In contract law, a non-compete clause (often NCC), or covenant not to compete (CNC), is a clause under which one party (usually an employee) agrees not to enter into or start a similar profession or trade in competition against another party (usually the employer). Some courts refer to these as "restrictive covenants." 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 exploiting 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.
However, an over-broad CNC may prevent an employee from working elsewhere at all. English common law originally held any such constraint to be unenforceable under the public policy doctrine. Contemporary case law permits exceptions, but generally will only enforce CNCs to the extent necessary to protect the employer. 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.
The extent to which non-compete clauses are legally allowed varies per jurisdiction. For example, the state of California in the United States invalidates non-compete-clauses for all but equity stakeholders in the sale of business interests.
History
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As far back as Dyer's Case in 1414, English common law chose not to enforce non-compete agreements because of their nature as restraints on trade. 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. Almost a hundred years later, the exception became the rule with the 1711 watershed case of Mitchel v Reynolds which established the modern framework for the analysis of the enforceability of non-compete agreements.
United States
The majority of U.S. states recognize and enforce various forms of non-compete agreements. A few states, such as California, Montana, North Dakota, and Oklahoma, totally ban non-compete agreements for employees, or prohibit all non-compete agreements except in limited circumstances. For this reason, non-compete agreements have been popular among companies with employees working in states where they are allowed. They are very common among commercial radio stations and television stations, especially for radio personalities and television personalities working for media conglomerates. For example, if a radio or television personality quits, is laid off or fired from one station in the media market they work in, they cannot work for another competing station in the same market until their contract expires with their former employing station.
California
Non-compete agreements are automatically void as a matter of law in California, except for a small set of specific situations expressly authorized by statute. They were outlawed by the original California Civil Code in 1872 (Civ. Code, former § 1673).
Out of state agreements are not enforceable
A leading court decision discussing the conflict between California law and the laws of other states is the 1998 decision Application Group, Inc. v. Hunter Group, Inc. 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 â€" valid non-compete agreements in California
There are limited situations where a reasonable non-compete agreement may be valid in California.
- Where the owner of a business is selling the entire business, or is selling the goodwill in the business, the seller may be bound by a non-compete clause.
- When there is a dissolution or disassociation of a partnership.
- Where there is a dissolution of a limited liability company.
Florida
The enforceability of non-compete agreements in the state of Florida is quite common. Some law firms build their law practice around these agreements and represent employees, employers and potential new employers of an employee currently bound by a non-compete agreement. The agreement is not allowed to be overly broad and generally difficult to enforce if it is for more than two years. However, Florida courts will rarely refuse to enforce a non-compete agreement due to its length or geographic scope. Instead, under Florida law, courts are required to "blue pencil" an impermissibly broad or lengthy non-compete agreement to make it reasonable within the limits of Fla. Stat. § 542.335. Also if the agreement is part of a general employment contract then there is the possibility of a prior breach by an employer. This may cause the non-compete clause of the contract to become unenforceable. However, recent case law from Florida's appellate courts has eroded the utility of the prior breach defense.
Hawaii
A new law bars high-tech companies, but only such companies, in Hawaii from requiring their employees to enter into “non-compete†and “non-solicit†agreements as a condition of employment. The new law, Act 158, went into effect on July 1, 2015.
Illinois
Noncompete agreements will be enforced in Illinois if the agreement is ancillary to a valid relationship (employment, sale of a business, etc.) and 1) must be no greater in scope than is required to protect a legitimate business interest of the employer, 2) must not impose an undue hardship on the employee, and 3) cannot be injurious to the public. While reasonable geographic and temporal limitations on the noncompete agreement are not expressly required by governing law, they tend to be examined as a measure of whether the scope of the noncompete is greater than is required to protect a legitimate business interest of the employer.
Unlike other jurisdictions, which follow the general rule that consideration is only important as to whether it exists and not as to whether it is adequate, Illinois will inquire into the adequacy of consideration. The majority of courts will require at least two years of continued at-will employment to support a noncompete agreement (or any other type of restrictive covenant). However, in certain cases involving particularly sharp conduct by an employee, courts have required less.
While Illinois courts state the rule above, logically the analytical steps should be in reverse orderâ€"because inadequate consideration is fatal to the claim. Thus, under McInnis v. OAG Motorcycle Ventures, Inc. there are three requirements in order for a post employment restrictive covenant limiting a former employee’s right to work for a competitor to be enforceable under Illinois law: (1) it must be ancillary to a valid contract; (2) it must be supported by adequate consideration; (3) it must be reasonable, considering whether it: (a) is no greater than is required for the protection of a legitimate business interest of the employer, (b) does not impose undue hardship on the employee, and c) is not injurious to the public. The McInnis decision interpreted the Fifield decision, above, to mandate two years' employment in order for consideration to be adequate.
Massachusetts
Noncompete agreements will be enforced in Massachusetts in appropriate circumstances.
Historical context
By 1837, Massachusetts had indisputably adopted the analysis established in Mitchel. In 1922, the Supreme Judicial Court eliminated any doubt that restrictive covenants in the employment context would be enforced when reasonable.
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.â€
Reasonableness
Reasonableness is the touchstone of the analysis and is highly fact-dependent. The context in which the CNC arises (such as employment relationship, contractual relationship) is a critical factor in the analysis. A CNC that is unreasonable because it is too broad, will be scaled back if it is in fact capable of being narrowed.
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.†Recognized legitimate business interests are generally identified as the protection of trade secrets, confidential information, and goodwill.
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 . . . .†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.
Texas
Under Texas law "a covenant not to compete is enforceable if it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made to the extent that it contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee." Specific rules apply to physicians, notably that a physician cannot be prohibited "from providing continuing care and treatment to a specific patient or patients during the course of an acute illness even after the contract or employment has been terminated."
However, Texas courts will not enforce a covenant not to compete if the court determines that such a covenant "is against public policy and therefore substantively unconscionable."
Utah
CNCs are enforceable, but any CNC entered into after May 10, 2016 may not extend for a period of more than one year.
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 enforce only 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. 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. Virginia courts will not generally attempt to revise or enforce a narrower restriction in a non-compete agreement. As a result, a drafting error or unenforceable restriction may render the entire agreement unenforceable in Virginia.
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.
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.
Washington
According to Racine v. Bender, CNCs will be enforced by courts if they are validly formed and reasonable. There are exceptions, like in Labriola v. Pollard Group, Inc., where the Washington Supreme Court invalidated a CNC not supported by independent consideration by strictly enforcing the pre-existing duty rule.
Canada
Canadian courts will enforce non-competition and non-solicitation agreements, however, the agreement must be limited in time frame, business scope, and geographic scope to what is reasonably required to protect the company's proprietary rights, such as confidential marketing information or client relations and the scope of the agreement must be unambiguously defined. The 2009 Supreme Court of Canada case Shafron v. KRG Insurance Brokers (Western) Inc. 2009 SCC 6, held a non-compete agreement to be invalid due to the term "Metropolitan City of Vancouver" not being legally defined.
The 2000 Ontario Court of Appeals case Lyons v. Multary established a general preference towards non-solicitation over non-competition agreements, regarding the latter as "much more drastic weapons" and held a non-competition agreement to be invalid when a non-solicitation agreement would have been sufficient to protect the company's interests.
Europe
Generally, CNCs are allowable in Europe only if the employer can show a reasonable business interest in having a CNC.
- In Belgium, CNCs are restricted to new employments within Belgium and for no more than one year. The employer must pay financial compensation for the duration of the CNC, amounting at least half of the gross salary for the corresponding period.
- In France, CNCs must be limited in time to a maximum of two years and to a region where there the employee’s new work can reasonably be seen as competitive. The region can be a city or the whole country, depending on the circumstances. The employer can be forced to pay financial compensation, typically 30 percent of the last salary, depending on the circumstances surrounding the termination of the employment. A CNC may not unreasonably limit the possibilities of the employee to find a new employment.
- In Germany, CNCs are allowed for a term up to two years. The employer must provide financial compensation for the duration of the CNC amounting to at least half the gross salary. Unreasonable clauses â€" for example, excluding similar jobs throughout the whole of Germany â€" can be invalidated.
- In Italy, CNCs are regulated by articles 2125, 2596, and 1751 bis of the civil code.
- In the Netherlands, non-compete clauses (non-concurrentiebeding or concurrentiebeding) are allowed regarding issues such as moving to a new employer and approaching customers of the old company. Unreasonable clauses can be invalidated in court.
- In Portugal, CNCs are regulated by article 136 of the labor code and restricted to two years extendible to three years in cases of access to particularly sensitive information. The employer must pay financial compensation for the duration of the CNC but the law doesn’t specify anything regarding the amount of the compensation.
- In Romania, CNCs are regulated by article 20-4 of the labor code and restricted to two years for managing positions and six months for other positions. The employer must pay financial compensation for the duration of the CNC, amounting to at least 25 percent of the last salary. ACI Worldwide has been known to block employees even after changing their job several times.
- In Spain, CNCs are regulated by article 21 of the labor law. CNCs are allowed up to two years for technical professions and six months for other professions.
- In the United Kingdom, CNCs are called Restraint of Trade clauses and may be used only if the employer can prove a legitimate business interest to protect in entering the clause into the contract. Mere competition will not amount to a legitimate business interest.
India
Section 27 of Indian Contract Act has a general bar on any agreement that puts a restriction on trade. On this basis, it would appear that all non-compete clauses in India are invalid. However, the Supreme Court of India has clarified that some non-compete clauses may be in interest of trade and commerce, and such clauses are not barred by Section 27 of the Contract Act, and therefore valid in India. Notably, only those clauses backed by a clear objective that is considered to be in advantage of trade and commerce survives this test. For instance, a co-founder of a startup who signed a non-compete clause can be held to it, but if a junior software developer or a call center employee signs a non-compete clause with the employer the same may not be enforceable.
Pakistan
According to Section 27 of Contract Act, 1872, any agreement that restrains a person from exercising a lawful profession, trade or business is void. However, courts of Pakistan have made decisions in the past in favour of such restrictive clauses given that the restrictions are "reasonable". The definition of "reasonable" depends on the time-period, geographical location and the designation of employee. The High Court of Sindh in Exide Pakistan Limited vs. Abdul Wadood, 2008 CLD 1258 (Karachi) stated that reasonableness of the clause will vary from case to case and depends mainly on duration and extent of geographical territory
Related restrictive covenants
While CNCs are one of the most common types of restrictive covenants, there are many others. Each serves a specific purpose and provides specific rights and remedies. The most common types of restrictive covenants are as follows:
- Garden-leave clause: a type of CNC by which an employee is compensated during the period that the employee is restricted.
- Forfeiture-for-Competition Agreement and Compensation-for-Competition Agreement: an agreement by which an employee either forfeits certain benefits or pays some amount of money to engage in activities that are competitive with his former employer.
- Forfeiture agreement: an agreement by which an employee forfeits benefits when his employment terminates, regardless of whether he engages in competitive activities.
- Nondisclosure/confidentiality agreement: an agreement by which a party agrees not to use or disclose the other party's confidential information.
- Nonsolicitation agreement: an agreement by which an employee agrees not to solicit and/or not to accept business from the employer's customers.
- Antipiracy agreement: an agreement by which an employee agrees not to solicit and/or not to hire the employer's employees.
- Invention assignment agreement: an agreement by which an employee assigns to the employer any potential inventions conceived of during employment.
The enforceability of these agreements depends on the law of the particular state. As a general rule, however, with the exception of invention assignment agreements, they are subject to the same analysis as other CNCs.
Cases
- In 2005, Microsoft and Google litigated the enforceability of a non-compete clause in Kai-Fu Lee's employment contract with Microsoft. Difference in state laws were highlighted as Google attempted to maneuver the case to California courts, where California law would be more likely to hold the clause unenforceable.
- IBM v. Papermaster (No. 08-9078, 2008 U.S. Dist): Mark Papermaster moving from IBM to Apple computer in 2008.
- In April 2010, after a year of non-compete clause stipulated on the contract, Paul Teutul Jr., formerly from Orange County Choppers, was able to start his own new non-motorcycle design company.
- On 2 September 2013 Microsoft litigated the enforceability of a non-compete clause on Nokia preventing it from producing any mobile devices under the Nokia name through 31 December 2015.
References
Works cited
External links
- What you should know about non-compete agreements, PBS