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What is a Covenant Not to Compete?

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  • Written By: Michael Pollick
  • Edited By: Niki Foster
  • Last Modified Date: 08 November 2016
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A covenant not to compete, also called a non-competitive clause, is a formal agreement asking former employees not to perform similar work within a designated area for a specified amount of time after leaving their original employer. Many workers sign one as part of the paperwork required for employment. It may be a separate document similar to a non-disclosure agreement, or buried within a number of other clauses in a contract. This agreement is generally legal and enforceable, although there are some exceptions.

Whenever a company recruits skilled employees, it invests a significant amount of time and training. It often takes years before a research chemist or a design engineer develops a workable knowledge of a company's product line, including trade secrets and highly sensitive information. Once an employee gains this knowledge and experience, however, all sorts of things can happen. The employee could work for the company until retirement, accept a better offer from a competing company or start up his or her own business. This is why companies encourage the signing of a covenant not to compete. Without something in writing, there would be few legal ways to prevent an employee from starting a new company across town.

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A covenant not to compete may cover a number of potential issues between employers and former employees. Many companies spend years developing a local base of customers or clients. It is important that this customer base not fall into the hands of local competitors. When an employee signs a covenant not to compete, he or she usually agrees not to use insider knowledge of the company's customer base to unfair advantage. The covenant often defines a broad geographical area considered off-limits to former employees, possibly hundreds or even thousands of miles.

Another area of concern covered by the agreement is a potential "brain drain." Some high-level former employees may seek to recruit others from the same company to create new competition. Retention of employees, especially those with unique skills or proprietary knowledge, is vital for most companies, so a covenant not to compete may spell out definite limits on the hiring or recruiting of employees. This type of agreement is difficult to enforce in real life, since many employees do not feel legally obligated to remain with any company without an iron-clad contract.

It may also define a specific amount of time before a former employee can seek employment in a similar field. This may seem especially harsh to outsiders, since the freedom to seek gainful employment appears to be a natural right for any worker. In reality, the potential damage of a disgruntled former employee, especially one with intimate knowledge of a company's inner workings, can be tremendous. Many companies offer a substantial severance package to make sure former employees are financially solvent until the terms of the agreement have been met.

Because the use of a covenant not to compete can be controversial, a handful of jurisdictions have already banned this type of employee contract. In the US, the legal enforcement of these agreements falls on individual states, and many have sided with the employee during arbitration. An agreement must be reasonable and specific, with defined time periods and coverage areas. If it gives the company too much power over former employees or is ambiguous, state courts may declare it to be overbroad and therefore unenforceable. In such a case, the employee would be free to pursue any employment opportunity, including working for a direct competitor or starting up a new company of his or her own.

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anon948111
Post 7

@anon23533: Most courts will find a two-year period to be unreasonable due to the length of the non-compete period. The primary areas of concern in a non-compete are the scope (restricted geographic area) and duration (length of time). If either is found to be overly restrictive or broad, the agreement is likely unenforceable.

The courts typically determine an acceptable scope to be the average length of time it takes for the employer to replace the position of the separated employee. Unless it is a tremendously highly specialized position, it is unlikely that any court would side with the employer on a two-year duration.

For the record, I am not an attorney and am not providing legal advice. I'm simply sharing information gleaned from my HR career and having been on both sides of the non-compete clause. Best of luck!

anon61897
Post 6

Reasonable will vary by each state's precedent. Generally, the covenant will have to meet the 'ancillary' requirement. The covenant will have to be entered in exchange for adequate consideration. And finally, the covenant must also be adequately limited in time, geographic scope, and substance.

The 'ancillary' requirement means that the covenant not to compete had to be ancillary to the former employment. For a covenant to be ancillary to the employment agreement, it must be entered in relation to the former employee's work agreements with their former employer. This is not a very high bar for an employer to meet, as covenant's not to compete are so common, that as long as they are signed while someone is still employed

and drawing pay checks or benefits, the courts will find that the covenant was or could have likely been ancillary to the former employee's employment. Unless the company attempted to force a former employee to enter the agreement after their employment had ended, the covenant will more than likely meet the ancillary requirement.

Additionally, the covenant must be entered for adequate consideration. This is another relatively low bar. Courts have found that continued employment constitutes adequate consideration. Courts have found that the final two weeks after someone puts a former employer on notice of their departure could constitute adequate consideration. This does not seem very fair, but it is the law in most jurisdictions. Therefore, as long as the company provided some sort of consideration, including continued employment or benefits for any reasonable length of time after the covenant was entered, there was likely adequate consideration. Unless an employee entered a covenant, and was told that afternoon or the next day to clear out his things and that they would not be paid, then it is likely adequate consideration.

Finally, a covenant not to compete has to be reasonably limited in time, area, and substance.

Time means that it cannot be an overly burdensome amount of time that a former employee is not allowed to work in a field. Adequately reasonable would be a more appropriate description because the standard for what is a reasonable amount of time will vary by state and by the type of employment. In many states, a two year ban is considered unreasonable in many industries because it takes at least a year for certain professions to get established at a new job. Again, this will vary by state and profession. Reasonable does not have its normal definition, but in this context, reasonable will mean whatever the courts have determined to be adequately reasonable relative to the industry.

Area is also an aspect that must be reasonable. The ban on similar employment cannot be overly broad. Typically, it will need to be limited to an area near the former employer's area of doing business. Once again, this will vary by state precedent and the type of business. If it is a state to state line of business, the area may be as broad as the entire eastern sea board.

However, the covenants will generally restrain future like-employment in a certain mile radius. If the distance of the ban is not obviously relative to the type of work, then it may be unreasonable. For example, if someone went to a competitor down the street, then it would be reasonable to restrict the former employee's area they could work. If someone wanted to work in an adjacent city or municipality that would be servicing a different client base, it would not be very reasonable to prohibit their employment. The reasonableness will be related to type of job and location.

Lastly, the covenant has to be reasonably limited in substance. The covenant cannot restrict all employment, but only the type of employment that would be harmful or detrimental to the former employer. IF the former employee has trade secrets, a reputation, a wide ranging, faithful clientele, or something else that the former employer depended on for their own companies welfare, then the covenant can be prohibit only regarding those attributes or skill sets. For example, a radio D.J. may enter an enforceable covenant not to compete for two years in the same market as another station's D.J.

However, this covenant could not likely restrict the same D.J. for working for another station in another capacity, such as sales or marketing.

The former station only wants to restrict the D.J.'s on air personality because that is what they are losing and do not want to compete with. They would not have any reasonable ground to restrict the D.J. from selling ad time at another station. The substance requirement will usually be adhered to, but is still a hassle because it requires a former employee to enter a new line of work.

In closing, a covenant not to compete will be as enforceable and as reasonable as the local state courts, or sometimes federal courts, have decided. If it is an agreement that was entered without relation to the employment, or without adequate consideration, or if the agreement is unreasonable in time, area, or substance, then it may not be enforceable. If it is potentially anyone of these things, the best thing to do is hire an attorney and try to come to an agreement with the company.

Meeting them half way will usually work. If they expect two years and 100 miles, then in order to avoid three years worth of litigation, they would likely settle for one year and/0r 50 miles. Still not a great deal, but it is definitely better.

If you really feel that it is unreasonable, as in the former employee does not have any trade secrets, faithful clientele, or skills or reputation that they acquired while at the former place of employment, then it is highly advisable you seek legal counsel and examine the possibility of entering former legal proceedings. Hope this helps.

anon44111
Post 4

I signed covenant not to compete clause with company. Company sells out-to new company. New company comes in and takes over. I'm not interested to move forward with new company. How can I use that contract to my advantage? Can I use this contract as a negotiation tool to my advantage? I want to continue in the same industry. they don't want me. they want the clients who I recruited and manage for company. This is a big mess! Best. --MM

anon34000
Post 3

I signed a covenant not to compete and my employer let me go, is it still valid if they let me go?

ash999999
Post 2

A Covenant not to compete is enforced only if it is necessary to restrain trade.

Is this a true statement?

anon23533
Post 1

So...from what I've read...the restrictions on a covenant to not compete have to be "reasonable." What does that mean? My husband has a potential job, but he is required to sign a covenant to no compete, stating that he could not work anywhere within a 100 mile radius for two years! In other words, we would completely have to uproot and relocate, should this job not turn out to be as great as expected. Any thoughts from anyone?

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