Creating an Enforceable Non-Compete Agreement
Today's increased job mobility and the amount of information available online have led many small businesses to turn to non-compete agreements (NCA). A valid agreement can protect trade secrets and other valuable assets. A well-written agreement can limit a former employee's ability to start a competing company or steal clients when they leave.
However, a poorly written agreement is unenforceable and can open the business owner to legal action or civil penalties. Many state laws no longer honor non-compete contracts or only allow them in very narrow circumstances.
If you believe your business needs a non-compete agreement, read on to learn how to write one that is enforceable. If you live in a state without enforcement, there are alternatives to these agreements that can protect your confidential information.
How Non-Compete Agreements Protect Your Business
In general, a non-compete agreement is part of your employment contract. You should include the non-compete clause with the contract or employee handbook when a new worker joins the company. You can also have the worker sign later and add it to their personnel file.
An NCA states that workers cannot reveal confidential or proprietary information they learned while in your employ. It may also prevent an employee from competing with you in other ways, such as:
- Working for a competing business for a certain period of time or within a specific geographic distance
- Starting a similar business with similar client lists
- Providing related services or products as an independent contractor
Small businesses have a legitimate interest in keeping their competition low, especially when the competitor knows about their business operations. However, there are some concerns about NCAs you should keep in mind before writing your own non-competition agreements.
Unfair Trade and Non-Compete Agreements
The Federal Trade Commission (FTC) views NCAs as potential restraint of trade. They result in lower wages and decreased innovation. In 2023, the FTC proposed a rule that would ban all non-compete clauses and contracts and rescind all existing NCAs.
The FTC's position stems from NCAs that prevent former employees from working following mass layoffs. Most FTC cases have involved large corporations with NCAs that were too long or had too many geographic restrictions.
In a recent case, the FTC sued a glass company whose NCA lasted one year. It defined competitors as any company making rigid packaging products the same or substantially similar to the manufacturer's. The geographic area covered all of America. The FTC held this meant all the company's workers would be unable to work during the year the NCA was in effect.
States and Non-Compete Agreements
California, Minnesota, North Dakota, Oklahoma, and Washington D.C. have completely banned enforcement of NCAs. Nine other states (Colorado, Illinois, Maine, Maryland, New Hampshire, Oregon, Rhode Island, Virginia, and Washington) only enforce non-compete agreements for employees above a certain earning threshold. For instance, Colorado's law only applies to workers making more than $101,250 per year.
Businesses in these states must use other methods to protect intellectual property and other sensitive information. State courts recognize that there is still a need to protect valuable assets. After all, Silicon Valley in California, one of the first states to abandon non-compete agreements, is the heart of technological innovation. Rather than blanket NCAs, businesses must use narrower, more specific devices to guard their trade secrets.
- Non-disclosure agreements: A nondisclosure agreement restricts the movement of the information. An NDA provides legal grounds for action against the employee if they use the information. It does not otherwise limit the worker's right to work.
- Non-solicitation agreements: In industries that rely on customer lists, a non-solicitation agreement can ensure that a former employee will not take clients with them when they leave. These agreements don't stop workers from going elsewhere. They stop them from bringing their customers with them to their new businesses.
- Restrictive covenants: A restrictive covenant is a clause in a contract that limits the rights of the signer in some way. As long as they are not overly restrictive and do not infringe on a worker's other rights, they can protect you like a non-compete agreement.
- IP assignment: Some technology companies include clauses in their employment contracts that automatically assign ownership of all inventions or designs made by the employee during the course of employment to the company. There's no issue of stolen trade secrets because the company owns everything already.
If you live in a state that enforces NCAs, ensure your agreement follows the strict requirements that make it enforceable.
Creating an Enforceable Non-Compete Agreement
Courts frown on NCAs because they limit an employee's ability to work. In general, the narrower and more specific your agreement, the better chance it has of standing up in court. Most human resources specialists agree that the sooner you inform employees about your agreement, the better. Signing a non-compete agreement should be part of the onboarding process.
Some experts suggest limiting NCAs to employees who have contact with confidential information. For instance, a tech company can have agreements for software developers to protect intellectual property but would not need them for office staff.
Other important considerations include:
A Clearly Defined Business Reason for Your Agreement
Trade secrets, intellectual property, and proprietary information are acceptable reasons for having NCAs. Limiting your workers' job options after they leave your employment is not. This is a reason why California and other states prefer NDAs to NCAs.
Clearly Defined Limits to Your Agreement
Look at the case brought against the glass company by the FTC. Although the agreement ran for only a year, it prohibited the workers from working in any glass manufacturing company anywhere in the U.S. Be sure your own agreement:
- Runs for a brief length of time: A year is the most any state considers reasonable.
- Does not unrealistically limit the geographic area: This may be location-dependent. For instance, in a large city, a 25-mile radius may be reasonable. In a rural location, such a restriction may mean the employee has to relocate to a different county.
- Does not prevent the employee from obtaining gainful employment in the industry: In highly specialized fields, this may be tricky, but you should do your best. Courts will not enforce a non-compete agreement that prevents a worker from getting a job.
Ideally, your agreement should explain what the employee can do as well as what they cannot. For instance, if you are a medium-sized accounting firm creating an NCA, your agreement would allow employees to work for large firms because they are not your competitors.
Clear Benefits for the Employee
If the employee is a new hire, a non-compete agreement is not a problem since the benefit is the job itself. If you are having workers sign later, such as C-suite executives, there must be consideration or some other bonus for signing.
Getting Legal Help With Your Non-Compete Agreement
Your non-compete agreement must protect your proprietary information. It must also give maximum freedom to your departing workers. Before putting any non-compete agreement before your employees, have it reviewed by an employment law attorney near you to ensure it is enforceable.
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