Covenants Not To Compete: Protection for Your Business

Are you concerned that one of your best employees will leave to join a competitor? Once there, the employee will use inside information to help a rival. Your worries may be eased if the employee signs a "covenant not to compete" as part of an employment agreement. The covenant (also called a "non-compete clause" or "non-compete agreement") is enforceable against a departing employee as long as certain conditions are met.

Usually, an employer requires employees to sign the covenant as a precondition of employment. But it may also be used as a release for an employee to receive severance pay after termination of employment or pursuant to the sale of a business or issuance of stock options. Caution: The covenant cannot be overly restrictive. For instance, your company generally can't prevent a former employee from pursuing a living anywhere in the same industry.

Laws regarding non-compete covenants vary from state to state. For example, courts in California reject non-compete agreements because state law makes them unenforceable except in limited circumstances. Because non-compete covenants are generally not allowed in California, employers there often use confidentiality agreements and other types of contracts to protect trade secrets and other information.

Still, non-compete agreements are allowed in many jurisdictions. In order for a non-compete covenant to be legally enforceable, it must be in writing, part of a contract and an employer must be able to demonstrate the following:

1. The agreement is supported by "consideration" at the time of signing. In essence, this means that the employee must receive something in value in return for the promise not to compete. When a covenant is signed prior to hiring, the employment itself is the "consideration." However, if an employee signs a covenant not to compete upon termination, it generally requires some form of severance or other benefits.

2. The agreement protects a bona fide business interest. Although the exact definition of a legitimate business interest is controlled by state law, this requirement usually reflects the need to retain valuable customer relationships and/or to shield proprietary information from the competition. For instance, a covenant not to compete may prohibit an ex-employee from soliciting the company's main clients. Similarly, the covenant may prevent a departing employee from revealing vital information about the company's business model. Note: An employee already has a duty not to disclose proprietary information, but the covenant makes it easier to enforce.

3. The agreement must be reasonable in scope. The third requirement is more difficult to pin down and often results in disputes that proceed to the courts. The outcome generally depends on the specific services provided by the employer and interests that are at stake. For example, a court is unlikely to restrict an ex-employee from working in a geographic area where the employer doesn't do business, although limitations may be imposed if the employer has clients in those areas. The duration of the agreement is also a key factor. If the covenant extends beyond three years, it may be suspect.

When a legally enforceable covenant is breached, the court may issue an injunction against the employee, prohibiting any further action. It may also assess damages for losses caused by the breach.

Remember that an employer is usually in a stronger bargaining position before employment begins. Include this type of covenant in employment agreements, especially with high-profile employees, for greater protection. Consult with your attorney about agreements to ensure they are enforceable.