Noncompete Agreements: How to Create an Agreement Your Business Can Enforce Against a Departing Employee

Use a noncompete agreement to prevent losing valuable trade secrets and employees.

After losing scores of valuable employees (and trade secrets) to competitors, a growing number of employers are asking, or requiring, employees to sign noncompete agreements. These agreements are sometimes called “noncompete covenants,” “restrictive covenants,” or “promises not to compete.”

Sometimes, they are contained in a clause within a larger employment contract; in other cases, they are a stand-alone document. By signing such an agreement, an employee promises not to work for a direct competitor for a specified period of time after leaving the company. Noncompete agreements will sometimes include related promises, such as promises not to solicit clients or employees away from the employer.

Should you require your employees to sign noncompete agreements? And, more importantly, will such agreements be enforceable in court?

How Noncompete Agreements Protect Your Business

Obviously, a noncompete agreement can keep your business from losing employees, but it can also protect your company's confidential information. If one of your employees has access to sensitive business information or trade secrets, you will obviously want to prevent this employee from disclosing this information to your competitors.

A trade secret is information that gives your company a competitive advantage because it is not generally known and cannot be readily learned by other people who could benefit from it. It can be a formula, pattern, compilation, program, device, method, technique, or process that you have made reasonable efforts to keep secret. For more information on trade secrets, see Trade Secret Basics FAQ.

When an employee with access to trade secrets leaves your company, either because the employee quit or has been fired, he or she could take this information and use it to personal advantage (and at your expense).

For example, a former employee may open a competing business or may go to work for a competitor and unwittingly or deliberately divulge your hard-won keys to success. A properly drafted noncompete agreement can keep this from happening.

Different States Have Different Rules on Noncompete Agreements

Noncompete agreements, like most contracts, are governed by state laws. Not all states permit noncompete agreements.
California, Montana, Oklahoma, and North Dakota, for example, ban them outright. Some states, like Illinois, ban them with respect to lower-income workers. These jurisdictions essentially take the position that noncompetes are bad public policy and impede commerce, since they restrict the ability of workers to move their labor and intellectual capital freely. Indeed, California's ban on noncompete agreements is often given as one of the reasons for the success of Silicon Valley as a hub for innovation.
If you are an employer in one of these states, you can still require your employees to sign more limited agreements, such as nondisclosure agreements, which would prohibit them from revealing certain trade secrets learned while under your company's employment. See Nondisclosure Agreements for an in-depth discussion of nondisclosure agreements.

Common Sense Considerations When Drafting Noncompete Agreements

Even in states that allow noncompete agreements, such agreements are scrutinized closely by courts. While noncompete agreements are an effective way to protect your business's trade secrets, you should know that the legal system puts a high value on a person's right to earn a living. If your noncompete agreement ends up under a legal microscope, it will have to pass some legal hurdles, as follows.

Your Business Will Need a Strong Reason for Requiring Employees to Sign

First and foremost, you need a good business reason for asking an employee to sign the noncompete agreement. The agreement should not simply punish an employee for leaving your company. Most likely, your business reason will be to protect your specific trade secrets or a customer base you have worked long and hard to develop.

If you are selective about the employees who sign noncompete agreements, you will increase your chances of success, because judges are much more likely to enforce noncompete agreements against employees who truly possess inside information.

The Agreement Should Provide a Benefit to the Employee

Next, you must provide a benefit to the employee in exchange for his or her promise not to compete with you after departure. Making a job offer contingent on signing a noncompete agreement probably satisfies this requirement, since the employee is receiving a benefit (a job) in exchange for the promise.

It is more difficult to provide an existing employee with a benefit, but generally, coupling the agreement with a promotion or a raise will do the trick.

Noncompete Agreements Must Be Reasonable

A noncompete agreement must also be "reasonable." What's reasonable? Courts will typically consider several factors:

  • Their term must be reasonable. Obviously, what is "reasonable" depends on the type of job, but generally, it would not be reasonable to try to prevent an employee for working for ten years or more.
  • The geographic area the agreement covers must be reasonable. It would not be reasonable to prevent an employee from working anywhere on the East Coast, for example, but it would likely be reasonable to prevent competing in Boston, where your company is located.
  • The agreement cannot prohibit a former employee from engaging in too many types of businesses. Courts will not allow an employer to deprive someone of the ability to earn a living. Thus, the agreement must prohibit only a specific type of job functionality, such as a "software developer" or "derivatives trader."

Of these concerns, the most common issue with noncompete agreements is how long the noncompete agreement lasts. While there is no set rule, noncompetes ranging from six months to two years are generally considered "reasonable," while anything longer than that will receive closer scrutiny.

Creating a Noncompete Agreement

When putting together your agreement, here is a summary of the main areas to think about:

  • When deciding whether to ask an employee to sign a noncompete agreement, think about your goals. Is the employee so valuable, and have you spent so much money training the employee, that losing him or her to a competitor would damage your business? Does the employee have access to important information you don't want revealed to a competitor? Make sure you can come up with a valid business reason for asking an employee to sign a noncompete agreement.
  • Do you run the risk that employees may leave the company, or refuse to join up, if you force him or her to sign such an agreement?
  • As tempting as it might be to create a "tough" agreement, it does not pay to be overreaching. Remember, most courts will not enforce an unreasonable noncompete agreement, in which case it will not be worth the paper it is written on. Instead, try to create an agreement that is meaningful to you, but does not simply punish the employee for leaving your company.

Next Step

While these rules might seem discouraging, they exist for a reason: to protect employees from unscrupulous employers. As long as you are reasonable, the law will be on your side. For a fill-in-the-blank agreement, see Nolo's Noncompete Agreement, which includes instructions on completing the agreement.

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