Client Q&A: Should I sign a non-compete agreement? How will it be enforced?

Should I sign a non-compete agreement? How will it be enforced?

Non-compete agreements are a recurring issue faced by both employers and employees. These contractual provisions are often an issue of concern both when contracts are being negotiated and when such a provision may need to be enforced. So how do courts treat non-compete agreements?

Two Distinct Types Of Agreements

The most important thing to know about non-compete agreements is that the New York courts recognize a substantial distinction between employee non-compete agreements and business non-compete agreements. Non-compete agreements signed by employees as a condition of their employment are disfavored by the New York courts, and will only be enforced in limited circumstances. On the other hand, business non-competes—often accompanying the sale of a business in some form—are subject to far fewer restrictions.

Enforcement Of Employer-Employee Non-Compete Agreements Is Very Limited

Employee non-compete agreements are disfavored because by law, everyone has the right to pursue their chosen occupation. For this reason, overreaching employee non-compete agreements will not be enforced, or will only be enforced as limited by the courts.

Employee non-compete agreements must (a) be no greater than is required for the protection of the legitimate interests of the employer, (b) not impose undue hardship on the employee, and (c) not injure the public.

The principal limitation on enforcement arises from the fact that New York courts only recognize a very few “legitimate” employer interests worth of protection. The principal ones are protection against misappropriation of the employer’s trade secrets or confidential customer lists, protection from competition by a former employee whose services are unique or extraordinary, and preventing employees from exploiting client relationships and goodwill they acquired during the course of their employment.

And in practice, these exceptions are further limited. Confidential client lists must actually be confidential, and not known or publicly accessible to others with industry knowledge. Indeed, some courts have held that mere knowledge of employer confidences is insufficient for enforcement of a non-compete—the employer must show that confidential documents were misappropriated by the former employee. The “client goodwill” exception is also narrowly drawn. Although an employer is allowed to prevent a former employee from exploiting client relationships built during the course of his or her employment, that protection does not extend to the employee’s “personal” or pre-existing clients, nor to all of the employer’s clients, only to employer clients directly serviced by the former employee. And the protection only lasts for the time the employer needs to have a new employee build a relationship with the affected clients.

The non-compete must also be reasonable in time and area. This is a highly fact-specific inquiry that depends on the type of business the employer is in, the geographic area it services, and the nature of the services the employee provides. An employer that solicits customers across the country is in a very different position than a storefront—or, say, a doctor’s or accountant’s office—that serves a local or regional clientele.

Business Non-Compete Agreements Are Far More Easily Enforced

Because non-compete agreements between businesses (including agreements between franchisors and franchisees) do not give rise to the same concerns about fairness as employee non-compete agreements—courts presume that they are the product of arms-length negotiation and less likely to be exploitative or oppressive—they are far more readily enforced. A business non-compete must only be reasonable in scope, duration, and geographic area. Some courts also include a general requirement that they protect against unfair competition, others merely require the provisions be fair or reasonable. That inquiry is very fact specific, but in general, courts will uphold prohibitions lasting several years if they are limited by geographic area or reasonably focused on, for example, a business’ former clients.

Non-Compete Agreements Are Often Enforced By Preliminary Injunction

A very common first step in enforcing a non-compete is to move for a preliminary injunction. By forcing the party allegedly in breach to stop some or all competitive activities, a preliminary injunction can put great pressure on the adverse party and often force a favorable settlement. However, a successful preliminary injunction application requires very substantial evidentiary support—to prevail, the moving party must supply evidence to address every element to be proven. Schlam Stone & Dolan has extensive experience in preliminary injunction applications to enforce non-compete agreements, and can advise parties on the proof required.

Non-Compete Agreements Can Be Enforced In A Limited Fashion

Unlike most contract clauses, a non-compete agreement can be enforced as limited by a court—if some or all of the clause is overbroad, a court can reduce the scope of the clause to the extent permitted by law.

Issues To Consider When Negotiating Non-Compete Agreements

Although employee non-competes are hard to enforce, a subsequent employer may well not want to take the chance of violating these contracts. Therefore, if you want to move on and your prospective new employer asks if you are subject to a non-compete agreement, regardless of the overbreadth or enforceability of the agreement, many employers will not want to risk litigation if you fall within its scope as written. (An employer who hires an employee subject to a non-compete can itself be sued for tortious interference with contract.) For that reason, it is important that an employee non-compete is drawn as narrowly as possible when the contract is actually signed. An experienced attorney who is familiar with the restrictions on enforcement can be very helpful at this stage.

For any party that thinks it might want to enforce a non-compete, reasonableness is also important. Especially at the preliminary injunction stage, an attempt to get interim relief in support of a patently overbroad non-compete can backfire. Two very helpful clauses that can and should be included are (a) an irreparable harm clause, in which the parties agree that breach of the clause can irreparably injure the other party and that injunctive relief would be appropriate, and (b) a liquidated damages clause, in which the parties agree that money damages arising from breach of the non-compete would be difficult or impossible to quantify, and therefore the amount of damages can be stipulated in the contract. Both of these provisions are usually enforced, and can make obtaining an effective remedy much easier.

Non-compete agreements should be carefully negotiated, and the specific terms agreed upon can make a very big difference in the event of a future dispute. If you are drafting a non-compete agreement, or being asked to sign one, consult a lawyer. Similarly, and regardless of which side of the dispute you are on, litigations to enforce non-compete agreements are often won or lost at the beginning of the action, and experienced counsel can be vital in protecting your rights.