Noncompete Agreements: How Solid Is Yours?

There are many misconceptions and assumptions regarding the use and effectiveness of noncompete agreements. This is mainly because legal enforcement of these agreements is very fact-intensive and situation-specific. There are no bright-line rules to help business owners determine whether a noncompete agreement will be enforceable, so it can be challenging to craft one that will provide maximum protection without being vulnerable to a challenge in court.

Common Pitfalls with Noncompete Agreements

1. Failing to properly identify what is actually being protected.One pitfall that business owners face is that they fail to put much, if any, time or effort into evaluating what legitimate business interest they are specifically trying to protect when asking their employees to sign a noncompete agreement. These agreements are often implemented for the simple reason that it seems like a good business practice from a human resources perspective. However, a deeper dive into the desired protections of these agreements is critical to ensure their effectiveness and enforceability.

2. Using a noncompete agreement when other protections are better suited for the need. Executives may assume that they need to use a noncompete agreement when they actually need a non-solicitation agreement (restricting someone from taking customers, employees, etc.) or a confidentiality agreement (restricting someone from using trade secrets or other information), which are both typically enforceable to protect a legitimate business interest. Business owners and managers should also remember that just because a noncompete agreement may have fit the company's needs and business activities years ago, this does not mean that such an agreement is still a good fit for the business today.

Noncompete Agreements in the “Business to Business” (B2B) Context

In 2020, the Supreme Court of California confirmed that noncompetes between businesses are not held to the same standard as noncompetes with employees under California Business and Professions Code § 16600.[1] Employment noncompetes are, generally, per se invalid, whereas businesses can enter into non-compete agreements with each other that will be deemed valid by the courts provided they are reasonable in scope.[2] Reasonableness is determined by evaluating whether an agreement harms competition more than it helps – that is, does the agreement protect a legitimate business interest, or is the agreement being used for unfair competition? [3]

Unfair competition is, as it sounds, centered on fairness. For example, courts often hold that in the case of the sale of the goodwill of a business it is ‘unfair’ for a seller to engage in competition that diminishes the value of the business or asset sold. To protect the buyer from that type of ‘unfair’ competition, a covenant not to compete will be enforced to the extent that it is reasonable and necessary to protect the buyer's interest.[4]

Issues to Consider When Requiring Employees or Contractors to Sign a Noncompete Agreement

Enforceability of a noncompete agreement can vary from state to state. This can be particularly problematic for larger companies with employees or contractors throughout the country. However, even California law, which generally invalidates employment noncompete agreements, recognizes the need to protect a company’s trade secrets and other confidential information.

If you want to add another layer of protection to your noncompete agreement pertaining to employment agreements, there are a few questions you should ask as you get started:

1. Is the obligation to sign the noncompete coupled with some type of valid consideration?
2. Could the employee or contractor make a valid claim that you negotiated the noncompete in bad faith?
3. Does your company have a legitimate business interest that the noncompete is attempting to protect?
4. Is the duration and geographic limitation of the noncompete reasonable to protect the company’s legitimate business interests?
5. Could the terms or conditions of the noncompete be viewed as being against public policy?

Nonlegal Issues to Consider

In determining whether noncompete agreements will be in the best interests of the company, business owners should consider how a noncompete agreement may affect employee morale or loyalty, both as a result of the required execution of the agreement and the enforcement of the agreement. Suing an employee who has quit or been fired might send the wrong message to current employees, even if the lawsuit is pursued for legitimate reasons.