Roughly half of US employers require at least some of their employees to sign a non-compete agreement, according to an Economic Policy Institute survey. Although this makes up a significant number of people in the workforce, asking employees to agree to a non-compete (and the terms these agreements spell out) is not standard practice across all industries. So, how do you know if your organization needs to use them?
If you’ve ever wondered how a non-compete agreement might protect your business interests or prevent proprietary information from being shared with a competitor, having a basic understanding of how these types of agreements work (and their limitations) is a good place to start.
Furthermore, it remains to be seen how the White House’s executive order aimed at limiting non-compete agreements in the workplace will affect businesses that regularly use them. In this overview for business owners, we’ll talk about what a non-compete agreement is, why employers use them, and how to make sure yours is reasonable.
What is a non-compete agreement?
A non-compete agreement, also known as a “covenant not to compete” or CNC, is a legal contract that prohibits an employee from competing against an employer for a fixed period of time after a working relationship ends. These agreements also prevent employees from revealing a company’s proprietary information or secrets to outside parties both during and after employment. Non-compete agreements can be standalone contracts or included as a non-compete clause in larger contracts.
Why employers use non-competes
A non-compete agreement is generally used to:
- Protect the investments a business makes in its customer relationships
- Ensure that no trade secrets or sensitive information get disclosed to the public (or a competitor)
Alyssa Devine, the founder and CEO of Purple Fox Legal, explains it this way: “The purpose of non-compete agreements is to help business owners protect certain company data and operations, including specialized training or proprietary information.”
Because non-compete agreements are typically enforced when an employee-employer relationship ends, almost all are designed to prevent an employee from taking a job with a competitor. Sometimes, they can even keep an employee from starting a competing business (in the same market).
Now that we better understand why businesses use non-compete agreements, let’s talk about what to consider before putting one in place.
What to consider when creating a non-compete
First, it’s important to note that some states, like California and Oklahoma, don’t even recognize the validity of non-competes, so if you do business in one of these states, you’ll need to explore other options (we’ll touch on some alternatives a bit further into this article).
Moreover, a good starting point is to check your state’s laws to see if non-competes will even be recognized should you decide to draft one. Keep in mind that even states that recognize non-compete agreements may not enforce them when too many restrictions are placed on the employee. It can also be a good idea to know a few of the factors that courts take into consideration when deciding whether to enforce a non-compete:
- Legitimate interests to protect: The courts will assess whether the company has a legitimate interest that needs to be protected via the use of such an agreement.
- Time: The shorter the time window preventing the employee from working for competitors, the more likely the court may find it reasonable. An average time frame is between one and two years.
- Geographic area: What is the geographical scope of the restriction? Courts are more likely to enforce non-compete agreements that are more limited in the areas they apply to. The size of the area courts consider reasonable will depend on the industry.
- What really counts as competition: Courts are more likely to enforce agreements with a shorter list of competitors for the employee to avoid, or agreements that only prevent the employee from starting their own business in the same field.
- Employee “consideration”: Non-compete agreements are only enforceable if employees receive “consideration” for signing it. That’s just a fancy legal way of saying there was an exchange of value between the employer and employee.
- For new hires, the agreement usually states that the employer’s job offer is the value exchanged for the employee’s agreement not to compete.
- For existing employees, additional consideration is necessary to make the agreement enforceable.
If you’re in an industry where it makes sense to ask your employees to sign a non-compete, knowing what courts look for can help. If (and when) the time comes, you want to be sure it will be enforceable by your state.
Taking the time to determine whether there’s a genuine need to protect your business interests with a non-compete agreement before moving full steam ahead can be a good idea.
We spoke with Tara Furiani, CEO and founder of Not the HR Lady and a former Chief People Officer with more than 12 years of corporate experience, for more insight. “A company should really only ask an employee to sign a non-compete agreement when there is a legitimate business interest at stake, such as protecting confidential information, customer relationships, or trade secrets,” she says. That’s because there can be a fine line between protecting business interests and limiting employee prospects. “It should not be used as a tactic to silence employees or limit their job prospects.”
With those considerations under our belts, let’s talk more about what’s commonly included in non-compete clauses.
What to include in a non-compete agreement
There’s no one-size-fits-all approach to non-compete agreements, but there is certain information required for them to be considered legally binding. This includes:
- Names and addresses of the parties involved
- Effective start date and the duration of the agreement
- Reason for enacting the agreement
- Geographical area covered by the agreement
- Compensation or “consideration” for signing the agreement
To summarize another way, a non-compete agreement must include an “offer, acceptance, intent, and a benefit or ‘consideration’ to the employee in exchange for his or her promise,” according to the legal website Justia. The benefit being referenced here could range from the individual being offered a job in exchange for signing, to a promotion or financial bonus for your existing employees.
It’s always a good idea to outline every detail of the agreement to the best of your ability, and having the information in writing is the best way to prevent disputes in the future. Before asking any of your employees to sign the agreement, speaking with a legal expert is always a good idea. With laws and regulations changing so often, they’ll walk you through it to ensure you comply with state laws.
There are options beyond non-competes that can also be effective.
Alternatives to non-competes
While non-compete agreements can be helpful under certain circumstances, you may be wondering whether other methods exist to protect your business’s interests. Once more, we asked Alyssa Devine to share her insights, and she says non-disclosure agreements or NDA’s can be an option worth a closer look. “Because non-disclosure agreements prevent existing employees (and former employees) from discussing, posting, or sharing certain company information they learned while employed, they can be a useful alternative.”
NDAs are not designed to prevent an employee from working for a competitor, but rather prevent the sharing of company information. NDAs are especially helpful if employees are dealing with sensitive client information, trade secrets, or if they have access to a company’s confidential information.
Devine mentions that non-solicitation agreements are another option “because they prohibit the poaching of customers, clients, and current employees.”
Essentially, a nonsolicitation agreement states that your current employees won’t try to take your customers (or recruit any of their co-workers) away from your company for a certain period of time after they leave your organization.
In addition, “nonsolicitation agreements are especially helpful for sales employees who have access to large amounts of client information,” she says. “Well-drafted nonsolicitation agreements will clearly answer two important questions. First, who the employee is barred from contacting? Second, what type of communication is considered “solicitation”?
NDAs and nonsolicitation agreements can also provide a middle ground for employers and employees. “These alternatives can protect employer interests while also allowing employees to seek new opportunities and promote competition,” says Furiani with Not the HR Lady. And she recommends that companies consider both sides of the coin before moving forward with any agreement. “Employers should carefully consider their options and choose the approach that is most appropriate for their business needs and the needs of their employees.”
The important takeaway here is that if you’re considering the protections that come with a non-compete, but remain unsure whether they’re a fit your goals, NDAs and nonsolicitation agreements may be worth investigating.
We’ve covered many of the ins and outs of how these agreements work, but before we go, let’s take a moment to discuss some federal government announcements about non-competes and what the future may hold.
No more non-competes?
In July 2021, the White House issued an executive order asking the FTC to “curtail the unfair use” of non-compete clauses, and earlier this year, the Biden Administration also proposed rules to prohibit them altogether. Also, the FTC could make a final determination regarding limits (or a total ban) by the end of this month.
“Employers may begin to use non-compete agreements less as a result of the executive order and increasing public scrutiny,” shares Furiani. “I believe it will end up being a positive development, as it will help to promote greater employee mobility and competition.”
Devine shares that while federal legislation can make a difference, there will be more “companies committed to fairness and retaining top talent who will use noncompete agreements less and less.” Executive orders and potential legislation are not the only reason. “Following the pandemic, employees have more bargaining power, and businesses are doing everything they can to retain top talent,” she says. “With more options for employees, coupled with the increasing public awareness around non-competes, it’s likely they’ll be used less as time goes on.”
Is a non-compete in the cards?
At the end of the day, the decision to use a non-compete boils down to a variety of factors. There’s a lot for business owners to think about, from understanding whether they are enforceable where you do business to deciding which details to include when drafting an agreement. Because non-competes aren’t one-size-fits-all, it’s important for employers to understand all of their options and how they fit into their long-term strategy.
Please note all material in this article is for educational purposes only and does not constitute tax or legal advice. You should always contact a qualified tax, legal or financial professional, in your area for comprehensive tax or legal advice.