For many emerging companies, especially those whose businesses focus on technology or research and development, the contributions of a few key employees with highly specialized skills may constitute their most important assets. The departure of an employee can therefore cost more than the investment made in that individual. Particularly for small startups, losing an employee with important company knowledge to a competitor may be a hurdle that is impossible to overcome. For these reasons, many startup companies use non-compete and non-solicitation provisions, which are types of restrictive covenants, to protect their legitimate business interests.
While a non-compete provision prohibits an employee from doing work for a company that operates in a similar field, a non-solicitation provision precludes an employee from poaching others who work for the company or from raiding other company assets, such as customer lists. These provisions apply while the employee is working for the company and may continue for a specified period following the termination of employment.
Every company should consider the following five factors when designing non-compete and non-solicitation provisions:
The enforceability of a non-compete or non-solicitation agreement ultimately boils down to issues of state law. Because non-compete provisions encumber the ability of individuals to make a living and non-solicitation provisions limit competition, many states have passed laws restricting when and how these provisions can be enforced. For this reason, using a one-size-fits-all approach is likely to leave a company unprotected and open to risk. Some states will narrowly enforce such provisions simply to protect a company’s legitimate business interests, while other states have designed rules for the specific regulated industries. Still others, such as California, go even further and flatly prohibit post-employment non-compete agreements in all but the narrowest circumstances. By working with a lawyer, businesses can narrowly tailor these restrictive covenants to bolster their enforceability and value within the context of an employment relationship and the applicable state laws.
Companies should recognize that they may not always be able to pick and choose which state’s laws will apply to their non-compete or non-solicitation provisions. Some state courts, such as those in California, may refuse to enforce choice-of-law provisions in agreements, including non-compete agreements, if the court determines that the provisions violate the state’s public policy goals. In other words, even if the employer is located in a state where non-competes are enforceable, outsourcing work to an employee in another state may diminish or eliminate the protection provided by a non-compete provision with that employee.
Non-compete and non-solicitation provisions must target a company’s “legitimate business interests.” Since these agreements limit people’s career opportunities and discourage competition, courts will not enforce non-compete and non-solicitation provisions that are overbroad and go beyond protecting genuine company interests. For this reason, companies may want to work with a lawyer to explicitly identify the narrow interests an agreement is meant to protect. For example, if an employee has access to confidential information, the company can work to limit a departing team member’s employment prospects only to the extent necessary to protect the company’s important secrets. On the other hand, if an employee has access to the company’s customer lists or has relationships with company clients, the company may be successful in preventing that employee from joining a business that serves the same client base.
Importantly, companies should remember that, in this situation, a one-size-fits-all form-agreement may create more problems than it solves. By working with a lawyer to customize non-compete and non-solicitation provisions, a company can protect its legitimate business interests confident that its most valuable assets will not leave the company with departing employees.
Companies should recognize that non-solicitation and non-compete provisions, like all other contracts, require consideration; , that is, the company must provide the employee with something of value in exchange for that employee’s pledge to not compete or not solicit. Ultimately, any agreement — including non-compete or non-solicitation provisions — that lacks adequate consideration will be considered an invalid and unenforceable contract.
A lawyer can help navigate the sometimes complicated issue of determining what constitutes adequate consideration. when an employment relationship already exists. Notably, an offer of continued employment, by itself, may not always be considered adequate consideration. For instance, in some states, an employer may need to provide additional consideration in exchange for an existing employee’s new promise to not compete. Examples of additional consideration include giving the employee a change in duties, a raise or a promotion.
Chiefly, companies should be proactive in providing employees adequate consideration. By consulting with counsel before drafting these provisions, a company can ensure that these restrictive covenants are more likely to be enforced in high-priority situations.
As discussed above, companies should narrow the scope of their non-solicitation and non-compete provisions to avoid limiting a departing employee’s prospects more than is necessary to protect the company’s interests. This includes placing a reasonable limit on the geographical scope of the departing employee’s non-compete provisions. For example, if a company only conducts business in one state, courts would likely view prohibiting a departing employee from engaging in similar business in all 50 states as an overbroad and unenforceable agreement. On the other hand, for some businesses, especially those that operate primarily on the internet, defining a geographic scope would be ineffective to protect their legitimate interests. In such circumstances, a lawyer can help the company draft narrowly tailored provisions that explicitly lay out the business interests being protected and defend the legitimacy of imposing broad geographical restrictions.
As with other aspects of their non-solicitation and non-compete provisions, companies should customize the length of time that restrictions will apply post-employment and narrowly tailor them to meet their company’s legitimate business interests. In fact, one of the most common circumstances in which courts invalidate non-compete and non-solicitation provisions is when the restrictions extend for too long after the employment relationship has ended.
The applicable time period for such restrictions will be based on the facts of the specific case. If an employer is worried about the disclosure of confidential information, a court may consider the value and life of that information. If the confidential information will lose its value shortly after the employee’s departure from the company, a court is unlikely to uphold a non-compete or non-solicitation provision that extends far beyond that period. On the other hand, if a departing employee has access to important business information that will remain relevant for years into the future, the employer may have a legitimate business interest in protecting that information for a longer period of time.
Overall, although non-compete and non-solicitation provisions are often integral to a company’s bottom line, they can be difficult to enforce. Conferring with a lawyer on these five issues can ensure that such provisions are narrowly tailored to fit a company’s needs while also complying with applicable law.