Ten Things: Drafting an Enforceable Non-Compete Agreement

For the last several years, non-compete agreements have been under attack in the U.S. by regulators, legislators, and even the courts.  For example, in October 2018, Massachusetts joined states like California, North Dakota, Montana, Idaho, Utah, and others by enacting a law regulating non-compete agreements, including providing for “garden leave” and making them inapplicable to “non-exempt” employees.  Courts do not favor non-competes and will often look for any reason to limit them or invalidate them completely. But, love them or hate them, non-compete agreements are here to stay, and businesses continue to rely on them as one way to protect customer goodwill along with confidential and proprietary information.  See, for example, the recent battle between Google’s Waymo unit and Uber over Anthony Levandowski and the theft of self-driving car technology and know-how.  Still, it’s clear that the forces fighting against non-competes are stronger than ever.  For example, there is legislation pending in Vermont to ban all non-compete agreements, and at the federal level to ban them for low-wage workers.  Which is why it’s important for in-house counsel to take every step possible to ensure the non-compete agreements used by their companies have the best chance of surviving regulatory and judicial scrutiny.  This edition of “Ten Things” discusses some tips on how to draft an enforceable non-compete agreement:

1.  What is a non-compete agreement?  A non-compete agreement is a contract entered into by an employer and an employee whereby the employee agrees that if their employment terminates (usually for any reason), then the employee will not – for some period of time and within some geographic boundary – compete directly with or go to work for a company that competes directly with the employer.  It’s easy to see the problem here: how do you balance the employers’ need to protect itself from a former employee using information they learned as an employee against them vs. limiting an individual’s ability to become gainfully employed after they leave that employer.  In general, most U.S. courts will enforce non-compete agreements if they are reasonable as to geography and time and there is a legitimate business interest at stake.  The key to drafting an enforceable agreement, therefore, is balance.

2.  Keep the group small.  If there is one thing that has drawn the ire of governments and regulators it’s the extension of non-compete agreements to all the employees of a company, including administrative assistants and minimum wage workers (think counter help at a fast-food restaurant).  One of the first things a court will look at when reviewing a non-compete dispute is whether the employee has access to sensitive customer information and/or any other specialized or confidential information that could harm the employer if that employee started their own competing business or went to work for a competitor.  Consequently, your non-compete agreements should be tailored to applicable employees and their particular circumstances.  To do so, focus on:

• The employee’s role in the company
• The nature of the company’s business
• The industry your company competes in
• Any specialized training or sensitive information the employee has access to
• Access to and relationships with the company’s customers

You should set out the specific business interest(s) you are trying to protect in the employee agreement.  If your company requires boilerplate non-competes from every employee, you are just setting up false hope of enforcement and creating a situation where your company will look silly in front of a judge.  Instead, focus non-competes on the smallest group of individuals needed to reasonably protect the company and tailor the agreements to their specific role.  By doing so, one of your arguments to the court will be your restraint and selectivity in requiring non-competes, making your case stronger when you do seek to enforce one.

3.  Keep the restrictions reasonable and narrow.  In addition to looking at the nature of the employee’s job, courts will review a non-compete to ensure it does not interfere with the public interest (as set out in state law/state court decisions) or impose an undue hardship on the employee.  Part of this analysis includes reviewing the non-compete agreement for reasonableness as to geography and time.  If either the applicable geography or length of the non-compete restriction is overly-broad, the court will not enforce the agreement.  For example, a world-wide, five-year non-compete is unlikely to survive.  Even more so if the list of companies the employee cannot work for is long (based on the definitions of the agreement).  Your non-compete stands a much better chance if the restrictions are narrowly drawn to the minimum necessary to protect the company.  A one-year (or 18 month) non-compete, limited to the state/geography where the company is based/competes and limited to the same type of job the employee held at the former employer will likely withstand scrutiny.  The shorter and narrower you can draw the non-compete restrictions, the better.

4.  Provide consideration for the agreement.  A non-compete, like any other contract, requires consideration to create a valid, enforceable agreement.  If you require your narrow set of employees to sign your non-compete as part of their initial job offer, that is sufficient consideration.  If you attempt to require an existing employee to sign a non-compete else they lose their job, that is not sufficient consideration.  But, if the agreement is part of a promotion, stock grant, special bonus payment, or similar offering, then it would count (because some new is being offered to the employee).  Just know that the court will likely spot a sham promotion, one share of stock, or a $10 bonus payout as your attempting to circumvent the consideration requirement.  Playing games is not the route to take.  Most importantly, be sure to set out the consideration provided in exchange for the non-compete in the body of the agreement.

5.  Get it in writing.  A little basic, but if your non-compete agreement is an oral agreement, you will have a very difficult time enforcing it.  Likewise, relying on the minimal common law rights around non-competition vs. a clear contractual obligation is playing with fire.  Any desire to have your employees subject to a non-compete should always be set out in writing and signed by both parties.  Additionally, strongly consider including a provision that gives the employee time to consult with an attorney to review the agreement before a signature is required (and have a place for the employee to initial that section).  This will help with enforcement should the need arise.

6.  Prepare multiple versions if necessary.  Utilizing a single non-compete template is a bad idea unless your employees work only in one state or one country and work under similar circumstances.  Otherwise, be prepared to customize your non-compete template based on the laws of each jurisdiction where your employees work.  The situation you want to avoid is having one template and then finding out it’s unenforceable somewhere when you actually need to enforce it.  Since the laws of different states are not uniform on non-competes (the same is true at the country level), it is well worth the incremental cost to do the research to ensure that your non-compete agreements comply with all applicable laws of the relevant jurisdictions.  For example, with very limited exceptions, you cannot use non-compete agreements in California.  So, asking employees based in California to sign your non-compete template is a waste of time.  Likewise, if you have employees in foreign locations odds are high that your non-compete template isn’t worth much unless you have tailored it to the laws of that country.

7.  Concede choice of law/forum.  As should be clear, courts are looking for reasons to invalidate non-competes.  One issue that should get extra attention is choice of law and choice of forum.  Typically, companies want to make enforcement of a non-compete as painful as possible for the employee.  Why should they cut her any breaks?  The problem is that if enforcement of your non-compete requires the employee to travel long distances at their expense (time and money) or if it imposes the law of state or country that conflicts with rights that employee would have if the law of where the employee is based applied, you can run into problems.  Remember that the key is balance and reasonableness.  It likely costs the company little (compared to the burden on the employee) to concede choice of law and forum to where the employee is based – you’re already doing business there.  Showing that you have made such a concession, makes your arguments to the judge that much more reasonable and fair.

8.  Provisions to include.  In addition to choice of law and forum, there are some basic clauses that you should include in every non-compete agreement (unless otherwise prohibited by law in the applicable jurisdiction):

• Injunctive relief.  Include a clause that directly provides for injunctive relief as a remedy in the event of a breach.  This clause should also state that if there is a breach there is a presumption of irreparable harm and consent to injunctive relief.  While injunctive relief is important, be sure your agreements also include provisions for the award of compensatory and punitive damages.
• Attorney’s fees.  Your non-compete should provide for an award of attorney’s fees and cost to the prevailing party.  Don’t fall into the trap of drafting a provision that only provides attorney’s fees to the company.  Balance is the key.
• Assignability.  Ensure the non-compete can be properly assigned in the event the company is acquired.
• Reasonableness.  A clause in the non-compete agreement whereby the parties agree that the restrictions are reasonable given the nature of the business and the situation of the parties.  Likewise, include language that the restrictions in the agreement are limited to provide reasonable and fair protection to the employer and do not impose an unreasonable hardship on the employee.  It’s difficult for the employee to argue otherwise when they have signed up to this type of language (more so when they were provided with the chance to have counsel review the agreement).
• Properly define “company.”  Another solution to the acquisition problem is to simply define “company” to include successors and assigns.
• Return of confidential information.  Seems silly but be sure to include a provision that requires the employee to return all of the company’s confidential information (including hard and soft copies and derivations).
• Savings clause.  A savings clause is a clause that states if a court of law should render any clause in the non-compete invalid, the remaining clauses survive intact.  This is likely more effective in a “blue pencil” jurisdiction, i.e., one that allows the court to rewrite provisions of a restrictive covenant to comply with the law or public policy.
• Extension of term upon breach.  Include a provision that extends the term of the non-compete in the event the employee breaches it.

Additionally, consider utilizing other types of agreements that might be less draconian than a non-compete but provide some of the same protections, i.e., non-solicitation agreements (customers and employees) and non-disclosure agreements (preventing the employee from using, releasing, or discussing confidential information of the company).  These agreements do not find the same hostility in court and with the public (but they are facing some problems in California).  Plus, you can have all employees sign these types of agreements with little concern the agreements are invalid.

9.  Be prepared to enforce it.  Having the right type of non-compete agreements in place is one thing, but nothing puts people on notice about the consequences of violating them like knowing you will file a lawsuit to enforce the agreement.  If you’re going to use non-compete agreements, you must be prepared to enforce them in court.  The best way to be prepared is to have counsel ready in each jurisdiction where you would seek to enforce your non-compete agreements.  They should be familiar with your business and the agreements and should have shell pleadings prepared in advance.  The reason for undergoing this level of preparation is because the first step in enforcing a non-compete agreement is seeking a temporary restraining order where time is of the essence.  If you roll into court a week after the employee has started competing against you or joined a competitor, it’s difficult to argue irreparable harm when you took your sweet time getting in front of a judge.  But, if counsel must learn your business, learn your non-compete, and prepare it all from scratch on the day a problem arises, that’s exactly what can happen.  As the Boy Scouts say, “Be Prepared.”

10.  Have a chat with the executive team.  In a vacuum, all the above makes perfect sense.  But in-house lawyers don’t operate in a vacuum.  They usually must deal with the whims and expectations of the senior executives.  Without knowing better, senior management will want you to put every employee under a non-compete, make the agreement as one-sided as possible, and use one version everywhere to save money.  Rather than having to discuss the problems with such tactics at the worst possible time (e.g., explaining why you lost the TRO hearing), it’s worth your time to have a meeting with the senior executives (including HR) to explain what’s workable and what’s not when it comes to non-compete agreements.  It can be very helpful to have outside counsel in the room or on the line during such a meeting.  Explaining how non-competes truly work (including highlights from the relevant court decisions for your jurisdictions) and the obstacles these agreements face can save you a ton of grief down the road.  The expected outcome of a meeting like this is clear direction from the business as to how the company’s non-compete strategy will work and – importantly – how it will get funded.  If you don’t have the funding to do the necessary work, your agreements will suffer and likely fail when they are needed most.

*****

Non-competes are an important tool in-house lawyers can use to help protect the legitimate business interests of the company.  While this post is U.S.-centric, the process of evaluating such agreements is the same anywhere in the world.  Resist the urge to draft broad and vague agreements and seeking to impose them on all company employees.  Make sure you are in alignment with the senior executives about what types of restrictive covenant agreements the company actually needs and that everyone agrees on the proper way to limit the use of non-compete agreements to the right employee set.  In the end, be balanced and thoughtful.  Doing so will give your company the best chance of enforcing a non-compete agreement should the need arise.

Sterling Miller

February 13, 2019

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“Ten Things” is not legal advice nor legal opinion and represents my views only.  It is intended to provide practical tips and references to the busy in-house practitioner and other readers.  If you have questions or comments, please contact me at sterling.miller@sbcglobal.net.