Will a Noncompete Agreement Stop Employees From Taking Your Trade Secrets?

Should your business require noncompetes of your employees, and will such agreements be enforceable in court?

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

What are these agreements? As their name suggests, they are contracts in which the employee promises not to unfairly "compete" against the employer, usually by not working for a competitor company within a certain period of time after leaving the employer. Noncompete agreements will also typically include related promises, such as not to solicit clients or employees away from the employer. These agreements are often contained in a clause within a larger employment contract, though they can also be a stand-alone contract.

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

How Noncompetition Agreements Protect Your Business

Noncompetition agreements are helpful for employers in multiple ways. First, they discourage employees from leaving your company, since they would be prohibited from working for direct competitors. Imagine that you have a talented computer engineer on your staff. Normally, she might apply for a job at a competing firm across the street and attempt to negotiate a raise in salary or title. But a noncompetition agreement would frighten her away from applying to such a job (and would frighten the competing firm from hiring her) due to the prospect of litigation. This keeps talent at your company.

Second, noncompetition agreements can 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, 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 (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 noncompetition agreement can prevent this situation by (i) frightening your employee away from this course of action and (ii) giving you a clear path to sue the employee if it happens.

State Laws on Noncompetition Agreements Vary

Noncompetition agreements, like most contracts, are governed by state laws. Different states will enforce noncompetition agreements to different degrees, so employers need to be mindful of their jurisdiction's laws.
Not all states permit noncompetition 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 noncompetition agreements 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 noncompetition 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 Using Nondisclosure Agreements to Protect Business Trade Secrets for an in-depth discussion.

Commonsense Considerations When Drafting Noncompetition Agreements

Even in states that allow noncompetition agreements, such agreements are scrutinized closely by courts. While these 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 agreement ends up under a legal microscope, it will have to pass some commonsense hurdles. Here are some things a court will consider in deciding whether to enforce your noncompetition agreement.

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

First and foremost, you need a good faith business reason for asking an employee to sign the noncompetition 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 such agreements, you will increase your chances of success, because judges are much more likely to enforce agreements against employees who truly possess "inside" information. For example, it might be difficult to justify having a janitor sign such an agreement, as compared to an engineer.

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 noncompetition 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 these factors:

  • Their term must be reasonable. Obviously, what is "reasonable" depends on the type of job, but it would ordinarily 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 noncompetition agreements is how long it lasts. While there is no set rule, noncompetition agreements ranging from six months to two years are generally considered "reasonable," while anything longer will receive closer scrutiny.

Creating a Noncompetition Agreement

When putting together your agreement, think about:

  • When deciding whether to ask an employee to sign a noncompetition agreement, what are 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 noncompetition agreement.
  • Do you run the risk that employees may leave the company, or refuse to join up, if you force them 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 noncompetition 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 your business, but does not simply punish the employee for leaving.

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 Employee Noncompete & Nonsolicitation Agreement, which includes detailed instructions.

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