Noncompete Agreements: How to Protect Your Company During an M&A

Some employers require new employees to enter into noncompetition agreements before beginning employment for a variety of reasons, including the protection of sensitive information and the practice of goodwill.

Noncompete agreements are a standard practice in company mergers and acquisitions (M&As). The acquiring party wants to be sure that the newly acquired employees are not going to start working for a competitor or set up a competing business if they quit. The agreements, in the form of contract clauses, preclude employees from exploiting confidential information such as customer/client lists, upcoming products and marketing plans.

Jim Southworth, an attorney at Houston Harbaugh P.C. in Pittsburgh, practices employment and labor law. He spoke to SHRM Online about the myriad issues around noncompete agreements that arise during an M&A, the enforceability of such agreements and how employers can protect themselves in this area.

SHRM Online: What are the most vexing issues around noncompetes during and after a merger?

Southworth: So the merger is over and the new owner sits down hoping to catch her breath after the arduous deal closing, and she finds out that a key employee has quit and is headed off to work for the primary competitor. This is never a good feeling for a new owner, and hopefully this is not the first time she has questioned whether or not she will be able to enforce her new employee’s noncompete agreement. Many factors will determine whether she is even a party to a noncompete agreement with the employees, let alone whether or not the agreements themselves are enforceable.

Let’s start with the first threshold question: whether or not that agreement was assigned to her as the new owner. In some jurisdictions this—by statute—happens by virtue of the merger or acquisition. In other jurisdictions, that is definitely not the case. For instance, in Pennsylvania, generally it requires that the original noncompete agreement contain an assignment clause, pointing the noncompete agreement to successor owners.

Assuming for sake of argument that the noncompete agreement was properly assigned to her as the new owner, the next questions are whether the agreements were valid at the time they were assigned.

SHRM Online: How is enforceability determined?

Southworth: Most states in the United States have a predisposed attitude against the enforcement of noncompete agreements. In general, noncompete agreements can be seen as stifling freedom and limiting competition. That being said, almost all jurisdictions will enforce a noncompete agreement so long as it meets fundamental requirements. The first question is generally whether or not it is supported by adequate consideration.

When parties agree to something, both have to give something to get something. This is called “quid pro quo,” or “this for that.” If an employee is going to give up their right to compete in the future, the employer must give them something in return. In some states, the new job is sufficient, so long as the noncompete agreement is executed at the initiation of employment. In other states, ongoing employment is sufficient, but the general rule is that if you ask an existing employee to sign a noncompete agreement, you are going to have to give them something, such as a raise, a bonus, a promotion, etc., in exchange for their signature. If the employer failed to do that, the agreement is likely not enforceable.

Or, the agreement may be enforceable, but its terms are not. For instance, if the term of time or geography is too great, then the agreement is seen as overly oppressive, and the court evaluating the document can either disregard the term itself and write in its own, or just make the entire agreement void.

Most states also look for a legitimate reason to enforce the agreement. More or less, this is a valid business interest, held by the party attempting to enforce the agreement, which will be harmed if the agreement is not enforced. Absent this legitimate business interest, the courts are not likely to enforce it.

SHRM Online: What are some ways employers can protect themselves?

Southworth: As an attorney, I can say without question, you need legal advice in matters related to noncompete agreements. This is particularly true in the mergers and acquisition arena, but even if you are considering noncompetes for your existing employees. Frankly, there are just too many issues to address. That being said, you want to keep the following principles in mind:

• If you are considering purchasing a business, do not assume that the noncompete agreements which bind the employees to that business will bind them to your business.
• Remember that any time there is a transition of ownership, hiring, promotions, or even bonuses given, you may want to consider establishing a noncompete agreement with your employees if you do not currently have them.
• Think reasonably when it comes to the terms of the agreement. Don’t try to prohibit employees from ever working in your field in the entire universe. Think in terms of when they can actually do harm, and where they can do that harm. Generally time is more important than geography.
• Don’t give up. Noncompetes are enforceable in most jurisdictions, if they are crafted properly.

Roy Maurer is an online editor/manager for SHRM.

Follow him @SHRMRoy​​