or even international clientele, the employee’s ability to earn a livelihood will also be weighed by the courts. All things considered, a restriction covering a large area might be deemed reasonable if in effect for a brief time, while a restriction covering a small area may be reasonable for a longer period.
Unfortunately, judges in most states, including Connecticut, will not rewrite an agreement to make it reasonable, but may strike provisions they find unreasonable. So, it has to be drafted right the first time.
Many employers play it safe, and still provide themselves with ample protection, by limiting the non-competition restrictions to just the customers and territory that the employee covered prior to leaving, or by restricting employment with specified competitors in a specific territory.
Consideration to Employee
If the non-compete agreement is part of the initial employment contract, the act of hiring the individual is a term and condition of hire and there will be adequate consideration. Problems of consideration arise when non-competes are offered to existing employees. Even if the terms of a non-competition agreement are found to be reasonable, they are often challenged on the basis that the employee was not paid any new “consideration” for signing the agreement.
Some courts say that the continued employment of a current employee is adequate consideration. Others say that it is not. The more prudent course is to give the employee some form of compensation that he or she would not be entitled to otherwise.
Although there is no minimum consideration required by the courts, a payment of $500 to $1,000 would be advisable. Some businesses will simply make the next pay raise or promotion or unearned bonus contingent on signing an agreement.
Employees Who Refuse to Sign
What to do with a current employee who refuses to sign a non-competition agreement is also a thorny problem. Can the employee be fired? This is a legal question that remains unsettled. A few courts have said that it is permissible to terminate the reluctant employee, but the issue is still unresolved in most states, including Connecticut. Employers should proceed cautiously in such circumstances.
Although non-competition agreements can be quite valuable and can be crafted to be both effective and legally valid, they can create more problems than they solve and might not be for everyone.
For example, in many instances, the question is not “can you” fire the key employee who refuses to sign, but, rather, do you really want to terminate the employee and actually cause the loss that the agreement was meant to avoid in the first place? What if several key employees refuse? Can you afford to have signers and refusers working side by side?
Do you refuse to hire the star player who refuses to accept an employment offer that includes a non-competition agreement? If an employee does sign the agreement and eventually quits to start a competing business or work for a competitor, are you willing to bring suit to enforce the agreement?
It may be that the employee who does resign to work for the competition does not pose a real threat; and litigation can be costly. Yet, if you let one person get away with ignoring the agreement, will it lose its teeth and be ignored by others?
If you don’t enforce the agreement or only do so sporadically, will a court conclude someday that, since your company apparently does not consider the agreement necessary to adequately protect its interests, the court can find its restrictions to be unnecessary and unreasonable?
Do you want employees to remain with your company against their will? How productive, supportive and loyal will a captive employee be? Which categories of employees will be required to sign? What will the overall impact be on employee morale?
The answers to these questions require a great deal of introspection and “what if” planning–with as much input from line management and human resources staff, as from legal counsel.
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