What You Need to Know Before Signing a Non-Compete Agreement
It's a dream scenario. You're offered a new job with great pay and benefits. They'll give you a car, and you even get to work out of your home! But, wait, there's a catch. Your new employer wants you to sign a non-compete agreement as a condition of hire. As far as you can tell, the agreement would prohibit you from working for any company in the same line of business as your new employer for two years after your job ends. Can they do that? Should you sign? Do you have any other options?
Before signing a non-compete agreement or any other restrictive employment covenant, you need to have a basic understanding of what it is you're signing and how it may limit your rights. Here are the answers to some common questions about employee non-compete agreements.*
What is a non-compete agreement?
A non-compete agreement in its most basic form restricts an employee's ability to go to work for a competitor of the employer during the employment period and for some time after employment ends. Because non-compete agreements interfere with people's ability to make a living, the courts don't particularly like them. An employer must meet exacting standards before a non-compete clause will hold up in a court of law.
Why do employers require employees to sign non-compete agreements?
The difficulties of enforcing non-compete agreements don't stop employers from asking employees to sign them. Today's skilled workforce is fickle. Employees are easily lured away with generous job offers from the competitors of their employers. When that happens, employers want to prevent the loss of customers and protect their trade secrets and other proprietary information from being used to compete against them.
A company's customer relationships can be its biggest asset. Businesses protect customer relationships by asking employees with substantial customer contacts to sign non-compete agreements. This prevents an employee who is the "face of the company" as far as customers are concerned from calling on those customers on behalf of a competitor until a replacement employee has an opportunity to build similar relationships.
Employers also use non-compete agreements to protect their proprietary and confidential information. The brain is not a memory card that can be wiped clean when an employee quits a job. It would be difficult, if not impossible, for the employee to forget information learned about the former employer in a new job, especially if that new job involves competing or negotiating with the old employer. The employer seeks to protect that information by preventing former employees from going to work for other companies that could use the information to their advantage.
While actual enforcement of a non-compete agreement may require expensive litigation, employers like them for their deterrent effect. The threat of litigation may make a former employee think twice before going to work for a competitor. A strongly worded letter may persuade a prospective new employer that hiring an employee who is restricted by the terms of a non-compete agreement isn't in anyone's best interest.
Under what circumstances will a non-compete agreement be enforced?
A non-compete agreement must be narrowly tailored to protect the employer's legitimate interests without unduly restricting the employee's ability to find meaningful work. No one factor is determinative; the courts will consider and weigh all facts to find a balance between the interests of the employer and the employee. Although the laws vary from state to state, courts generally will look at the following factors in determining whether a non-compete agreement should be enforced:
- What the agreement is trying to protect: In order to be enforceable, non-compete clauses must protect legitimate business interests. These include trade secrets and other proprietary information, the employer's investment in specialized technology and training, long-term customer relationships, and customer lists and contacts. A non-compete agreement may not be used to prevent normal competition.
- The impact of the agreement on the employee's ability to earn a livelihood: Courts will balance the employer's interests with the hardship to the employee. If the agreement leaves an employee with little ability to find new work without violating the non-compete clause, the court is more likely to strike it down than if the employee's skills are easily transferable to a new, unrestricted industry.
- The scope of the geographic restrictions: The courts will look to see if any restrictions on where the employee can go to work are reasonable based on where the employer actually does business and the area in which the employee worked. The courts also will consider the scope of the employee’s position. For example, a broader restriction will be more appropriate if the employee was active in all aspects of the company’s affairs than if the employee worked in a limited area. Alternatively, a customer-specific non-compete provision (especially if limited to the employee's customer contacts) probably would be enforced even if there is no geographic limitation.
- The duration of the restriction: The length of time during which a former employee is restricted from competing must be reasonable. If the employer is seeking to protect its confidential information from a competitor, the courts will look at the reasonable "shelf life" of the information. For example, a shorter time period would be needed to protect pricing information in a volatile market while a longer time would be necessary to protect the formula for making a product. If the employer is trying to protect its customer relationships, the courts will look at how long it would take a new employee to establish relationships with those customers. Although longer restrictions have been upheld and shorter restrictions have been struck down, a general rule of thumb is a duration of two years or less is reasonable.
- What the employee received in consideration for signing the agreement: To be enforceable, the employee must have received something of value in exchange for signing the agreement. This condition is most easily satisfied by making signing a condition of hire. Then, the promise of employment is deemed sufficient consideration. If the agreement is imposed after employment already has begun, the courts of some states will find continued employment to be sufficient. In other states, the courts require that the employee received something else of value, like a raise, signing bonus, or additional benefits.
- The circumstances under which the employee's employment terminated: Some courts will look to the reasons why the employee left in deciding whether to enforce a non-compete agreement. The court may find the employer doesn't have a legitimate interest in enforcing an agreement against an employee fired for poor performance because the employee's incompetence demonstrates a limited ability to compete. On the other hand, if the employee resigned to accept new employment, the court may be more likely to enforce the agreement.
What are my options if a prospective employer asks me to sign a non-compete agreement?
If you are being asked to sign a non-compete agreement as a condition of hire, you won't have a lot of choice as to whether or not you sign it. If you don't sign, you likely will not be hired, plain and simple. The good news, however, is that many employers don't put much time and effort into their non-compete agreements. They simply pull out a form agreement that was drafted years earlier, taking a one-size-fits-all approach to a document that should be fact specific and narrowly tailored to fit the employee's circumstances. That means there should be plenty of room for a savvy employee to negotiate a better deal.
The first thing you should do when told you'll be required to sign a non-compete agreement is ask to see a copy of the agreement in advance. Then review the agreement with qualified legal counsel who can help you understand its terms and identify the provisions you should request to be modified. Once you know the changes you would like to make, you can deal directly with the prospective employer or have your attorney talk to the employer's legal counsel to negotiate the terms.
Some things to look for and potential changes to request include the following:
How does the agreement define competition? What is considered prohibited competition should be defined as narrowly as possible. For example, if the agreement would restrict you from working for "any company that manufactures outdoor recreational equipment," propose that the following qualifiers be added:
- "that is substantially the same or that competes with products manufactured by Employer at the time the employment relationship ends," and
- "about which Employee acquired confidential information in the course of employment."
This language does a couple of things:
- It would allow you to work for a company that makes outdoor recreational equipment different than the products your employer makes; and
- It would allow you to work for a company that makes some of the same products as your employer but not those about which you have specialized knowledge.
Is there a geographic restriction? Again, your goal is to limit the restriction as much as possible. Request that it include only those areas in which you actually worked as opposed to all markets in which the employer does business. You should resist any restriction that goes beyond the areas where the employer does business during your employment.
Is there is a customer based restriction? Request that any limitation on your future ability to work for or have contact with your employer's customers be limited to those customers with whom you had contact during your employment or, even better, during the last six months or year of your employment. Also, if you will be bringing customers to the employment relationship, you should specify that the prohibition does not apply to any customers with whom your relationship predated your employment.
What is the duration of the restriction? It's in your best interest to negotiate the shortest duration you can get. You also should attempt to get some protections against being fired. This can be done with language specifying that in the event you are involuntarily terminated, the duration of the restriction shall be equal to the number of weeks of severance pay you receive. This means if you receive a year's severance pay, you would be restricted from competing for a year. If you receive no severance pay, there would be no restrictions.
Are there any provisions for damages? Because economic loss for violation of a non-compete agreement can be difficult for an employer to prove, many non-compete agreements specify an amount of damages that must be paid by the employee for a violation of the agreement. The amount of these "liquidated damages" need not be based on an actual loss. Some agreements also specify that an employee found to be in violation must pay the employer's attorneys fees and return any profits made to the employer. There provisions are not in your best interest and you should ask that they be eliminated.
Are you being asked to sign a non-compete agreement after you already have started employment? If that's the case, ask for additional consideration beyond continued employment in exchange for signing. This would be a good time to secure that raise or promotion you've been seeking.