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This article or section deals primarily with the United States and does not represent a worldwide view of the subject. Please improve this article or discuss the issue on the talk page. |
A non-compete clause or covenant not to compete (CNC), is a term used in contract law under which one party (usually an employee) agrees to not pursue a similar profession or trade in competition against another party (usually the employer). As a contract provision, a CNC is bound by traditional contract requirements including the consideration doctrine. The use of such clauses is premised on the possibility that upon their termination or resignation, an employee might begin working for a competitor or starting a business, and gain competitive advantage by abusing confidential information about their former employer's operations or trade secrets, or sensitive information such as customer/client lists, business practices, upcoming products, and marketing plans.
Conversely, a business might abuse a non-compete covenant to prevent an employee from working elsewhere at all. Most jurisdictions in which such contracts have been examined by the courts have deemed CNCs to be legally binding so long as the clause contains reasonable limitations as to the geographical area and time period in which an employee of a company may not compete. Courts have held that, as a matter of public policy, an individual cannot be barred from carrying out a trade in which he has been trained except to the extent that is necessary to protect the employer.[citation needed]
The majority of U.S. states recognize and enforce various forms of non-compete agreements. A few states, such as California, totally ban or prohibit non-compete agreements. For this reason, non-compete agreements have been popular among companies with employees working in states where they are allowed.
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History
As far back as 1415, English common law had already been "old and settled" that restraints on trade were unenforceable.[1] That ban remained unchanged until 1621, when a restriction that was limited to a specific geographic location was found to be an enforceable exception to the previously-absolute rule.[2] Almost a hundred years later, the exception became the rule with the 1711 watershed case of Mitchel v. Reynolds,[3] which established the modern framework for the analysis of the enforceability of noncompete agreements.[4]
Enforceability in the Commonwealth of Virginia
In Virginia, the enforceability of covenants not to compete is governed by common law principles. As restrictions on trade, CNCs are not favored by Virginia courts, which will only enforce narrowly drafted CNCs that do not offend public policy.
In Virginia, a plaintiff must prove by a preponderance of the evidence that the covenant is reasonable in the sense that it is: (1) no greater than necessary to protect its legitimate business interests, such as a trade secret; (2) not unduly harsh or oppressive in restricting the employee’s ability to earn a living; and (3) not against public policy. Paramount Termite Control Co., Inc v. Rector, 380 S.E.2d 922, 924 (Va. 1989).
Legitimate business interest
In Virginia, courts weigh the (1) function, (2) geographic scope and (3) duration of the CNC against the employer’s legitimate business interests to determine their reasonableness. See Advanced Marine Enters., Inc. v. PRC Inc., 501 S.E.2d 148, 155 (Va. 1998); Simmons v. Miller, 544 S.E.2d 666, 678 (Va. 2001) (stating that the function, geographic scope and duration of the CNC must be considered together to determine the reasonableness of the restriction). Additionally, CNCs are only reasonable if they prevent the employee from entering into direct competition with the employer and must not encompass any activity in which the employer is not engaged. See e.g. Omniplex World Servs. Corp. v. US Investigations Servs., Inc., 618 S.E.2d 340, 342 (Va. 2005) (“covenants not to compete have only been upheld when employees are prohibited from competing directly with the former employer or through employment with a direct competitor.”); See Motion Control Sys. v. East, 546 S.E.2d 424 (Va. 2001).
Reasonable restriction on employee's ability to earn a living
Second, to enforce the CNC, a Plaintiff must show that it is not unduly harsh or oppressive in restricting the employee's ability to earn a living. In Virginia, a CNC is not unduly harsh or oppressive if balancing its function, geographic scope and duration the employee is not precluded from (1) working in a capacity not in competition with the employer within the restricted area or (2) providing similar services outside the restricted area. See Paramount, 380 S.E.2d at 925.
Public policy
Third, to enforce a CNC, a Plaintiff must show the CNC is reasonable from the standpoint of a sound public policy. Virginia does not favor restrictions on employment and therefore CNCs are generally held against public policy unless they are narrowly drafted as enumerated above. In Virginia, a CNC does not violate public policy if the restrictions it imposes do not create a monopoly for the services offered by the employer or create a shortage of the skills provided by the employee. See Blue Ridge Anesthesia & Critical Care, Inc. v. Gidick, 389 S.E.2d 467, 470 (Va. 1990); Paramount, 380 S.E.2d at 925.
Enforceability in the State of California
Unlike the situation in other states, non-compete agreements are illegal in California and against public policy. (California Business and Professions Code Section 16600).
Out of state agreements are not enforceable
The preeminent court decision discussing the conflict between California law and the laws of other states is Application Group, Inc. v. Hunter Group, Inc., 61 Cal.App.4th 881 (1998). In Hunter, a Maryland company required that its Maryland based employee agree to a one-year non-compete agreement. The contract stated that it was governed by and to be construed according to Maryland law. A Maryland employee then left to work for a competitor in California. When the new California employer sued in California state court to invalidate the covenant not to compete, the California court agreed and ruled that the non-compete provision was invalid and not enforceable in California. Business and Professions Code Section 16600 reflects a "strong public policy of the State of California" and the state has a strong interest in applying its law and protecting its businesses so that they can hire the employees of their choosing. California law is thus applicable to non-California employees seeking employment in California.
Whether California courts are required by the full faith and credit clause of the United States Constitution to enforce equitable judgments from courts of other states, having personal jurisdiction over the defendant, that enjoin competition or are contrary to important public interests in California is an issue that has not yet been decided.
Exceptions - valid non-compete agreements in California
There are limited situations where a reasonable non-compete agreement may be valid in California.
(1) If an owner is selling the goodwill in their business. (Business & Professions Code Section 16601).
(2) When there is a dissolution or disassociation of a partnership. (Business & Professions Code Section 16602).
(3) Where there is a dissolution of a limited liability company. (Business & Professions Code Section 16602.5).
Enforceability in the State of Ohio
History of non-competition agreements in Ohio
As in other states, Ohio courts at one time viewed noncompetition agreements with some skepticism. Agreements in restraint of trade, including noncompetition agreements, were disfavored as being against public policy. Further, the law initially developed in a society in which workers entered skilled trades only by serving apprenticeships, and mobility was minimal. Hence, restrictive covenants precluding an ex-employee from competing with his ex-employer "either destroyed a man's means of livelihood, or bound him to his master for life." Raimonde v. Van Vlerah (1975), 42 Ohio St.2d 21, 71 Ohio Op. 2d 12, 325 N.E.2d 544.
Much has changed in Ohio since then. In 2004 the Ohio Supreme Court noted that modern economic realities do not justify a strict prohibition of noncompetition agreements between employer and employee in an at-will relationship. Instead, Ohio courts now balance an employer's ability to protect its trade secrets, customer relationships and other legitimate business interests against the employee's ability to earn a living.
Accordingly, courts in Ohio now recognize the validity of agreements that restrict competition by an ex-employee if they contain reasonable geographical and temporal restrictions. Such an agreement does not violate public policy if it is reasonably necessary for the protection of the employer's business, and not unreasonably restrictive upon the rights of the employee.
Consideration as a barrier to Enforcement
At one time employees in Ohio argued that a non-competition agreement was unenforcable for lack of consideration unless it was required as a condition to, and at the time of, new employment. This view was supported by the facts of Rogers v. Runfola & Assoc., Inc. (1991), 57 Ohio St.3d 5, 565 N.E.2d 540, in which the Ohio Supreme Court found valid a noncompetition clause in a written contract in which the employer agreed to discharge the employee only for specified reasons. In Runfola the Ohio Supreme Court rejected the argument of the ex-employee that her promise not to compete lacked consideration in light of the "the exchange of mutually beneficial promises." From this, employees argued that a non-competition agreement required valid cause for termination or some other consideration.
In Lake Land Empl. Group of Akron, LLC v. Columber, 101 Ohio St. 3d 242, 245-246 (Ohio 2004), however, the Ohio Supreme Court held that continued at-will employment was sufficient consideration to support a non-competition agreement. The Court viewed presentation of a noncompetition agreement by an employer to an at-will employee as, in effect, a proposal to renegotiate the terms of the parties' at-will employment. As a result, an employer can require non-competition agreements from all of its employees and can terminate, without legal liability, those employees who refuse to sign.
Assignment of the Non-Competition Agreement in a Sale
Since non-competition agreements are contracts, the ability of one employer to enforce a non-competition agreement entered into with another employer depends on the law of contract assignment. As a general rule, a party to a contract can assign the contract to another party, unless the contract does not permit the assignment. Thus, unless the non-competition agreement itself prohibits an assignment, the agreement can probably be assigned to another employer, who would then have the right to enforce it.
Enforcement of Otherwise Valid Non-compete Agreements
If the parties enter into a valid non-competition agreement, then Ohio courts will enforce it in light of the guidelines pronounced in Raimonde v. Van Vlerah (1975), 42 Ohio St. 2d 21, 71 O.O. 2d 12, 325 N.E. 2d 544. In Raimonde, the Ohio Supreme Court held:
A covenant not to compete which imposes unreasonable restrictions upon an employee will be enforced to the extent necessary to protect an employer's legitimate interests. A covenant restraining an employee from competing with his former employer upon termination of employment is reasonable if the restraint is no greater than is required for the protection of the employer, does not impose undue hardship on the employee, and is not injurious to the public.
If the restraint from a covenant not to compete is greater than that required for the protection of the employer, Ohio courts are empowered to fashion a reasonable covenant between the parties and, in so doing, they should consider the following factors:
The absence or presence of limitations as to time and space, Whether the employee represents the sole contact with the customer; Whether the employee is possessed with confidential information or trade secrets; Whether the covenant seeks to eliminate competition which would be unfair to the employer or merely seeks to eliminate ordinary competition; Whether the covenant seeks to stifle the inherent skill and experience of the employee; Whether the benefit to the employer is disproportional to the detriment to the employee; Whether the covenant operates as a bar to the employee's sole means of support; Whether the employee's talent which the employer seeks to suppress was actually developed during the period of employment; and Whether the forbidden employment is merely incidental to the main employment.
Courts will rewrite overly broad non-competition agreements by redrawing geographic, time or other restrictions on an employee's non-competition agreement.
Enforceability in the Commonwealth of Massachusetts
Noncompete agreements will be enforced in Massachusetts in appropriate circumstances. See, e.g., Novelty Bias Binding Co. v. Shevrin, 342 Mass. 714, 716 (1961); Marine Contractors Co., Inc. v. Hurley, 365 Mass. 280, 287 (1974); Edwards v. Athena Capital Advisors, Inc., C.A. No. 07-2418-E, 2007 Mass. Super. LEXIS 378, 4-5 (Super. Ct. Aug. 7, 2007).
I. Historical Context
By 1837, Massachusetts had indisputably adopted the analysis established in Mitchel. Alger, 36 Mass. at 53. In 1922, the Supreme Judicial Court eliminated any doubt that restrictive covenants in the employment context would be enforced when reasonable. See Sherman v. Pfefferkorn, 241 Mass. 468 (1922)
II. Current Law
The basic proposition enunciated long ago continues to apply: “A covenant not to compete is enforceable only if it is necessary to protect a legitimate business interest, reasonably limited in time and space, and consonant with the public interest.” Lunt v. Campbell, No. 07-3845-BLS, *5 (Super. Ct Sept. 2007), quoting Boulanger v. Dunkin’ Donuts Inc., 442 Mass. 635, 639 (2004), citing Marine Contrs. Co. v. Hurley, 365 Mass. 280, 287-88, 289 (1974) and All Stainless, Inc. v. Colby, 364 Mass. 773, 778 (1974).
A. Reasonableness
Reasonableness is the touchstone of the analysis and is highly fact-dependent. Edwards v. Athena Capital Advisors, Civil Action No. 07-2418-E (Super. Ct. Aug. 7, 2007) (“Covenants not to compete are valid if they are reasonable in view of all the facts in a particular case.”), citing Marine Contractors. Co. v. Hurley, 365 Mass. 280, 287-288 (1974); All Stainless, Inc. v. Colby, 364 Mass. 773, 778 (1974). The context in which the CNC arises (e.g., employment relationship, contractual relationship, etc.) is a critical factor in the analysis. Sentry Ins. v. Firnstein, 14 Mass. App. Ct. 706, 707 (1982) (quoting Restatement (Second) of Contracts § 188 comment g (1981)); Zabota Community Center, Inc. v. Frolova, No. 061909BLS1, *2 (May 18, 2006). A CNC that is unreasonable because it is too broad, will be scaled back if it is in fact capable of being narrowed. See Edwards v. Athena Capital Advisors, Inc., C.A. No. 07-2418-E, 2007 Mass. Super. LEXIS 378 (Super. Ct., Aug. 7, 2007), quoting All Stainless, Inc. v. Colby, 364 Mass. 778, 778 (1974).
Even when a CNC is limited in duration, geographic reach, and scope, it will be enforced “only to the extent . . . necessary to protect the legitimate business interests of the employer.” EMC Corp. v. Gresham, No. 01-2084-BLS (Super. Ct. Nov. 2001), citing Novelty Bias Binding Co. v. Shevrin, 342 Mass. 714, 716 (1961); Marine Contractors Co., Inc. v. Hurley, 365 Mass. 280, 287 (1974). Recognized legitimate business interests are generally identified as the protection of trade secrets, confidential information, and goodwill. Marine Contractors Co., Inc. v. Hurley, 365 Mass. 280, 287 (1974), citing All Stainless, Inc. v. Colby, 364 Mass. 773, 779-80 (1974); Sentry Insurance v. Firnstein, 14 Mass. App. Ct. 706, 708 (1982); Lunt v. Campbell, No. 07-3845-BLS, *5 (Super. Ct. Sept. 2007), citing Boulanger v. Dunkin’ Donuts Inc., 442 Mass. 635, 641 (2004); EMC Corp. v. Gresham, No. 01-2084-BLS (Super. Ct. Nov. 2001), citing Kroeger v. Stop & Shop Co. Inc., 13 Mass. App. Ct. 310, 316 (1982).
B. Consideration
An otherwise valid CNC must still, like other contracts, be supported by consideration. Accordingly, the Supreme Judicial Court has held that a CNC must be “ancillary . . . to an existing employment or contract of employment” or some other “permissible transaction . . . .” Novelty Bias Binding Co., v. Shevrin, 342 Mass. 714, 716-17 (1961). However, consideration can exist regardless of whether the CNC is entered into at the beginning of the employment relationship, during the term of employment, or even at the end of an employment relationship. See Marine Contractors Co., Inc. v. Hurley, 365 Mass. 280, 288 (1974) (“Marine’s interest in protecting its accrued good will from possible incursions by Hurley is not weakened by the fact that it negotiated the agreement not to compete at the end of Hurley’s employment rather than at some earlier time.”); Novelty Bias Binding Co., v. Shevrin, 342 Mass. 714 (1961); Richmond Bros. Inc. v. Westinghouse Bdcst. Co. Inc., 357 Mass. 106 (1970). But see Zabota Community Center, Inc. v. Frolova, No. 061909BLS1, *2 n.3 (Super. Ct. May 2006) (Although the plaintiff cited its mid-employment threat of termination as proof of consideration for the CNC, the court “exercising its equitable powers, sees it rather differently.”).
External links
- California Non-Compete Agreement Law and Cases
- Employlaw.com - Discussing California Noncompete Agreements
- LEGAL ISSUES - The Fine Line in Noncompetes
- Hypothetical and Issues Involved in Enforcement of Non-Competes
- Noncompetes: A Tale of Two Companies - Why your noncompete agreement must be properly crafted. By Russell Beck
References
- ^ Alger v. Thacher, 36 Mass. 51, 52 (1837).
- ^ Alger v. Thacher, 36 Mass. 51, 53 (1837).
- ^ Mitchel v. Reynolds, 24 Eng. Rep. 347 (Q.B. 1711)
- ^ See C. L. Fisk, Working Knowledge: Trade Secrets, Restrictive Covenants in Employment, and the Rise of Corporate Intellectual Property, 1800-1920, 52 Hastings Law Journal no. 2, 453-54 (2001); Alger, 36 Mass. at 53.
