Managing: Legal Issues
Non Compete Clauses
Some of your most valuable employees know they could succeed
on their own. Do you want to risk competing with them?
You watch as Mary, your best sales associate, finesses a difficult
sale another salesperson may well have lost. "I taught her
how to do that," you remind yourself proudly. But deep down,
you admit she's a natural, a dynamo who would shine wherever
What you don't know is your prize protégé has
been thinking the same thing for some time, and where she wants
to go is into her own business. She's perfectly positioned to
do just that. She's known and liked by all your suppliers' reps
and is on a first name basis with more of your best customers
than you'd like to think. When the bombshell drops, it's probably
too late for you to do much about it.
Welcome to the risky world of "at will employees."
Unless sales associates belong to a union, it's common for them
to work without written employment contracts. They're free to
quit at any time, and you're free to fire them at any time (with
the proviso you don't fire them for one of many illegal reasons
such as race, religion, gender, in some jurisdictions sexual
orientation or as part
of or in retribution for sexual harassment).
There are legal restrictions on what your at will employees
can do before quitting, but there are very few restrictions on
what they can do afterward. For example, a former employee can't
use legally protected trade secrets learned while in your employ.
The main thing a former employee can do is compete directly with
your business even if this competition puts you out of
business. The only way to protect yourself (and the protection
is far from absolute) is to have your employees sign an employment
contract that contains a non competition clause. Sounds
simple, right? Unfortunately it isn't.
Restricting the Restrictions
As with so many of the laws we've looked at in this column, non competition
clauses in employment agreements are governed primarily by state
statutes or common law (rules of law developed by state courts).
The laws vary from state to state, but some basic principles
apply in most states that can make non compete clauses tricky
to enforce if crafted too strictly. One New York court summed
them up when it wrote: "Non compete clauses or restrictive
covenants tending to prevent or limit an employee from pursuing
a similar vocation after termination of employment are disfavored
by the law. However, where the covenants are reasonably related
as to time and scope, are not unreasonably burdensome to the
employee and are not harmful to the public, the law has held
these covenants to be enforceable."
The Court's View
A survey of numerous state statutes and court opinions shows
non compete clauses are viewed in much the same way all
over the country. As a general rule, the law doesn't favor them
because they are a restraint of trade. They are enforceable only
if they are reasonable.
A court will scrutinize non compete clauses carefully;
you bear the burden of convincing the court it's reasonable in
your particular circumstance. And remember a clause that's found
to be reasonable in one circumstance may be found unreasonable
and unenforceable in another.
The court will look at the business interest you're trying
to protect and balance that interest against the burden the clause
puts on the employee. In the scenario imagined with Mary, your
star salesperson who now wants to open her own jewelry store
across the street, the business interest you need to protect
is the revenue you will lose if many of your best customers follow
Mary to her new store.
A non compete clause that prohibited Mary from ever working
in the retail jewelry industry anywhere would certainly protect
that interest, but also would be unduly burdensome on Mary and
would be unenforceable.
A clause preventing Mary from working in the retail jewelry
industry in your town for one year would protect your interests
to a degree and probably would still leave Mary in a position
to work, to start a business somewhere else or, after a year,
start a jewelry business near your.
The question of whether a non compete clause is harmful
to the public is likely not to be an important issue in this
kind of case, but it could be a factor if yours is the only jewelry
store in town. Remember, the law seeks to encourage competition.
Any restraint of trade is considered harmful to the public. The
issue in any given case is how harmful the suppression of competition
Keep Former Owners at Bay
There's another kind of agreement not to compete that becomes
important if you buy an existing jewelry store. Suppose you have
a local competitor who decides to retire and sell his business.
You buy him out, purchasing his customer lists, trade name and
good will among the other assets of the business. Two months
later, he decides he hates retirement and selling his business
was the biggest mistake of his life. He opens a new store down
the block from the old one. He can't use the name you bought,
but trading under a different name, it doesn't take long before
many of his customers gravitate back.
A covenant not to compete included in the sales documents
would have prevented this problem. While such agreements have
to be reasonable, most courts enforce them more liberally than
non compete clauses in employment contracts.
Whether you face competition from a former employee or from
the former owner of a business you bought, non compete agreements
can buy you the time you need to minimize the damage. But they
must be drafted properly and they have to be supported by consideration.
In other words, you have to offer the employee something in exchange
for signing it, or it must be part of the sale price of the business
you are buying. Speak with the attorney who prepares the non compete
clause for you to be sure you comply with all the legal requirements
your state imposes. If you don't, you will likely end up with
an agreement that's unenforceable when you need it most.
by William H. Donahue Jr.
William H. Donahue Jr. is an attorney practicing in New Jersey
Copyright © 1999 by Bond Communications.