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What Is a Noncompete Agreement?

Noncompete agreements can help business owners protect their interests. These agreements are also called restrictive covenants or covenants not to compete. The purpose of a noncompete agreement and noncompete clauses between an employer and an employee is to ensure that the employee can't take confidential information that they learned during their employment to a competitor.

A noncompete agreement could benefit your small business if employees or independent contractors gain information about your processes and techniques. When workers leave, you don't want them to take your information to a competitor who can use it to gain a competitive edge. The employee could also use the information to become your competitor if you don't have a noncompete contract.

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Key Takeaways

  • Noncompete agreements keep workers from competing with their employers. This is during the employment and after. It only lasts for a limited time after their job ends.
  • Noncompete agreements are not always separate documents. Sometimes, you will see noncompete clauses in an employment contract.
  • Some businesses require their independent contractors and consultants to sign noncompete agreements.
  • Enforcement of noncompete agreements varies by state. Employment laws in states like California prohibit them. This means the agreements or clauses are unenforceable.
  • Some agreements may include nonsolicitation agreements. This allows businesses to stop ex-workers from contacting other employees or using client lists from the company.

How Noncompete Contracts Work

Many businesses have confidential information that they protect because of its value. This information could relate to intellectual property, processes, or techniques for making a product or providing a service. Privileged information or trade secrets are only valuable if they are unknown to competitors. When competitors have this information, they can use it to their advantage.

Employers use noncompetition agreements and clauses to ensure that employees don't take the information they learned on the job to a competitor for a certain period of time. Most noncompete provisions prohibit employees from working for a competitor within a geographic area for a particular period.

This helps to protect an employer's information, but it limits worker mobility. For this reason, the terms must be reasonable. It's also crucial that the employer has a legitimate business interest, such as protecting intellectual property, client lists, and sensitive information.

When Are Noncompete Agreements Useful for a Small Business?

There are quite a few reasons for a small business to consider noncompete agreements or noncompete clauses:

  • Before the pending sale of the business, your employees cannot compete against you and devalue the company during the sale
  • Before a merger or acquisition of the company
  • When the company pays tuition or class expenses for an employee, this helps keep the talent within the company for a set amount of time or prevents them from competing after they leave.
  • For a new startup or a business with an innovative idea or process
  • When a company has experienced high growth and is looking to continue to expand its market locally or internationally

How Courts View Noncompete Agreements

If an employee signs a noncompete agreement but breaks the deal, the employer may sue the former employee. Courts carefully examine noncompete clauses to determine if they will enforce noncompete agreements.

Courts look to the following factors to determine if a noncompete agreement is valid:

  • Duration: The period of time during which the noncompete provision is effective. It must be reasonable. Your state courts determine what time frame is reasonable. For example, Louisiana and Florida find two years to be the maximum time.
  • Geographic Location: The geographic area covered by the noncompete provision must be reasonable. Consider a small business operating in Louisiana with no business in California. A court will likely find its restriction of a former employer working for a competing business in California unreasonable.
  • Type of Work: The kind of work the employee is prohibited from doing should be limited to the employer's specific field.

Why are the courts concerned with the duration and scope of noncompete agreements? The courts recognize that small-business owners are interested in protecting the information that keeps them in the market. Workers also have the right to earn a living.

If the noncompete provisions are too broad, the former employee may not be able to get another job in their field for several years. This could cause talented people to leave their industries to find work. The courts balance the interests of the employer and the employee when they assess noncompete agreements.

Validity of Noncompete Agreements

For a contract to be valid, parties to it must exchange something of value. This means the employer and the employee must get something of value from the noncompete agreement. Employment can be the thing of value that the worker receives from the contract before starting the job. The employer must provide additional benefits if the worker has already started employment.

For example, the employee could receive a raise or a bonus. If the courts find a noncompete provision invalid, they might not enforce the agreement. The courts might make changes to the agreement instead.

Suppose an individual signs a noncompete agreement as a condition of employment with a software company. The employer is based in Memphis and only does business there. The noncompete agreement states that the employee can't work in the software industry in any state for six years after their employment ends.

One year after the employee left the company, he worked at a software company in North Carolina. The employer sues the former employee for violation of the noncompete agreement. The court may view the duration and geographic scope of the noncompete provision as too broad.

In a case like this, the court may not enforce the noncompete agreement at all. The court may not strike the whole contract, though. Instead, it may narrow the duration and scope of the noncompete provision to make it reasonable.

How State Laws Affect Employment Agreements

Laws on noncompete agreements vary from state to state. In some states, like North Dakota, noncompete agreements are not enforceable. California takes an even stronger stance against noncompete agreements. In California, employees can sue an employer for requiring them to sign a noncompete agreement. As of October 2023, those agreements are now illegal.

Some states only allow noncompete agreements if they meet specific standards. Talk to a business lawyer to know the laws in your state on noncompete agreements.

High-Level Employees and Low-Level Employees

Consider the type of information that different types of workers gain working. Senior or high-level employees are more likely to learn more than lower-level employees. They learn more confidential business practices, techniques, and processes.

When a court considers a legitimate business interest, they look at the type of information the employee gains from employment. If the employee's duties don't give them access to confidential information, it may be hard to show a legitimate business interest.

Noncompete Agreements and Nondisclosure Agreements

You might wonder if noncompete and nondisclosure agreements are the same. Business owners use both types of agreements to protect their interests. There are differences.

A noncompete agreement prohibits a former employee from competing with the employer. A nondisclosure agreement prohibits employees from sharing confidential information. This includes customer lists or trade secrets.

A nondisclosure agreement doesn't affect worker mobility or ability to work for a competitor. This means an employee who only signs a nondisclosure agreement may be free to work for a competitor.

It may be easier to enforce a nondisclosure agreement than a noncompete agreement. This is because nondisclosure agreements don't limit the employee's job mobility. With a nondisclosure agreement, there is less concern that the employee will be harmed. For this reason, it could be a good idea to use a nondisclosure agreement instead of a noncompete agreement in some cases.

Feeling Unsure About Noncompete Agreements? Contact a Local Attorney

There are many ways for small-business owners to protect their information. You may want to think about the best way for you to go about protecting your business.

Don't hesitate to ask for legal advice if you're unsure whether a noncompete agreement is for your small business. A skilled employment attorney can review your facts and situation if you signed a noncompete agreement.

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