What Is a Non-Compete Agreement, and Is it Enforceable?
(Part 1 of a 4-Part Series)
As an employment litigation attorney, the most common question I am asked about non-compete agreements is this: “Are non-compete agreements really enforceable?” My answer: “YES!”
The second question is usually: “So if my employee signed this non-compete agreement, it’s enforceable, right?” My answer: “Not necessarily!”
Non-compete agreements are a special type of contract called a “Restrictive Covenant.” A Restrictive Covenant—either as a stand-alone contract or a provision in a broader employment agreement—is intended to restrict an employee from engaging in certain behavior after termination of employment. These restrictions may include things like restrictions on working for a competitor, soliciting or doing business with customers of the former employer, poaching other employees, etc. Broadly speaking, a Restrictive Covenant is any restraint on open competition or employment.
Utah courts will enforce Restrictive Covenants, and do so regularly. However, different from ordinary contracts, restraints on open competition are enforced reluctantly. Courts will only enforce Restrictive Covenants that are expressly agreed on by the parties in a proper contract, and confined within certain bounds of “reasonableness.” The Utah Supreme Court has held that Restrictive Covenants may place “no greater restraint” than is “reasonably necessary” to secure protection of an employer’s “legitimate interests.”
What does this mean for you? An employer may use a Restrictive Covenant to protect its “blood, sweat, and tears”—the competitive advantage it has earned through innovation, investment, nurturing of customer goodwill, and countless hours and dollars expended building a successful company. Employers can also use Restrictive Covenants to protect their extraordinary investment in certain employees and their proprietary and confidential information. The law recognizes that it would be unfair for an employee or competitor to take a short-cut to competitive parity without expending the same effort and taking on the same risk. However, an employer cannot use a Restrictive Covenant solely to keep competition out of the marketplace or to keep employees enslaved to their company. Open competition, workforce mobility, and consumer choice are important characteristics of our economy and a benefit to society.
Non-compete agreements, non-solicitation agreements, no-hire clauses and similar provisions are always evaluated against this backdrop. Courts balance the competing interests of the employer and employee as they review each Restrictive Covenant to determine if it places “no greater restraint” than is “reasonably necessary” to secure protection of the business’ “legitimate interests.” Understanding this balancing act will help you craft Restrictive Covenants that will protect your business and have an increased likelihood of being enforced by the courts. With these principles in mind, Part 2 in this five-part series will look at who can be restricted by a non-compete agreement, before we later discuss the types of restrictions that will be upheld by the courts.
Who Can Be Restricted by a Non-Compete Agreement?
(Part 2 of a 4-Part Series)
In Part 1 of this series, I explained that Utah courts will enforce Restrictive Covenants (like non-compete agreements, non-solicitation agreements, no-hire clauses, and similar provisions), as long as they are written to protect the employer’s “blood, sweat, and tears”—its innovation, investment, goodwill, etc. However, a court will not allow an employer to simply stifle competition in the open marketplace.
Against that backdrop, we next ask: “Who can be restricted by a non-compete agreement?” To answer this question, an employer must be able to explain why a particular employee must be restricted to protect the employer’s legitimate interests. Several Utah cases hold that restrictive covenants must be limited to employees who are “special, unique or extraordinary”—those with access to the employer’s confidential information and know-how, or responsible for building and nurturing goodwill with the employer’s customers, or specially trained by the employer. So-called “common” employees cannot be restricted.
To illustrate the concept, imagine you own a local ice cream company that sells your famous “Beehive Butterscotch” ice cream in local grocery stores. Your head glacier who mixes each batch and knows the secret “Beehive Butterscotch” recipe could likely be restricted by a non-compete. You would have little trouble explaining to a judge that your “blood, sweat, and tears” would be at risk if this employee took his know-how to a competitor across town. Similarly, you may be able to restrict the employee who negotiates your contracts and maintains the company’s relationships with the local grocers who carry your product, or the local farmers that supply your operation.
Could you restrict the truck driver that delivers ice cream around town each week? Probably not. This employee likely has no special knowledge about your company, no special relationships with your customers, and no special or extraordinary training. It would be difficult to convince a judge that a competitor would obtain an unfair advantage from hiring your delivery driver.
When writing a non-compete agreement (or other Restrictive Covenant), ask: Does the employee need to be restricted to protect the employer’s confidential information and know-how, goodwill, or extraordinary investment in training/education of the employee? Did the employee have a unique role in the company that made him or her privy to the employer’s “secret recipe” of success? If the answer is yes, you have cleared the first hurdle on the path to drafting an enforceable Restrictive Covenant.
What Kinds of Restrictions Can Be Placed On Employees?
(Part 3 of a 4-Part Series)
In Part 1 of this series, I explained that Utah courts will enforce Restrictive Covenants (like non-compete agreements, non-solicitation agreements, no-hire clauses, and similar provisions), as long as they are written to protect an employer’s “legitimate business interests” and they place “no greater restraint” than is “reasonably necessary” to do so. In Part 2, I discussed the types of employees that can be restricted. In this Part 3, I discuss the types of restrictions that are commonly placed upon employees, and how to ensure that restrictions are enforceable.
Striking a Balance
When courts examine Restrictive Covenants, they often attempt to balance the interests of the parties. On one side of the equation, they examine whether a restriction protects an employer’s legitimate business interests—its innovation, investment, goodwill, etc. Courts respect an employer’s interest in protecting its hard-won business. Courts are also sensitive, however, to the burdens a Restrictive Covenant may place on an employee. It is one thing to require an employee to keep a business secret. It is quite another, however, to force an employee out of the workforce, leaving the employee unable to support his or her family.
Non-Compete Restrictions:
Non-compete agreements typically restrict an employee from competing with an employer’s business for a period of time in a specific geographical area. Utah courts require that non-compete restrictions be “reasonably limited in time and geographic area” in order to be valid and enforceable. Generally speaking, the geographic restriction in a non-compete provision cannot be more broad than the territory encompassed by the employer’s business. This case-specific limitation makes sense—a medical office in Salt Lake City probably could not convince a court that its business would be harmed if a physician left and opened a practice in Vermont. However, the employer very well might be harmed if the physician opened a competitive practice in Sugarhouse. In contrast, an internet-based marketing company may field clients from across the country, and may convincingly argue that a nationwide geographical restriction is necessary to protect its business.
Historically, there has been no bright-line rule for time restrictions in non-compete provisions. Instead, courts engaged in a similar case-specific inquiry into the nature of the business and the employment relationship to determine the reasonableness of restrictions. Although an early Utah case upheld a five-year non-compete provision, more recent experience shows that time limits under a year can often be enforced, restrictions up to two years are sometimes enforced, and restrictions beyond two years are rarely enforced.
As discussed in a previous post, the law regarding time limits for non-compete provisions changed dramatically in 2016 with the passage of the Utah Post-Employment Restrictions Act, Utah Code § 34-51-101 et seq. Under this new law, any “post-employment restrictive covenant” entered into on or after May 10, 2016, that has a restrictive period longer than one year from the end of an employee’s employment is void. The Act defines a “post-employment restrictive covenant” as an agreement that an employee “will not compete with the employer in providing products, processes, or services that are similar to the employer’s products, processes, or services.” The Act expressly does not apply to non-solicitation agreements or non-disclosure or confidentiality agreements. It also excludes non-compete agreements entered into at the conclusion of employment as part of a severance agreement, or in connection with sale of a business (so long as the employee benefits from the sale of the business).
Non-compete agreements entered into before May 10, 2016, continue to be governed by the old “reasonableness” analysis as to period of time. However, non-compete agreements entered into after this date are subject to the strict one-year limit. The new law also makes employers liable for attorney fees if they unsuccessfully attempt to enforce an invalid non-compete restriction. Therefore, employers should carefully review their non-compete agreements to ensure that they are compatible with current Utah law.
Non-Solicitation Restrictions:
Non-solicitation restrictions are inherently less restrictive to a departing employee, and therefore are often easier to enforce. A non-solicitation provision allows a departing employee to engage in competition with the employer generally, but restricts solicitation of certain customers to protect the employer’s goodwill and investment in those customer relationships. Non- solicitation provisions may broadly identify the off-limits customers generally (i.e., all customers the employee had contact with while employed) or specifically (i.e., by name). Some non-solicitation clauses focus on preventing the employee from soliciting the employer’s customer, but will allow the employee to service the customer if the customer initiates contact. Other times, restrictions are drafted to prevent a former employee from doing business with former customers regardless of which party approached the other. This type of restriction can be drafted to protect any valuable business relationship—customers, suppliers, vendors, distributors, etc.
As with any Restrictive Covenant, an employer must be prepared to explain why the scope of the particular restriction is necessary to protect the employer’s legitimate business interests. In the case of a pharmaceutical salesperson, for example, an employer might explain why a departing salesperson should be restricted from contacting doctors in the employee’s sales territory to pitch a competing medication. This employee knows these customers’ needs, costs, sales volume, and incentives, and has built relationships with these customers on behalf of the employer. Taking this information elsewhere could give a competitor an unfair and unearned advantage. However, it may be more difficult to defend a restriction preventing the salesperson from pitching a different drug to doctors in another sales territory with whom the employee never had any contact.
Other Restrictions:
Other types of restrictive covenants may be useful in specific situations. A confidentiality or non-disclosure provision generally restricts a departing employee from either using or disclosing a former employer’s trade secrets and other confidential information. A no-hire clause may restrict a departing manager from poaching former colleagues or subordinates, and may protect an employer from a company-ending exodus. A non-circumvention provision is designed to prevent a “cut-out-the-middle-man” scenario by prohibiting a former employee from directly offering products or services to a customer that the employee was supposed to be offering on behalf of the employer. These different types of restrictions can be used by themselves or in some combination, and either with or without a broader non-solicitation or non-compete restriction. Of course, the suitability of any Restrictive Covenant to a particular situation should be carefully considered in each instance, and experienced employment counsel should be consulted. A Restrictive Covenant that does not accomplish the goal sought to be achieved, or that cannot be enforced, is literally not worth the paper on which it is written.
Are There Other Ways to Protect My Business?
(Part 4 of a 4-Part Series)
In Parts 1, 2, and 3 of this series, I discussed using Restrictive Covenants (like non-compete agreements, non-solicitation agreements, no-hire clauses, and similar provisions) to protect an employer’s “legitimate business interests”, such as its innovation, investment, and goodwill with its customers, suppliers, vendors, distributors, etc. Restrictive Covenants are valuable and powerful when used correctly. But they are by no means the only tools available to employers. In Part 4 of this series, I discuss other ways employers can protect themselves and their blood, sweat, and tears.
Confidentiality and Non-Disclosure Agreements:
One of the most basic items in every employer’s toolbox is the confidentiality agreement. Whether used as a stand-alone contract, a provision in a larger employment agreement, or a policy in an employee handbook, confidentiality and non-disclosure agreements have become ubiquitous in the modern workplace, and can be an effective way to protect the company’s “secret sauce.” Despite being common, they are often carelessly drafted and inconsistently followed, often making them largely ineffective. When using confidentiality agreements or policies in the workplace, two basic rules need to be followed:
- Rule #1: A confidentiality agreement is only enforceable as far as it clearly defines what constitutes “confidential information.” Courts will often reject policies and provisions that prohibit disclosure of “confidential information” but fail to describe precisely what that is. Catch-all language in a confidentiality provision is useful, but no substitute for clear identification of information the company wants to keep secret. Why leave your company’s “secret sauce” to the whims of a judge? If it’s important, mark it “CONFIDENTIAL.”
- Rule #2: Employers should take care to ensure that confidential information is treated as such. If you don’t carefully guard your company’s confidential information, don’t expect the judge to do it for you.
Properly drafted confidentiality policies and agreements should restrict an employee from both using confidential information and disclosing the information to others. A confidentiality clause should also expressly survive termination of the employment relationship.
Trade Secrets:
State and federal law provides additional protection for certain types of confidential information. The Utah Uniform Trade Secrets Act (the “UTSA”) and the federal Defend Trade Secrets Act (the “DTSA”) each provide power protections for employers.
Trade secrets law will receive in-depth treatment in a future article, but a few basic points are worthy of discussion here. First, both state and federal law first require that information meet the definition of a “trade secret” before it is entitled to legal protection. In the UTSA, a trade secret is defined as follows:
“Trade secret” means information, including a formula, pattern, compilation, program, device, method, technique, or process, that:
(a) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use; and
(b) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.
A similar definition is found in the DTSA. In other words, a “trade secret” must be two things: secret (because you work to keep it that way), and valuable (because it is secret).
If the information meets the definition of a trade secret, the law provides powerful protections. The UTSA provides injunctive relief, monetary damages, and recovery of attorney fees and costs in certain cases. The DTSA provides these remedies, and may even allow for exemplary damages and criminal prosecution in certain cases.
The Duty of Loyalty:
What if you don’t have a non-compete or a confidentiality agreement? Courts have long recognized that employees have a basic duty of loyalty to their employer both while employed and when approaching separation from the company. This duty of loyalty prevents the employee from competing with the employer while still employed, and from using the employer’s resources or taking business opportunities for themselves. The duty of loyalty is even more restrictive for corporate officers or directors, who “are obligated to use their ingenuity, influence, and energy, and to employ all the resources of the corporation, to preserve and enhance the property and earning power of the corporation, even if the interests of the corporation are in conflict with their own personal interests.”
The duty of loyalty frequently arises when employees are in the process of moving from one job to another. It commonly applies in situations like these:
- Example 1: A sales employee is moving from one telecommunications company to another. As she approaches her planned separation date, she decides not to pitch her last few leads and instead tells the customers she’ll contact them the following week after she moves to her new company.
- Example 2: An accountant is moving from one firm to another. As he approaches his planned separation date, he uses his office computer to prepare and print announcements regarding his move, which he mails to his entire customer list using the employer’s postage machine.
The duty of loyalty has its limits, and courts have cautioned that it should not be applied to broadly. Employees undoubtedly cannot compete with their employer, or solicit customers elsewhere while still employed, or use company resources to set up a competing business. However, courts have allowed employees to plan to go into competition and even make preparations to do so which still employed. In fact, an employee can even tell customers he is going to quit and will soon be working elsewhere—he just can’t ask the customers to follow until he has officially separated from employment.
