After you part ways with former employees, noncompete contracts can keep them from sharing confidential information with competitors. However, some noncompetes have come under attack. Learn what courts are likely to rule against and how to craft agreements that are effective and enforceable
Editor’s note: Advice presented in this article is intended for general informational purposes. To create or revise noncompete agreements for your company or for other guidance regarding noncompetes, consult your own legal counsel.
Noncompete agreements have been big news recently — at least big news in the worlds of labor law and human resources — as a number of states and localities have restricted or banned their use. One of the latest missives came in mid-December 2020 when the District of Columbia City Council passed what some have called the strictest ban on noncompete agreements in the country.
These recent moves against noncompete agreements might lead companies to think that “noncompetes are no longer enforceable,” write attorneys Mark Oberstaedt and Douglas Diaz in an online March 2020 article for the Society for Human Resource Management, a professional organization based in Alexandria, Virginia. Oberstaedt and Diaz are partners in the Haddonfield, New Jersey, office of Archer & Greiner.
“Although they are restricted in a few states, noncompetes remain generally enforceable elsewhere,” the attorneys say. “The general rule in the majority of states is that enforceability requires the employer to prove the following (each of these factors is case sensitive):
• The agreement is necessary to protect the employer’s legitimate interests (for example, to protect confidential information or client relationships).
• The noncompete will not impose an undue hardship on the employee.
• It will not cause public harm.”
In fact, Oberstaedt and Diaz say, noncompete agreements remain “valuable tools.” “When properly used, a well-crafted noncompete can protect the employer from significant harm,” they write.
Noncompetes are not uncommon
A noncompete agreement, also called a noncompete clause or a restrictive covenant, is an employment contract that prohibits an employee from competing with an employer. Details vary, but such agreements typically restrict an employee from starting a competing business or working for a competitor for a specific period of time and in a specific geographic area, and usually are designed to prevent an employee specifically from sharing confidential or sensitive information such as customer lists, product research, manufacturing processes, personnel data and strategic plans.
“Business owners work very hard and spend a lot of money to develop their products, form their customer base, build out their partnerships, recruit talent/employees, and develop their proprietary information or intellectual property,” Dani Fontanesi, founder and managing partner of Fontanesi Legal Consulting told Business.com in a September 2020 article by Skye Schooley. “They want to know that if they hire an employee, that employee can’t just steal their customers, misappropriate their proprietary information and start a competing business without doing the hard work of building a business legitimately from the ground up. Noncompetes are intended to protect businesses from this type of behavior.”
A report by the Economic Policy Institute indicates use of noncompete agreements in the United States is fairly common.
In a survey, nearly half (49.4%) of employer respondents said they require at least some employees to sign noncompete agreements, and nearly a third (31.8%) reported that “all employees in their establishment were required to enter into a noncompete agreement, regardless of pay or job duties,” according to a 2019 report released by the Washington, D.C.-based think tank. The institute’s survey of 634 private-sector U.S. businesses with 50 or more employees was conducted in 2017.
“The survey data do not allow us to determine the precise share of workers nationwide that are subject to noncompete agreements. However, we can calculate a range, and we find that somewhere between 27.8% and 46.5% of private-sector workers are subject to noncompetes,” say report authors Alexander J.S. Colvin and Heidi Shierholz in an executive summary of the research findings. In contrast, an earlier survey of workers conducted in 2014 and published in the Journal of Law and Economics found that 18.1% of employees were covered by noncompete agreements.
State laws regarding noncompetes vary widely, and attorneys who specialize in labor law note that, when deciding cases brought by employers or employees, courts tend to heavily weigh whether provisions of such agreements are reasonable and not unduly restrictive.
For example, Fontanesi told Business.com that a noncompete agreement between an employee and a tech company that makes an app for photo editing would be too restrictive if itprohibited the employee “from working for any other technology company in the United States for 10 years.” But “a noncompete that restricted the employee from creating a competing photo-editing app or working for a direct competitor that created a photo-editing app in the same state for six months” could be considered reasonable, Schooley writes.
“Even if you have employees sign noncompete agreements, be aware that they aren’t always easy to enforce. Employees often challenge the agreement in court, and some state laws make noncompete agreements difficult to uphold,” Schooley adds.
Some states specifically limit the length of time that noncompetes can restrict an employee. Such windows generally range from six months to two years after an employee leaves a company. Other states don’t specify but courts typically consider the length of time when considering whether the noncompete agreement is reasonable or not.
Similarly, some states limit the types of employees who can be required to sign noncompete agreements, for example, exempting low-wage hourly workers “or employees who have been terminated without cause or laid off,” Fontanesi told Business.com.
Threats on the horizon
In a Jan. 3 article for the tax law website Law360 Tax Authority, attorneys Allegra Lawrence-Hardy and Linda Spencer include “Prepare for Attacks on Noncompetes” as No. 7 on their list of “Top 10 Employer Resolutions for 2021.”
“Our employer resolutions for 2020 advised companies to stay informed on state laws banning noncompetes for low-wage employees after five additional states — Maryland, Maine, New Hampshire, Rhode Island and Washington — joined the emerging trend of enacting legislation that prohibits an employer from utilizing noncompete agreements for certain low-wage positions,” Lawrence-Hardy and Spencer say. “Noncompetes are on our list again this year as potentially coming under broader threat of federal action arising out of bipartisan support for greater worker mobility during a period of high unemployment.”
“Even if there is no action at the federal level, the trend of states restricting noncompetes is expected to continue and go beyond federal restrictions,” they add.
Guidelines for drafting noncompetes
To craft effective, enforceable noncompetes that can withstand challenges by an employee, human resource and labor law experts recommend following guidelines.
• Customize the agreements. There are a number of online resources that offer templates for creating noncompete agreements, including those tailored for specific states. Such templates may help to get you started in creating a noncompete agreement, but do not rely on them solely. In their Law360 Tax Authority article, attorneys Lawrence-Hardy and Spencer advise that companies should further tailor their own forms, customizing them “to individual employees’ positions, responsibilities, access to trade secrets and geographic scope of work.” Have your legal counsel or an attorney who specializes in labor law review any such documents before you or a new hire sign them.
• Limit agreements to specific types of employees and use other types of agreements. “Companies would be wise to prepare for state or federal attacks on noncompetes and limit noncompete agreements to high-level employees or those employees with access to trade secrets,” Lawrence-Hardy and Spencer say. “Companies should implement standalone agreements with employees related to trade secrets and confidential information, and separate agreements related to nonsolicitation of employees and customers.”
Specifically, experts recommend that some companies may want to require employees to sign a proprietary information and inventions assignment agreement in addition to or instead of a noncompete agreement. PIIAs typically require an employee to treat proprietary information as company property and keep it confidential. Such proprietary information can range from information about product development and manufacturing processes to information about personnel to information about finances and strategy, and more.
Like noncompete agreements, PIIAs typically are “drawn up by the employer and signed before the employee starts working,” Schooley writes. “Other alternatives to consider are nonsolicit agreements, or agreements not to hire or recruit employees,” Fontanesi told Business.com.
• Limit the time frame of agreements. Even if some state laws allow noncompetes to restrict employees for longer, Lawrence-Hardy and Spencer advise companies to tie noncompete agreements “to severance periods to protect against claims of inadequate consideration.”
• Remember that one size does not fit all. A “common misconception among regional or national employers is that they should use the same noncompete in all states. State laws vary, and often significantly,” attorneys Oberstaedt and Diaz write. “… In Pennsylvania, an employer must provide additional consideration, such as a meaningful bonus, if the agreement is presented to existing employees. This is quite different from New Jersey, where continued employment can be sufficient consideration to support the agreement.”
And it’s not just the laws of the state in which a company is headquartered that matter, experts say. “Particularly right now, when many employees are working remotely, it’s important to know that the law of the state where the employee is working may govern the noncompete, rather than the law of the state where the company is located,” Fontanesi told Business.com.
• Include a severability provision. In legal terms, severability means that if part of an agreement is found to be unenforceable, other provisions still would apply. Without a severability provision, an entire noncompete can be found to be unenforceable because of one invalid provision, Schooley writes.
When you are hiring
If you hire an employee who is subject to a noncompete agreement with a former employer, you can be liable if that agreement is breached, say attorneys Oberstaedt and Diaz.
“A new employer can be directly liable, most often on a ‘tortious interference’ or conspiracy claim, or on a ‘respondeat superior’ basis (sometimes referred to as vicarious liability),” they say. “In fact, even when the new employee violates the noncompete without the new employer’s knowledge, courts in many states can still hold the new employer liable if it receives the benefits of that breach.”
How can you protect your company? Oberstaedt and Diaz have a few recommendations:
• Ask about noncompetes early on. “It is always important to ask a new hire if he or she executed a noncompete or another restrictive covenant with a former or current employer,” they wrote in the SHRM article. “If the answer is yes, obtain a copy and share it with legal counsel before hiring the employee. Counsel specializing in this area can advise on the enforceability of the agreement, as well as on whether there is a tendency to enforce or not enforce in that specific jurisdiction.”
• Have the employee sign another agreement. “If you decide to hire someone subject to a restrictive agreement, have that employee sign an agreement not to disclose any restricted information or violate any rights of the former employer,” Oberstaedt and Diaz recommend.
• Consult legal counsel. If you are threatened with litigation by another company over a noncompete agreement, retain legal counsel with expertise in this area. “Experienced counsel can often work out these disputes,” they advise. “Waivers, buyouts or agreements to stay away from specific customers can often lead to settlements that avoid protracted and expensive litigation.”
States Move to Restrict Noncompetes
Since 2018, Massachusetts and several other states have enacted new laws restricting noncompete agreements, with some specifically restricting enforcement of noncompetes against low-wage workers.
The law firm Jones Day published a white paper in July 2020 explaining state by state the legislative changes that have occurred since 2018. “The new legislation generally disfavors noncompete agreements as against public policy, and creates significant limitations on enforcement. Employers should take care to ensure that their employment agreements are compliant,” according to the white paper. You can download a copy here: JDSupra.com/LegalNews/An-Update-on-Noncompete-Legislation-49947.
The most recent move to restrict noncompete agreements comes from the District of Columbia City Council, which in December 2020 voted to prohibit “any D.C. employer from requesting or requiring an employee to sign a noncompete agreement,” according to a Jan. 6 article by Stephanie Baron of Miles & Stockbridge’s Baltimore office published on JD Supra, a publisher of legal news. There is a grandfathering period and the measure contains limited exceptions, but those exceptions don’t apply to sleep products manufacturers.
Although Mayor Muriel Bowser opposed the measure, it passed with enough votes to sustain a veto. Congress and the Trump administration also had an opportunity to act during a 30-day “period of consideration,” according to the article. At the time BedTimes went to print, no such action had been taken, and the law was expected to take effect.
Biden Is No Fan of Noncompetes
Coming into office facing a pandemic, a struggling economy and other crises, addressing noncompete agreements won’t be the No. 1 priority for President Joe Biden. But the issue is expected to be a key part of his jobs and workplace agenda, which also includes items like a $15 minimum wage and expanded paid family leave.
During the presidential campaign, Biden indicated his administration will aim to restrict employers’ use of noncompete agreements by allowing only those that protect a narrowly defined category of trade secrets.
“It’s simple: Companies should have to compete for workers just like they compete for customers. We should get rid of noncompete clauses and no-poaching agreements that do nothing but suppress wages,” Biden tweeted in December 2019. His campaign website posted a similar message. (A no-poaching agreement is an agreement between companies to not compete for each other’s employees, say, by not hiring or even interviewing them for jobs.)
“Democrats have typically been more apt to call for limits on the use of restrictive covenants that they perceive as impeding employee mobility, and especially in light of the pandemic and the massive unemployment rate, it would not be surprising to see the new Congress and President Biden team up to implement a national approach to noncompetition,” Susan Guerette said in a November 2020 online article by Roy Maurer for the Society for Human Resource Management, a professional organization based in Alexandria, Virginia. Guerette is a partner in the Philadelphia office of Fisher Phillips.
Even without new legislation, the Biden administration could “rely on the broad rulemaking authority of the Federal Trade Commission” to limit or ban noncompete agreements, write attorneys Allegra Lawrence-Hardy and Linda Spencer in a Jan. 3 article for the tax law website Law360 Tax Authority.
If Congress or the administration limit noncompetes, Ana Dowell, an attorney in the Atlanta office of Ackerman LLP, told SHRM, “employers would have to consider new ways to protect their customer relationships, financial investments, business goodwill and confidential information.”