Employers Should Carefully Craft Noncompetes

Businesses should also consider using less restrictive covenants

April 4, 2018
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Employers may want to use noncompetes and other restrictive agreements to protect their business interests, but they must be careful not to overreach. Some state legislatures have significantly limited—or are considering legislation to limit—the permissible terms of such agreements.

Multistate employers need to give thought to the nuances in state laws when it comes to crafting restrictive covenants, said Michael Greco, an attorney with Fisher Phillips in Denver and Philadelphia.

"Make sure that your agreement is thoughtful and reflects the legitimate business interests of your company," said Robert Milligan, an attorney with Seyfarth Shaw in Los Angeles. "Cutting and pasting a form from the Internet is a sure-fire way to select a form that may not be right for your business."

State Trends

"Despite low levels of unemployment nationwide, state governments are concerned about contracts that unduly or unnecessarily limit employees from switching employers," said Laurent Drogin, an attorney with Tarter Krinsky & Drogin in New York City. States view employee mobility as good for business, he added.

Thus, most states disfavor restrictive covenants, but will allow their use if:

  • There is a legitimate business interest that needs to be protected (such as trade secrets or customer lists).
  • The agreement is narrowly tailored to protect that interest.

Some states, such as California, North Dakota and Oklahoma, go even further and place substantial limits on the types of agreements that are enforceable. For example, in California, agreements not to compete are only enforceable in very specific circumstances, such as during the sale of a business. And nonsolicitation agreements—those that prohibit former employees from soliciting workers or clients away from the business—are limited in enforceability as well.

[SHRM members-only multistate coverage: Multistate Employer Resources]

Other states have noncompetition laws that apply to specific industries or wage-earners. For example, in New York, employers can't use noncompetes with certain broadcast employees. In Illinois, noncompetes cannot restrict low-wage earners who are paid less than a set hourly rate. 

Some states require businesses to notify prospective employees—prior to the start of employment—of any requirement to sign a noncompete, Milligan said. Furthermore, some states have laws limiting the enforceability of noncompetes against employees who are laid off or fired. For instance, Nevada recently reformed its noncompete laws to require employers to pay workers for the duration of the noncompete period if they are terminated due to reduction in force.

Greco noted that before President Obama left office, his administration called on states to lessen the power of noncompetes, and indications show that some states are heeding his call.  Proposed legislation in Vermont and Pennsylvania would broadly limit restrictive covenants. And a New Hampshire bill would ban noncompetes for low-wage workers. Over the last few years, bills have also been introduced in Massachusetts, Missouri, New Jersey and Oregon.

However, if a state legislature lumps in other types of restrictions—like nonsolicitation agreements—with noncompetes, it could unduly harm businesses, Greco cautioned.

Other Restrictions

"Restrictive covenants come in many different shapes and sizes," Greco said. They include confidentiality agreements, which require workers to take reasonable steps to ensure valuable business information and materials are not shared, and nondisclosure agreements, which may also be used to protect confidential and proprietary information or trade secrets.

"Full noncompete agreements should be reserved for very senior executives who have so much knowledge about a company and its strategic direction and strategies that they would do unfair damage simply by working for a direct competitor without any delay," he said.

Noncompetes might also be reasonably used for employees who work in research and development and know so much detail about new products or services that it would be unfair for them to immediately go to work for a competitor, he added.

For salespeople, however, a nonsolicitation agreement with customer-based restrictions might be more appropriate.

By continuing to allow reasonable and less restrictive agreements for other employees, small and medium businesses are encouraged to take a risk by investing in talent that could otherwise turn into competition, he added.

Drafting Agreements

Employers should take into account their various employees and chose the right type of agreement for that sector's employees, Milligan said.

To start, businesses should figure out what they are really looking to protect, and they should draft covenants accordingly, Drogin said. "The narrower the covenant, the greater likelihood it will be enforced."

Clients often say they want noncompetes, but what they really need is to protect their business relationships with customers, contacts, clients and referral sources, he noted. Therefore, a less restrictive agreement, such as a nonsolicitation, may suffice. Employers should consider the time constraints and geographic restrictions that are appropriate for the specific roles. Some confidential information—such as a secret recipe—has no expiration date, but pricing information might quickly become obsolete.

Geographic limitations may also vary in their appropriateness. "Salespeople can do just as much damage from around the world as they can from across the street," Drogin said. "On the other hand, professionals, such as doctors, really do need geographic restrictions as their goodwill exists with patients who are generally near their office." 

The key is to use the right tools to protect relevant business interests—but employers should also consider other ways to retain valuable employees. "Fear of losing talent to a competitor is a great motivator to reward good employees with promotions and raises, and induces businesses to establish and maintain a positive culture where the competitor's grass never looks greener," Drogin said.

 

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