In general, when an individual signs a covenant not to compete, they agree that if they leave their employer, they will not go to work for a direct competitor of the employer. A covenant not to compete may also be known as a non-compete clause or a non-competition agreement.
In some cases, an employee will receive compensation for signing the non-compete agreement. Companies and businesses that commonly use covenants not to compete include those that handle:
- Highly confidential materials
- Client demographic or information databases which an employee can access
- Businesses with a direct competitor
- Trade secrets
- Trademarks and copyrights
The typical restrictions contained in a covenant not to compete often address:
- Time: After the employee leaves the former employer, they must refrain from working for the competitor for a certain period of time.
- Type of business: Working in certain industries and businesses that are related to that of the employer, may be prohibited.
- Location: The employee may not be able to work for a competitor within a specified geographic location.
For certain businesses and companies that are involved in a unique trade, non-compete agreements may be necessary for the protection of the company’s:
- Plans
- Trade secrets
- Confidential information
This is also a way of ensuring that the company will not lose their employees to a similar business.
What Is the Most Recent Law Governing Non-Compete Agreements?
A new law was voted into effect by the Federal Trade Commission (FTC) in April of 2024 that places a ban on non-compete agreements. This new law is called the Final Rule or Non-Compete Clause Rule.
The rule enacts a ban on almost all types of non-compete agreements. This rule will not be in effect until 120 days after the publication of the Federal Register that contains the rule.
In other words, although the rule was voted into effect in April, it will not likely apply until August of 2024. Every type of employer will be required to comply with the new regulations under this rule.
Because of this, employers should take time to prepare not for when the rule will be implemented. This can be done by consulting with in-house counsel or a local lawyer to help ensure compliance with the rule.
There is one important exception to the ban under the Final Rule which applies to non-compete agreements that were provided to senior executives by their employers. This is an exception because non-compete agreements that were entered into with these higher-level employees are more likely to have been negotiated between the employer and worker, as opposed to agreements with other types of employees.
When the Final Rule takes effect, employers will have to provide notice to all other types of workers who signed non-compete agreements that these agreements will not be able to be enforced in the future.
How Does this Affect State Laws?
The Final Rule does not have an effect on or limit the enforcement of an existing state law that places restrictions on a non-compete agreement, as long as the state law is not in conflict with the Final Rule. This is because the Final Rule is a federal law, which means that it preempts any state laws that conflict with it.
What if the Final Rule Is Challenged in Court?
There is a strong likelihood that the Final Rule will be challenged in court and will be interpreted further as time goes on. The rule contains a severability clause, which means that if any provision or application of the rule is deemed unenforceable or is invalidated, the rest of it will remain in effect.
It may also be possible that the entire rule will be struck down in the future. Because of this, it is essential for all employers who use non-compete agreements to consult with legal counsel regularly to ensure they are in compliance with the rule.
If a party is currently involved in litigation involving a non-compete agreement, they should note the possibility of upcoming changes and the consequences that may have on their claim. A client may want to request that their attorney do their best to argue their case so that it will result in a favorable outcome based on both the current and the previous rules governing these types of agreements.
Current clients should also request that their attorneys update them on the status of the Final Rule throughout 2024 and in the future.
Do I Still Need to Know about the Previous Non-Compete Agreement Laws?
Yes, it is very important to be aware of the current and previous laws that govern non-compete agreements in an individual’s state. As this area of law is currently undergoing changes and will likely be doing so for the foreseeable future, the remainder of this article will cover the rules that apply until approximately August of 2024.
When Are Non-Compete Agreements Used?
Non-compete agreements are frequently used in the following contexts:
- Employment: An employer can prevent employees from offering their services to competing businesses.
- Sale of business: A new owner of a recently purchased business may want to prevent the previous owner from engaging in the same business.
- Various business associations: When one of the business partners leaves a professional partnership to open their own practice, their partner or partners may want to limit the degree of competition.
- Sensitive business information: If an employer has a trade secret that would be easily passed from employee to employer, the previous employer may seek to enforce a covenant not to compete.
What Should Be Included in a Non-Compete Agreement?
Covenants not to compete are typically part of an employment contract. They may also be signed as separate agreements.
They are typically treated similar to any other type of contract. A non-compete agreement or covenant not to compete typically contains information such as:
- The names of the employer, employee, and other parties
- The names of companies or businesses that the worker is restricted from working with
- Some agreements simply forbid the employee from working with any other company.
- How long the agreement lasts
- Penalties or consequences for breaches of contract
- Specific instructions regarding litigation and lawsuits
What Are the Elements for a Covenant Not to Compete?
A covenant not to compete typically includes 3 main elements, including:
- Limits on the work that the employee may pursue
- A definite time period
- A definite geographical area
Typically, the time and geographical restrictions are fairly straightforward. The limitations on work, however, may be more complex.
Are Covenants Not to Compete Enforceable?
It may be difficult to determine whether a court will enforce a non-compete agreement. Although the secrets of employers may be valuable, the legal system also places value on the individual’s freedom to pursue other employment.
In order for a covenant not to compete to be enforceable, a court will typically require that the covenant not to compete is reasonable. The covenant not to compete will be considered unreasonable, or not enforceable, if:
- It lasts for too long
- Depending on the trade of the employer, a court will determine how much time is appropriate.
- The geographic area it covers is too large
- The types of business the covenant includes are too far-reaching
- The covenant usually prohibits employment in companies related to the employer’s industry.
- The employer does not have a legitimate business interest in enforcing the covenant not to compete.
What Are the Consequences of Breaching a Covenant Not to Compete?
A breach of an employment agreement arises when either of the parties fails to perform their duties as outlined in the contract. For example, if an employee failed to pay the employee wages as outlined in the contract or denied providing them benefits they were entitled to.
Both an employer or an employee may be liable for a breach of the employment contract. A breach of a covenant not to compete, however, is typically committed by the former employee.
If an individual violates a valid covenant not to compete, their former employer may pursue legal action against them, which may include:
- An injunction
- A lawsuit
- Monetary compensation
The former employer will likely take legal action to protect its legitimate interests. This may arise if a departing employee obtains confidential information during their employment, for example, a trade secure, that the employer wants to protect from being provided to the individual’s new employer.
In addition, if the former employee would not have had contact with the former’s employer’s customers without their employment, the former employer would have a legitimate interest in protecting their almost permanent customer base.
An injunction may be used to stop a former employee from engaging in certain activities and direct them to honor the non-compete agreement. A lawsuit may be filed to obtain compensation for money damages and actual losses that were suffered by the employer.
In some cases, a court may prevent an employee from working for a competitor for the duration that is specified in the covenant not to complete.
What if I Refuse to Sign a Non-Compete Covenant?
In general, if an individual refuses to sign a non-compete covenant, an employer is permitted to end their relationship with the employee or prospective employee. In states that dispute the legality of no-compete covenants, however, rejecting or terminating an employee or prospective employee who refuses to sign a non-compete covenant may be regarded as wrongful retaliation.
Do All States Allow Covenants Not to Compete Agreements?
No, not every state allows covenants not to compete in employment contracts. This is because some states hold it is unfair to the employee if they are limited in their freedom to work.
Certain states contest the use of non-compete clauses on the basis that it would be unfair to limit the employment opportunities of workers in contracts.
One example of this is California’s ban on non-compete covenants. Because of these issues, an individual may wish to check the laws of their state if they have any questions or concerns related to covenants not to compete.
It may also be helpful to consult with an attorney who can review any employment agreements or covenants not to compete prior to signing.
Do I Need an Attorney When Dealing with a Covenant Not to Compete?
Before you sign anything that may restrict your future employment access, it is important to have an attorney review the document, as with any other type of contract. Your attorney can also assist in drafting a covenant not to compete or negotiating the terms of the covenant.
If you have any issues, questions, or concerns related to a covenant not to compete that you have signed, an employment lawyer can help. If you are an employee, your lawyer can advise you whether you can go work for a competitor.
If you are an employer, your lawyer can advise you whether or not you can sue an employee for breaching a covenant not to compete. If you do file a lawsuit, your lawyer will represent you in court.
