United States: Can Non-Compete And Non-Solicitation Agreements Be Enforced?

Competition for employees in Colorado’s tight labor market has caused many employers to rely on non-compete agreements and non-solicitation agreements to protect the investment in their employees and to protect the loss of proprietary information. Colorado law permits such agreements only in certain circumstances and care needs to be taken in the preparation of these agreements in order to maximize their enforceability.

In 1979, the Colorado legislature adopted C.R.S. § 8-2-113(2), which provides that non-compete agreements are void. However, the statute provides for the following four exceptions to this general rule:

1. Contracts for the Purchase or Sale of a Business or the Assets of a Business. A buyer who purchases an ongoing business, including customers and good will, can protect those assets by insisting that the seller agree to a covenant not to compete.
2. Contracts for Protection of Trade Secrets. This exception permits the employer to enforce a non-compete agreement in circumstances where such an agreement is required to avoid the disclosure of trade secrets. The court will first examine the factual situation to determine whether a trade secret is involved, and then examine the specific terms of the non-competition clause to determine the reasonableness of the limitation, that is, whether the clause is really designed to prevent the disclosure of trade secrets.

Colorado courts have defined a trade secret as follows:

The factors relied upon by Colorado courts in determining whether a trade secret fits within the above definition are as follows: (1) the extent to which the information is known to those outside the business; (2) the extent to which it is known to those inside the business, i.e., by the employees; (3) the precautions taken by the holder of the trade secret to guard the secrecy of the information; (4) the savings effected and the value to the holder in having the information as against competitors; (5) the amount of effort or money expended in obtaining and developing the information; and (6) the amount of time and expense it would take others to acquire and duplicate the information.

An employer who desires to rely on the trade secret exception in order to enforce a non-compete agreement is well advised to not only take steps to limit access to the trade secret from people outside the company, but to take steps to limit internal access to the information to only those who truly need access to the trade secret.

3. Recovery of Training Expenses. This exception permits an employer to recover employee training expenses from employees who leave after less than two years of employment. No Colorado appellate cases have interpreted this exception.
4. Management Exception. Under this exception, a non-compete agreement can be utilized with "executive management personnel and officers and employees who constitute professional staff to executive and management personnel." This exception is frequently litigated because it is often not clear whether a particular employee constitutes executive or management personnel. An employee’s title is not determinative of whether the management exception applies. Factors which will be considered by the court include the following: (1) how many other employees, if any, are supervised by the employee in question; (2) the degree of skill required; (3) whether the employees are involved in making decisions relating to general operation of the business; and (4) whether the employee has the authority to hire and/or fire other employees.

Even if one of the four statutory exceptions applies, Colorado case law requires that a non-compete agreement must still be reasonable in time and area. Typically, non-compete agreements restrict competition for a period of one to two years. In cases involving the sale of a business, a longer time period may be reasonable. No reported Colorado case has invalidated a time limitation. The determination of a reasonable geographic limitation depends on the circumstances of the business. If your customers are located within a 20-mile radius of your place of business, you will not be able to enforce a non-compete agreement which restricts competition throughout the State of Colorado. On the other hand, there are some businesses which do business throughout the country and in those situations the court may well enforce a nationwide limitation.

If one of the exceptions applies, and a non-compete agreement is valid, the courts can enforce the agreement in one or both of two ways: injunctive relief and/or damages. These cases often focus on injunctive relief, that is, an order requiring the former employer to stop the forbidden conduct. Typically, an employer seeks a preliminary (temporary) injunction at the beginning of the case, at which time the court gives its tentative opinion as to the merits of the case. The eventual trial, if ever held, takes place approximately one year or more after the commencement of the action, and determines whether a permanent injunction prohibiting the competition should be entered. Damages are awarded if they can be proven, but often times damages are difficult, if not impossible, to prove. In some instances, the new employer is sued by the former employer for damages at the same time that an action is brought against the former employee. The basis for the lawsuit against the new employer is that the new employer has tortiously interfered with the contract between the employee and the original employer. The new employer can become liable for interfering with the non-compete agreement if the new employer hires the former employee in circumstances where the non-compete agreement is valid. When faced with hiring an employee who may be subject to a non-compete agreement with his or her former employer, the new employer should obtain a copy of the non-compete agreement and consult with a lawyer prior to making a decision to retain the new employee.

Employers in Colorado frequently use a more narrow agreement than a non-compete, that is, an agreement to refrain from soliciting customers and/or employees. Such an agreement can have much the same effect as a non-compete agreement, depending on the type of business involved. There are no reported decisions in Colorado regarding whether a non-solicitation agreement falls within the prohibition of the statute which generally voids non-compete agreements. It can be expected that Colorado courts, as in other states, will be more likely to enforce non-solicitation agreements as opposed to non-compete agreements.

From the employer’s standpoint, it is clearly preferable to have a non-compete agreement executed at the time of hiring. If employment has already commenced, there can be a question as to whether there was any consideration given for a non-compete agreement which was subsequently executed. If the employer desires to have a non-compete agreement executed subsequent to the commencement of employment, the employer should discuss with his or her attorney what consideration needs to be given in order to make the non-compete enforceable.

Employers need to realize that courts are suspicious of any attempts to restrict competition. The courts view competition as an essential element of a free market economy. An employer needs to show not just that a former employee is competing but that there is something "unfair" about the competition such that the court needs to step in and stop the unfair competition. As the number of technology-based companies in Colorado increases, the use of non-compete agreements will continue to grow. The best way to avoid litigation over these agreements is to properly draft and execute the initial non-compete agreement.