Note that the U.S. Federal Trade Commission has proposed a rule that bans non-competes. If this rule is implemented and passes constitutional muster, it will apply retroactively to currently existing non-competes. However, for now they are still legal in most states so we will cover them.
Non-compete agreements are also known as covenants not to compete and are part of a group of restrictive covenants. They can be stand-alone agreements or can be encompassed within an employment agreement. If your client has one, you need to know what it says and be able to advise them.
A non-compete is exactly what it says it is; it is an agreement that disallows an employee from competing with their employer. This restriction typically applies during and after employment. The restriction applies to leaving to work for a competitor or starting a competing business. Non-competes do not prohibit an employee from leaving to start a business that does not compete with the employer, only one that would become a competitor. I reemphasize this because sometimes students forget about the competition part of all of this.
Non-competes are a restraint of trade and against public policy and therefore they are closely scrutinized by courts. “The employer bears the burden to show that the restraint is no more than necessary to protect its legitimate business interest, is not unduly harsh or oppressive in curtailing an employee’s ability to earn a livelihood, and is reasonable in light of sound public policy.” Roanoke Engineering v Rosenbaum, 223 Va. 548 (Va. 1982). We will cover more details on non-competes in Unit 15 but here is some information to get us going in our current context.
What do we need to look for when reviewing a non-compete? First, we must evaluate whether the business the entrepreneur wants to start will in fact be a competitor or a competing business. If the answer is yes, we then need to look at whether the contractual language is permissible by state law. Some states (and now Washington DC) have statutes that void non-competes except in certain instances: California Business & Professions Code section 16600 states: “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” If the entrepreneur’s non-compete is governed by California law, then it’s void, full stop. If your jurisdiction does not prohibit non-competes, we continue with our analysis.
Next, we consider whether our client executed the contract free from duress and that there was adequate consideration for the non-compete.
If the above is met, you will then need to ascertain whether the restriction is reasonable. Check the jurisdiction that applies for the appropriate test. States have a wealth of non-compete common law and the current trend is for states to enact statutes providing limitations on the use of non-competes. In Pennsylvania, the common law test requires reasonableness in terms of time (temporal scope); territory or market (geography); and activity. Essentially, is the restriction reasonable in duration, reasonable in geographical scope, and are the restrictions on activity (what the employee is not allowed to do) reasonable. We will cover more details on this in Unit 15.
Lastly, consider whether the restriction protects a legitimate business interest. Did the entrepreneur obtain special knowledge, or learn a valuable skill while working for the employer? Courts balance the interests of the (former) employer against those of the (former) employee. As shown above, the courts will enforce a non-compete only so far as would be necessary to protect that legitimate business interest while keeping in mind the hardship on the employee.
💡Consider the policy considerations surrounding non-competes. How are non-competes good for entrepreneurship and how are they bad?
Of interest is a recent case in Pennsylvania where Judge Joy Flowers Conti ordered an injunction prohibiting a former employee-chemist from working for a new employer despite the lack of a non-compete. Valspar Corp. v. Van Kuren, No. 12-cv-95, 2012 WL 3245477 (W.D. Pa. Aug. 9, 2012). The reliance here is on trade secret protection. Judge Conti held that there was no way that the former employee could do the job at the competitor without using knowledge that he gained while working for his former employer (Valspar).