To preface, this article is intended for owners, in-house counsel, and others in C-suite who have input into their company’s employment agreements. This article is not intended to reflect the views of any of the firm’s clients and is not legal advice. You should consult with us or another non-compete and trade secret law attorney for guidance on any specific matter.
Summary
As we enter 2024, federal and state efforts to ban or limit the use of workforce non-competes are stronger than ever. Those administrative and legislative efforts are largely political. This article, however, is not about what the federal government or states should do concerning regulating non-compete agreements. It’s about what your company should do.
Having represented hundreds of businesses in non-compete matters, I’ve realized that many companies include non-compete provisions in employment agreements without much thought to the matter. The reasoning company leaders often state for implementing non-competes is typically something along the lines of “the more protections for the business, the better!” or “our competitors use them, so we should too!” or, perhaps, the most used “even if we don’t enforce them, they help deter former employees from competing against us!”.
But unlike other restrictive covenant provisions, there are many serious downsides to a company requiring most of their workers to sign non-compete agreements. The downsides include compliance costs for multi-state employers, high-risk litigation, and losing talent. And, in most circumstances, non-compete provisions are also simply not needed to protect a company’s legitimate business interests.
What is often needed, however, is other robust and well-written restrictive covenant provisions, such as non-solicit, non-acceptance, non-interference, and non-disclosure provisions. When drafted and implemented properly, the use of those restrictive covenants is generally more than sufficient to protect a company’s business interest.
There are exceptions of course for when it’s prudent to use a non-compete agreement, such as for partners or shareholders, the sale of a business, a franchisee-franchisor relationship, and substantial investment in marketing an employee in a specific area. As explained below, outside of those situations, your company should be seriously considering whether it makes sense to continue using non-compete agreements.
Downsides to Using Non-Compete Agreements
What are the downsides of using non-compete agreements? First, for multi-state employers, the obvious downside is the cost associated with compliance. A growing handful of states outright ban non-competes and many others prohibit non-competes for low-wage workers or many types of workers. The states that currently outright ban non-compete provisions include:
- California
- Minnesota
- North Dakota
- Oklahoma
Notably, New York also has a bill pending before its governor that, if signed into law before the end of 2023, will ban most non-competes in New York. Most close observers of that bill believe it will either be signed as-is or, at minimum, will be sent back to the New York legislature for some minor amendments before it is presented again and signed in 2024.
The states or territories that currently prohibit non-competes for low-wage workers or many types of workers include:
- Colorado
- District of Columbia
- Georgia
- Idaho
- Illinois
- Maine
- Maryland
- Massachusetts
- Nevada
- New Hampshire
- Oregon
- Rhode Island
- Virginia
- Washington
There are several other states with bills pending or making their way through their respective state legislatures that would either ban or substantially limit the use of workforce non-compete agreements. If you are a multistate employer, clearly there is a real burden associated with your in-house or outside counsel ensuring compliance. That includes, for example, ensuring you comply with state-specific notice or disclosure requirements and ensuring you don’t roll out non-compete provisions to employees in states that impose penalties for so doing.
Second, even in states that allow non-compete agreements, litigation to enforce such provisions is high-risk. The attorneys’ fees incurred to enforce a non-compete can be substantial both pre-suit and during litigation. Pre-suit, if you are considering filing a lawsuit against someone for violating a non-compete provision, the best practice is to thoroughly research the state law jurisprudence and even judge-specific trends towards non-compete enforcement to help set the company’s expectations.
The attorneys’ fees for the lawsuit itself are also much more expensive and frontloaded than other lawsuits when a company is seeking a temporary injunction. A temporary injunction often requires an evidentiary hearing, i.e., a mini-trial, and is often preceded by expedited discovery.
To be sure, many companies are well financed and don’t balk at the cost of litigation when it is perceived as worth the cost. But the odds of success in enforcing a non-compete agreement are much lower relative to other types of restrictive covenant provisions, i.e., non-solicits and non-disclosure provisions. When a company loses its bid to enforce a non-compete provision, that loss is in the public record and will likely be used against the company in future litigation if it ever tries to enforce the same provision against another former employee.
Finally, employees obviously don’t like signing non-compete agreements. Entry-level and junior employees may not appreciate how non-compete agreements can limit their future career aspirations or, even if they do, may not have the leverage to negotiate such agreements. Experienced candidates who have options, however, will often heavily weigh any non-compete agreements when deciding on a new position.
Non-Competes are Generally Unnecessary to Protect Legitimate Business Interests
While there are serious downsides to using non-compete provisions, a business still needs to protect its business interests. How can a business adequately protect its business interests without the use of non-competes? That question is answered by examining the typical legitimate business interests given for non-compete agreements:
- Protecting trade secrets and other confidential information. True, but these business interests are protected with non-disclosure and return of property provisions.
- Protecting substantial customer or patient relationships. True, but these business interests are protected with non-solicit, non-acceptance, and non-interference provisions.
- Protecting referral sources, vendor relationships, and employee relationships. True, but these business interests are protected with non-solicit, non-acceptance, and non-interference provisions.
- Protecting intellectual property, such as trademarks, trade names, etc. These business interests are protected by the Lanham Act and state intellectual property laws.
In sum, virtually all legitimate business interests can be adequately protected through the use of restrictive covenants other than non-compete provisions.
The primary circumstance justifying a non-compete provision is protecting goodwill associated with a limited geographic area. To be sure, this business interest only arises when a company invests in marketing a specific individual for a limited geographic area. In most cases, however, a company is focused on marketing itself – not a specific employee.
To be sure, some businesses mistakenly take the position that a non-compete provision should be enforceable because the company would not have hired the employee but for the employee agreeing not to compete for a period of time. While that may be a business interest, it is not a recognized “legitimate” business interest under any state law.
Remember, the underlying rationale for some states permitting non-competes in the first place is that, under certain circumstances, a non-compete can prevent unfair competition. No state considers as legitimate business interest the mere fact that a business claims they would not have hired an employee but for the employee signing a non-compete.
Strong Mechanisms to Protect Legitimate Business Interests Without Non-Competes
How can a company adequately protect its legitimate business interests without using non-compete agreements? As discussed above, in most circumstances there are serious and expensive downsides to using non-compete agreements. But at the same time, it’s important to ensure that the company has strong mechanisms to protect business interests. Here is a non-exhaustive list of provisions companies should consider to protect their legitimate business interests:
- Non-solicitation, Non-Acceptance, and Non-Interference Provisions. These provisions most often apply to customers, prospects, referral sources, vendors, employees, and contractors. They should be drafted broadly to avoid a former employee arguing that, technically, a “solicitation” never occurred. For example, broadly defining the phrase solicit, coupled with non-acceptance language, no-contact language, and other broad language ensure clients, prospects, and employees don’t follow a former employee without legal recourse for the company.
- Presumption of Breach Provision. This provision effectively states that if a client, prospect, employee, or contractor enters into a relationship with the former employee during the restricted period, there is a presumption of breach of contract.
- Inspection Rights. This provision provides the company with future inspection rights of certain documents, for example, future communications between the employee and the customers, prospects, or employees.
- Non-Disclosure and Return of Property Provisions. Admittedly, non-disclosure provisions are the hardest provisions to enforce because it is often difficult to establish that a former employee used or disclosed a company’s trade secrets or other confidential information.
- Requiring Disclosure of Agreement. This provision obligates a former employee to inform any potential new employers of the agreement prior to starting work. Sometimes competitors will not hire someone with non-solicit and non-acceptance restrictions, especially in sales positions.
- Right to Inform New Employers of Agreement and Allegations. This provision removes legal exposure for a company sending a cease and desist to a former employee’s new employer to notify them of the former employee’s obligations and suspicions of a breach.
- Long Notice Period. Employees can be required to provide a long notice period, such as 30 – 45 days. While often employees will ignore that notice obligation, an employer can attach contractual penalties to it, such as reducing the employee’s final paycheck to the minimum amount allowed by law and/or not being entitled to any otherwise earned commissions or bonuses. Longer notice periods enable companies to shore up customer relationships that could be weakened by a departing employee.
We have template language for all the provisions referenced above.
There are of course many other actions companies can take to protect their assets apart from strong contracts. For example, it is easy and helpful to send off-boarding letters to departing employees that include standard language reminding them of their post-employment obligations – sometimes someone may honestly have forgotten they have any post-employment obligations in the first place. And of course, there is no better safeguard to keep key employees away from competitors than developing and fostering a great company culture, so that such employees don’t want to leave.
If you have any specific questions or have insights to add, please reach out to Will Cantrell at wcantrell@caklegal.com or 1-877-858-6868.