24 Jan Covenant Gardens: Demystifying Noncompetition Agreements
by Philip I. Frankel, Esq.
I often receive questions concerning the legalities of non-competition agreements (NCAs), also known as restrictive covenants or covenants not to compete. There is usually confusion about how they may apply to employees or self-employed individuals. Traditional NCAs apply only to an employment setting. Their purpose is to protect the employer’s interests.
Independent contractors are free to contract and negotiate any terms and conditions they want in their own agreements. In fact, one of the tests used in confirming independent contractor status is to show that the individual is not bound by the traditional employee-employer relationship and is free to contract with anyone they choose.
Three Types of Noncompetition Agreements
A number of different types of agreements are often confusingly lumped together and summarily called non-competition agreements. It’s important to identify each type of arrangement and determine its effect and enforceability.
The traditional NCA provides that an employee will not, during his or her employment or after the termination of the agreement, work for the employer’s competitor for a certain period of time. By using an NCA, the employer is hoping to prevent the employee from taking sensitive information acquired while working with the employer and using it against the company by working for the competition.
A second type of agreement is called a “non-solicitation agreement” (NSA). An NSA usually prevents a former employee from soliciting, contracting, or transacting business with the employer’s customers or clientele for a certain period of time after termination of employment. NSAs can also restrict terminated employees from enticing or soliciting co-workers to leave their employer and work for a competitor.
A third type of agreement is a “nondisclosure agreement” or “confidentiality agreement.” This contract prevents employees from using their employer’s trade secrets, proprietary information, confidential business information, customer lists, or any other sensitive information that could only be known through working for a particular company. While customer-pricing lists may be confidential, the names and addresses of the customers that can be looked up easily in a phone book are not considered confidential. However, if the employer goes to great lengths to keep its customer lists confidential and the information cannot be found in other sources, then the disclosure or use of those names may be restricted by an agreement. Since trade secrets are also vital to a company’s continuation, there is usually no restriction of time during which an employee is bound not to disclose any confidential information.
What’s tricky is that non-solicitation and nondisclosure agreements can apply to employees and independent contractors alike. Since they do not restrain anyone from earning a living, these agreements are enforceable and depend on each state’s laws. However, just what is considered to be a “solicitation” is also subject to the court’s interpretation. For example, in one case, an employee left to form her own company and sent letters to each of her clients notifying them of her resignation. The letter was carefully worded to say that she enjoyed working with each of the clients and hoped they continued to be happy with the employer. She advised that she was starting her own business but specifically stated that “this was not a solicitation for their business,” only a chance to tell them how much she appreciated their support while she worked with them. In such a case, the court found that even though a number of clients moved their accounts over to her new business, there was no evidence that the departing employee had, in fact, solicited the clientele.
However, a different outcome could occur if the agreement limits the solicitation to include “indirect solicitation.” For example, if an employee tells a former co-worker over lunch how much he enjoys his new job and that co-worker quits to work for the competitor, there may be a question about whether indirect solicitation enticed the employee to leave. Each scenario is evaluated on a case-by-case basis.
Are NCAs Enforceable?
The most common question is whether or not an NCA is enforceable. The law disfavors traditional NCAs because the courts feel that they are a restraint of trade and may prevent an employee from earning a livelihood. In fact, California has outlawed the use of NCAs all together. However, that doesn’t mean that all such agreements are unenforceable. Courts will enforce an NCA if:
- the employer shows it has a legitimate business interest to protect by restricting its employees’ rights to compete;
- the restriction is no greater than is necessary to protect the employer’s interest;
- the agreement is supported by consideration (money); and
- the agreement itself is reasonable in its restrictions of time and geographical area.
Just what is considered a “legitimate interest” remains a question for the courts to decide. Employers who can show that they have spent a great deal of time and money training an employee in technical skills only for the employee to leave and compete with them may, in fact, have a good case for enforcement of the agreement to restrict the competition’s use of that information for a period of time. However, if the job is rather routine and does not involve learning special skills, such as a sales person or secretarial position, then the employee may claim that the enforcement of such agreement would essentially deprive them of a living.
In a job performed by a graphic artist, which obviously includes the artist’s talents and creativity (as compared with learned or trained skills), there is a good argument that the individual’s talents were not obtained through the employer’s time and money. Thus, an NCA is not likely to be enforced against an employee in order to restrict them from creating artwork for a competitor. However, the courts may look to see whether or not the graphic artist had obtained any confidential proprietary information and then restrict the artist’s use of that information in pursuing future endeavors.
The scope and time period of an NCA need to be carefully scrutinized. For example, if the provisions provide that a graphic artist cannot do work for any business within a 15-mile radius, the court will most likely determine that the provisions are too broad and a restraint of trade. However, if the provisions provide a more restrictive limitation, such as not being able to work in advertising for the health food products industry within a 15-mile radius, that may be more acceptable to the courts.
While time limits are an important factor in NCAs, they are also industry-specific. For example, while a restriction of six months or one year may be considered reasonable in the business area, it will be deemed much too long a time period in the ever-changing computer software development industry.
For those employees who already have an NCA, it may be advisable to have an attorney review the agreement to find out if it would be enforceable in their jurisdiction. Those employees who want to quit and start their own business may find themselves bound by a valid covenant not to compete. If an employee finds they are being approached by the employer to sign an NCA after their employment has started, they may be in a position to negotiate some of the terms, like limiting the restrictive covenant to 60 days or to a specific targeted clientele, industry, or geographic area. Unfortunately, there is little room to negotiate if the employee is already work- ing, though he or she may be able to demand severance payment in the event of an involuntary termination that is not for cause.
Employees should also be aware of the courts’ limitations in reviewing agreements. When some courts find a particular provision to be too restrictive, they can throw the entire agreement out. For example, if the court feels that a 100-mile radius is much too broad an area and therefore too restrictive, they have the option to modify the agreement to a 25-mile radius or they can throw out the entire agreement because of its un-enforceability. A provision in the agreement that specifically authorizes the courts to modify the agreement and not to throw the baby out with the bath water is only beneficial for the employer.
Should You Sign an NCA?
Aside from the legalities of these agreements, employees and independent contractors must consider the reality of client issues. While an independent contractor may not be asked to sign an agreement that restricts working for competing companies, he or she has to consider the politics of customer relations. For example, if a graphic artist provides services in a particular facet of a particular industry, his or her client may consider it bad faith were the artist to start doing similar work for a competitor in the same industry. While an independent contractor would not be restricted from providing these services either legally or ethically, he or she cannot ignore the fact that their client may consider this an act of bad faith and seek to discontinue the business relationship.
Therefore it’s vital for graphic artists to consider all the ramifications of an NCA’s restrictions before signing one. Negotiating equitable terms with a client may be a critical phase in developing a good working relationship with that client. On the other hand, some graphic artists believe they should never be required to sign any type of NCA. They contend that every client should trust them to work in each particular client’s best interests. There is no hard and fast rule governing NCAs. Each independent contractor needs to set up their own studio policy on this matter.
The reality of the working world is that professionals — both employees and independent contractors — move from job to job or client to client in the same industry, and their departure from one job for greener pastures or one client for another one cannot be prevented by an employer, but it can be limited by the provisions of an NCA. However, a reasonably drafted NCA can protect both the employer and the employee or independent contractor without restricting the employee’s or contractor’s future options. Before you sign any agreement that may affect your employment future, it’s always best to consult a legal professional who can review the agreement to make sure your interests are protected.
Philip Frankel, Esq. is a partner with Rifken Frankel Greenman Friedman & Levine, P.C. in DeWitt, NY. His primary areas of focus are employment law and intellectual property, and he frequently writes articles about both topics for business publications. These materials are pre- pared for educational and informational purposes only and are not intended to be legal advice or legal opinion on any specific matters. Always consult an attorney before taking action. E-mail: firstname.lastname@example.org.