Using Non-Compete Clauses

When an employee leaves, your secrets can continue to be safe from competitors.

By Fred S. Steingold

Competition is good. Few of us would dispute that basic tenet of American business life. But, like all good things, limits are sometimes needed. Consider the following examples:

• Aspiring to become the proverbial millionaire next door, hard-working Paul develops a successful plumbing supply business in a mid-sized city. As the business expands, Paul hires Al as a manager, paying him a generous salary. Paul teaches Al the ins and outs of the business and, of course, gives him full access to the list of manufacturers and the all-important customers with whom he's carefully built relationships. After five years on the job, Al leaves to open a competing business a mile away.

• Lydia, who's always had a green thumb, decides it's time to make it pay. She learns that Springtime Floral and Garden Center--owned by Joan--is for sale. Lydia buys the business for $250,000. Six months later, Joan opens a competing flower and garden shop right across the street.

Of course, both Paul and Lydia are outraged. They feel that they've been victimized. But guess what? Neither of them would have much of a legal case against their new competitors because unfair competition isn't unlawful. There's no law that says an employee can't quit and then open a business like yours. And there are no legal restraints on someone selling you a business and then opening a similar operation right under your nose.

The best way to protect yourself from this type of unfair competition is through a non-competition clause (sometimes called a "covenant not to compete"). True, such a clause isn't foolproof, but if it's carefully written, it can provide a great deal of protection.

The main problem is that the law favors competition--and the right of people to earn a living doing what they know best. For that reason, courts carefully scrutinize non-competition clauses signed by employees. In some states, they're rarely if ever enforced. Judges are much more likely to enforce a clause signed by someone selling a business.

So how do you improve your chances that a court will enforce an employee's promise not to compete? The key is to keep the non-competition clause reasonable. You should focus on three questions--each of which relates to the specific job and the specific employee.

Do you have a valid business reason for restricting the future activities of the employee? You probably do if you expect to spend a lot of time and money training a high-level employee and you entrust the employee with sensitive contacts on lucrative accounts. On the other hand, if you have a lower-level employee sign a non-competition clause--say, a receptionist or typist--a judge would probably find you don't have a legitimate reason to restrict where the employee can work in the future.

Is the non-competition clause limited to a reasonable geographical area? A 50-mile limit may be reasonable for a particular employee. A limit spanning several states might not be reasonable.

Is the non-competition clause reasonably limited in time? A one-year limitation may be reasonable for a particular employee. A three-year might not be.

Crafting a workable non-competition clause can be especially tricky if your business engages in e-commerce. Why? Well, for one thing, the Web is everywhere. We don't know yet whether the courts will enforce wide geographical limits on ex-employees who worked in your e-commerce division.

Similarly, the fast-paced nature of online businesses may shrink the time period during which an ex-employee can be kept from competing. Recently, a federal judge in New York refused to enforce a non-compete agreement that barred a technology employee, Mark Schlack, from competing for one year.

Tips for Drafting Non-Competition Clauses for Employees
• Don't overreach. Try to protect only your reasonable business interests. If you go too far, a court may throw out the non-competition clause.

• Identify the business interests you're seeking to protect. They may be different for a salesperson than for an engineer or a director of long-term planning.

• Be reasonable in how you define the duration of the restriction--and its geographical scope.

• Carefully define the type of business activities that are prohibited.

• Include a non-disclosure clause for confidential information.

• If an employee is already on your payroll, offer some additional benefit to induce the employee to sign. The legal term for this benefit is "consideration"--and it improves the odds that the non-compete clause will be enforced.

• Have a lawyer draft--or at least review--the clause before the employee signs it.

Resources
Hire, Manage and Retain Employees for Your Small Business: CCH Business Owner's Toolkit, by Joel Handelsman. 1998.

The Legal Guide for Starting and Running a Small Business, Vol. II: Legal Forms, by Fred S. Steingold. 1998.

Noncompete Agreements: Help Maintain the Confidentiality of Your Ideas, www.toolkit.cch.com/tools/nocmpt_m.asp is a page of the CCH Business Owner's Toolkit Web site, with a link to a downloadable noncompete form in rich text format.

Books are available at www.fatbrain.com
The judge said that in the information technology world, a one-year hiatus translates to "several generations, if not an eternity." In the judge's eyes, keeping Schlack out of the job market would cause "significant hardship." Schlack would have difficulty finding work in his field after a one-year absence.

Spell Out the Details
In getting an employee to sign a non-competition clause, timing can be crucial. The best time to approach an employee is at the time of hiring. Later on, the employee may be more reluctant to sign anything--and you'll have less leverage in negotiation. If you're buying a business, the non-competition clause should be included in the purchase agreement.

In either case, spell out exactly what constitutes competition. The employee--or business seller--should agree not to own or work for a similar business, either as an employee or a consultant.

In the case of employees, consider including language on trade secrets and other confidential information, listing the types of information that you consider confidential. The misuse of inside information can be as damaging as outright competition.

If you have to enforce a non-competition clause, you'll need to go to court and ask for an injunction. That's a court order prohibiting the ex-employee or seller from continuing to compete. A person who disobeys an injunction faces a fine and even jail time. You can also seek monetary damages for losses your business has suffered. n

Legal strategies may vary depending on the state in which you live and the specifics of your situation, so talk with your lawyer.

Fred S. Steingold practices law in Ann Arbor, Mich. He is the author of The Legal Guide for Starting and Running a Small Business and The Employer's Legal Handbook, both published by Nolo.com.

For a collection of sample business contracts, see also AgreementBuilder -- a collection of business contract templates including 'Non-Dosclosure,' 'Termination Agreement,' Employment Agreement' and about 130 more...

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