United States: Tailoring Non-Compete Agreements to Enhance their Enforceability

This article was published in the August 2008 issue of SuperVision, The Magazine of Industrial Relations and Operating Management.

I. INTRODUCTION

Many companies utilize non-compete agreements in order to prevent their employees from working for a competitor while they are still working for the company, or for a period of time after leaving that employment. Because courts often look with disfavor on non-compete agreements, it is important that companies carefully draft these agreements in order to ensure their enforceability. The law governing the enforceability of covenants not to compete varies from state to state. Therefore, in order to increase the chances that a non-compete agreement will be enforced, you must be sure to plan ahead, draft the agreement with specificity and be certain that the agreement is supported by adequate consideration.

II. PLAN AHEAD

Proper planning is the first step in creating an enforceable covenant not to compete. Courts are more likely to enforce non-compete agreements that are tailored to the company's specific needs. Therefore, before drafting a non-compete agreement, you must identify the interests that your company seeks to protect through the non-compete agreements. The planning process also must include a review of the applicable state law in order to ensure that the agreement will be held enforceable by the courts of that state.

A. Identify the Objectives of the Non-Compete Agreement

Before drafting a non-compete agreement, the first question you must ask yourself is, "What are the interests that the company is entitled to protect with respect to this particular employee?" It is crucial that you first determine what specific activity or activities the company seeks to deter the employee from performing with another organization.

B. Be Aware of the Applicable State Law

After identifying the interests the company seeks to protect through the use of a non-compete agreement, you must become familiar with the applicable state law regarding such agreements. It is important that you know whether the state legislature has enacted a statute limiting the enforceability of non-compete agreements; what geographic and time durations have been found to be reasonable by courts in that state; and what public policy considerations should be addressed in your agreement.

Approximately one-third of the states have enacted legislation that directly address non-compete agreements, and other forms of restrictive covenants, including Alabama, California, Colorado, Florida, Hawaii, Illinois, Louisiana, Massachusetts, Michigan, Montana, Nevada, North Dakota, Oklahoma, Oregon, Texas, South Dakota and Wisconsin. Although the particular statutes of each state may vary, most permit non-compete agreements to the extent that they are reasonably necessary to protect a company's legitimate interests.

Statutes in Hawaii, South Dakota, Texas and Wisconsin permit non-compete agreements, so long as they are reasonable and necessary. The statutes of Alabama, California, Florida, Louisiana and Michigan specifically prohibit non-compete agreements, except those that prohibit an employee from engaging in a similar business within a reasonably limited time period and geographic area. Louisiana limits the duration of a reasonable non-compete agreement to a period of two years.

In Oregon, the statute provides that non-compete agreements are void unless entered into at the inception of employment or subsequent to a bona fide advancement of employment.

The Colorado statute voids non-compete agreements, except for those that protect trade secrets, provide recovery of education and training expenses for employees who have been employed for less than two years and those that were executed by executive/management personnel and their professional staff.

States in which the legislature has not addressed the enforceability of non-compete agreements generally apply the common law rule regarding restrictive covenants, as stated in the Restatement (Second) of Contracts, Sec. 188. Under the common law, a non-compete agreement that is ancillary to an otherwise valid transaction or relationship will be enforced to the extent that it is no greater than necessary to protect the company's legitimate interests, and if the company's need to protect its legitimate interest is not outweighed by the potential hardship to the employee or likely to cause injury to the public.

You should also be aware of whether or not state courts will "blue-pencil," or modify, non-compete agreements to enforce the reasonable provisions of an agreement, while at the same time refusing to enforce unreasonable provisions. The Texas statute specifically allows courts to reform a non-compete agreement that contains unreasonable limitations as to duration, geographic area or scope of restricted activity to the extent necessary to create reasonable limitations, and enforce the altered agreement. Other states, such as Georgia, prohibit blue-penciling, and will not enforce a non-compete agreement if any of its terms are unreasonable. MacGinnitie v. Hobbs Group, LLC, 420 F. 3d 1234 (11th Cir. 2005).

III. DRAFT WITH SPECIFICITY

Determining whether a non-compete is reasonable requires a balancing of the employer's interests against the interests of the employee and the public, in order to ensure that the restraint is neither overly harsh nor oppressive to the employee, and does not cause injury to the public. Determination of the reasonableness of a non-compete agreement also requires an analysis of whether the restraint is no greater than necessary to protect the company's legitimate interests.

Generally speaking, over-broad non-compete agreements that prohibit an employee from performing any work for a competitor will not be enforced. In order to be enforceable, the non-compete agreement must be narrowly tailored and no more restrictive than is necessary to protect the company's legitimate business interests. Courts generally find that the following are legitimate interests that a company may seek to protect through the use of a non-compete agreement:

The interests that a company is entitled to protect through a non-compete agreement must relate to the company's specific business. The fact that an employee obtained "general knowledge, skill, or facility" regarding a particular industry "through training or experience while working for an employer" does not, "by itself, give the employer a sufficient interest to support a restraining covenant, even though on-the-job training has been extensive and costly." Nike Inc. v. McCarthy, 379 F.3d 576 (9th Cir. 2004) (non-compete agreement enforced where the employee had obtained knowledge regarding the company's product launch dates, product allocation strategies, new product development, product orders six months in advance and strategic sales plans up to three years in the future).

In order to enhance the chances that a court will enforce your non-compete agreement, it is important that you avoid general form agreements, and instead draft non-compete agreements that are specifically tailored to a particular employee. After you have identified the specific interests of the company that will be protected by a non-compete agreement, you must then determine whether the interests that you seek to safeguard are better protected by (1) a general non-compete, which prohibits the employee's employment or affiliation with a competitor or an organization that conducts similar business, or (2) a specific non-compete, which prohibits the employee from engaging in business with one of your customers.

After identifying the interests to be protected by the agreement and the type of non-compete agreement that will best protect those interests, you must then draft the terms of the agreement so that they are reasonable and no greater than necessary to protect the company's legitimate interests. In determining the reasonableness of a non-compete agreement, courts will examine the duration, territorial coverage and scope of the activities restrained. See, W.R. Grace & Co. v. Mouyal, 262 Ga. 464, 422 S.E.2d 529 (Ga. 1992). Reasonableness may also be judged based on the specific facts underlying the agreement and the nature of the interests the employer seeks to protect. The Estee Lauder Co. v. Batra, 430 F. Supp.2d 158 (S.D.N.Y. 2006).

The reasonableness of a non-compete agreement is a factual determination that will be made on a case-by-case basis, and may vary from industry to industry and job to job. In Minnesota, the durational reasonableness can be tested under two standards: (1) the length of time necessary to eliminate a customer's identification of a former employee with the company; or (2) the length of time necessary for the former employee's replacement to obtain any necessary licenses and learn the essentials of the company's business. Dean Van Horn v. Wold, 395 N.W.2d 405 (Minn. Ct. App. 1986). Under New York law, the "durational reasonableness" of a non-compete agreement is determined by the length of time during which the company's protectible interest is "competitively valuable." The Estee Lauder Co., supra.

Additionally, the nature of a company's business and the work performed by a particular employee will determine the reasonableness of a particular geographic limitation. For instance, while a worldwide restriction may be unreasonable for many professions, it is reasonable for the Global General Brand Manager of a cosmetic company given the employee's responsibilities and the international scope of the company's business. The Estee Lauder Co., supra.

The following recent decisions address the reasonableness of various non-compete agreements:

• Cambridge Engineering v. Mercury Partners, 27 IER Cases 68 (Ill. App. Ct. 2007).
  A non-compete agreement that prohibited an employee from engaging in any activity for the company's competitor anywhere in the United States or Canada for a two-year period was recently found to be unreasonable by the Illinois Appellate Court. Although Cambridge conducted business throughout the United States and Canada, the geographic scope of the agreement was overly broad as the company did not conduct business in all of Canada, and the former employee was not aware of its customers in Canada. Further, the "blanket bar on all activities for competitors" was overly broad and "excessive in light of the limited arenas in which [the former employee's] knowledge would be competitively useful."

• H&R Block Eastern Enters. v. Swenson, 26 IER Cases 1848 (Wis. Ct. App. 2007).
  A non-compete agreement that prohibited the employee from providing particular services to the company's clients for two years, and contained a provision which extended the time period of the restraint "by any period(s) of violations" was held to be unreasonable by the Wisconsin Court of Appeals. The court found that the duration of the restraint was neither fixed nor definite because a former employee cannot determine, from the terms of the non-compete agreement, how long the extension will be for a violation of the agreement. Therefore, the court found that the extension provision rendered the two-year restraint period unreasonable.

• Whirlpool Corp. v. Burns, 457 F. Supp.2d 806 (W.D. Mich. 2006).
  Applying Michigan law, the United States District Court for the Western District of Michigan found that the company's standard non-compete agreement, which contained no geographic limitation, was unreasonable as to the particular former employee, as it would essentially bar the former employee from "selling home appliances anywhere in the world for a one year period, even if such sales did not involve any of the same customers he served during his tenure [with the company] or the use of confidential information obtained from [the company]."

• Mohanty v. St. John Heart Clinic S.C., 866 N.E. 2d 85, 225 Ill.2d 52 (Ill. 2006).
  The Illinois Supreme Court held that non-compete agreements restricting two physicians from practicing medicine for three and five year periods within two and five miles, respectively, of their former employer's cardiology practice were reasonable. The restriction on the "practice of medicine" was not unreasonable because cardiology was "inextricably intertwined with the practice of medicine." Additionally, the three and five year durational restrictions, as well as the two and five mile geographic restrictions did not cause an undue hardship to the physicians as there were many other employment opportunities for them in the Chicago metropolitan area. Finally, the restrictions on the physicians' practice of medicine would not create a potential harm to the public as there "exists a sufficient number of cardiologists in the area to meet patient needs."

• Coventry First LLC v. Ingrassia, No. 05-2802, 23 IER Cases 249 (E.D.Pa. July 11, 2005)
  A non-compete agreement that prohibits an employee, for a three-year period, from engaging in competition with the company, which is defined as engaging in or working for a company that engages in the same or similar business as the company throughout the United States, Puerto Rico and Canada was found to be overbroad and beyond what was reasonably necessary to protect the company's interests. The Court blue-penciled the agreement to narrow the non-compete clause to permit the former employee to work for competitors of the company that engaged in a similar business, so long as he did not perform the same work as he had for his former employee. While the Court found that the three-year durational limitation was reasonable, it modified the agreement to limit the change of the geographic restriction from the United States, Puerto Rico and Canada, to the former employee's five-state territory.

IV. SUPPORT THE NON-COMPETE WITH ADEQUATE CONSIDERATION

As with any contract, a non-compete agreement must be supported by bargained for consideration. If an employee signs a non-compete agreement at the inception of the employment relationship, the employment alone is sufficient consideration to support the terms of the agreement. However, if the non-compete agreement is signed after the employee's continued employment, such employment may or may not provide sufficient consideration to support the restrictions. Again, the applicable state law will determine whether continued employment constitutes adequate consideration. Compare, Camco Inc. v. Baker, 936 P.2d 829 (Nev. 1997) (an at-will employee's continued employment constitutes adequate consideration), with, Labriola v. Pollard Group, Inc., 100 P.3d 791 (Wash. 2004) (continued employment, absent other independent consideration, does not provide sufficient consideration).

Additionally, where the former employee receives monetary compensation in exchange for signing a non-compete agreement, the compensation constitutes adequate consideration to support the restraint. See, West Publishing Corp. v. Stanley, 20 IER Cases 1463 (D. Minn. 2004) (former employee's receipt of $200,000 "in exchange for" the terms of the non-compete agreement constituted adequate consideration.)

V. CONCLUSION

Because the enforceability of non-compete agreements varies from state to state, it is critical that you narrowly tailor your agreements to meet the requirements of the state in which you plan to have the agreement enforced. Additionally, each agreement should be drafted with specificity in order to ensure that it does not seek to unreasonably restrain a former employee's future employment. Tailoring non-compete agreements to fit the needs of the company with respect to certain positions, rather than using form agreements, is the best way to ensure that your non-compete agreement will be enforced.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.