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October 1999

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 she goes.

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 is.

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.


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