Drafting Effective and Enforceable Non-Compete Agreements: General Guidelines to Keep in Mind
By Lauren A. Shurman
With today’s increasingly mobile workforce, employers are continually at risk of losing their key employees to a competitor. In order to minimize the risks associated with departing employees, many businesses rely on written non-compete agreements to help maintain their competitive position in the market. However, courts disfavor agreements that primarily limit competition or restrain the right of an employee to engage in a common, or non-specialized, occupation. Therefore, if you decide to use non-compete agreements in your business, you must take care in drafting these agreements to ensure that they will hold up in court.
As a general rule, non-compete agreements are only enforceable if tailored to protect the legitimate interests of the employer. A one-size-fits-all approach will not work. At the outset, you should be aware that the law regarding non-compete agreements varies greatly from state to state. Therefore, if you employ individuals in multiple states, you should tailor your non-compete agreements to comply with the laws of those various states. Under Utah law, to ensure that your non-compete agreement will be valid, your non-compete agreements must be: (1) supported by consideration; (2) negotiated in good faith; (3) necessary to protect the goodwill of the business; and (4) reasonable in their restrictions as to time and geographic scope.
A. Supported By Consideration
In order to show that a non-compete agreement was supported by consideration, you must show that the employee received something of value in exchange for signing the agreement. Practically speaking, this means that you should ask employees to sign a non-compete at the outset of employment, as a condition of employment. Otherwise, at-will employees can only be asked to sign a non-compete agreement post-hire if the non-compete is coupled with a promise of continued employment, or some other benefit to the employee, such as a pay raise or promotion. For employees who are under a preexisting employment contract for a definite term, you can only require that they sign a non-compete agreement post-hire if the non-compete is coupled with some additional benefit that the employee would not otherwise be entitled to under his or her employment contract, such as an extension of the term of employment.
B. Negotiated in Good Faith
A court will not uphold a non-compete agreement when the employee is able to show that the employer asked him or her to sign it in bad faith. Most often, bad faith is shown when the employer terminates the employee shortly after asking him or her to sign the non-compete.
C. Legitimate Interests of the Employer
A non-compete will only be enforceable to the extent that it is reasonably necessary to protect a legitimate business interest. Utah courts have recognized three general categories of “legitimate interests” that employers may protect with non-compete agreements. First, employers may use non-competes to protect their trade secrets. Under Utah’s trade secret statute, this means that, as an employer, you can prohibit an employee from using or disclosing any information that (1) derives independent economic value from not being generally known or ascertainable by others; and (2) is subject to reasonable efforts to maintain its secrecy. In other words, you cannot use non-compete agreements to protect information unless it is truly confidential and a secret. By way of example, Utah courts have held that customer identity and location are not protectible trade secrets because they are generally known and/or ascertainable.
Second, employers may use non-compete agreements to protect their goodwill. However, in protecting goodwill with a non-compete agreement, you may only restrain those employees who rendered special, unique, or extraordinary services to your business. This means that you cannot use a non-compete agreement to restrain employees engaged in a “common calling.” For example, you may not prohibit a salesperson who engages in routine sales calls, who shares a sales territory with other salespersons, and who is not privy to your trade secrets from competing against you with a non-compete agreement. On the other hand, you may be able to prohibit a sales manager from competing against you if the manager rendered special services to your business. Similarly, Utah courts have allowed employers to enforce non-compete agreements against salespersons who handle exclusive territories because the exclusivity of the territory renders the salespersons’ services unique.
Finally, employers may protect any specialized investment or training that they provide to their employees with non-compete agreements. To justify the use of a non-compete agreement for this purpose, you must show that the employee acquired more than general on-the-job training while working for you. In other words, you must show that you provided the employee with extensive and specialized training.
Non-compete agreements must be narrowly tailored so that they do not exceed that which is reasonably necessary to protect the employer’s legitimate interest. Courts will look at both the temporal and geographic scope of a non-compete agreement to determine whether it is reasonable.
In crafting the geographic scope of a non-compete, consider two things: (1) the location and nature of your clientele, and (2) the scope of the employee’s duties. If your clientele are restricted to a particular geographic region, your non-compete agreements should be similarly restricted. On the other hand, if you cater to a national or international market, you may be able to restrict employees from competing against you anywhere where they engaged in business. For example, you may be able to restrict a salesperson from competing against you anywhere in his or her sales territory. Or, rather than specifying a geographic scope, you might instead prohibit your employees from working for designated competitors or customers.
Non-competes should further be limited in their timeframe. Courts will not uphold non-compete agreements that seem longer than necessary or unduly harsh to the employee. A common rule-of-thumb is to limit non-competes to the length of time that it will take you to adequately train the departing employee’s replacement. Utah courts have upheld the reasonableness of a two-year restriction, though there is a growing trend in many states to increasingly limit the permissible timeframes, given the increasingly fast pace at which technology and businesses change.
E. Other Restrictive Covenants to Consider
In lieu non-compete agreements, you might also consider using non-disclosure or non-solicitation agreements. A non-disclosure agreement prevents employees from disclosing your business’ trade secrets or confidential information to a competitor or anyone outside your firm. A non-solicitation agreement restricts employees from soliciting your current or prospective customers for a certain period of time. Each of these agreements is narrower in scope than a non-compete agreement, and, consequently, viewed more favorably by the courts. You should note, however, that when a non-solicitation or non-disclosure agreement is adequate to protect your interests, a court might view any concomitant non-compete agreement as superfluous and refuse to enforce the non-compete agreement.
In sum, you should only use non-compete agreements when necessary to protect your trade secrets, business goodwill, or specialized investment in employees. These agreements should be limited to your “key employees” and should be custom-tailored to each employee’s particular situation. By keeping these general guidelines in mind when crafting your non-compete agreements, you are much more likely to convince a court that your agreement is fair, reasonable, and enforceable.
Originally appeared in The Enterprise, June 11-17, 2007.