Small business owners understandably may be reluctant to use non-compete agreements for many reasons.  The desire to divert precious resources to paying an attorney to prepare a contract is hardly appealing.  Similarly, businesses may feel that such agreements are unnecessary because they have few employees.  But as Ben Franklin once wisely advised, an ounce of prevention is worth a pound of cure. 

The term “non-compete agreement” technically refers to a contract that preclude a person from engaging in certain acts of competition for a prescribed period of time within a prescribed geographic area.  In common usage, however, the term often is used more broadly to refer to any contract by which someone has any type of competitive restrictions, including non-solicit, non-recruit, non-disclosure and confidentiality agreements.  Simply put, non-competes come in all shapes and sizes, but the reasons small business owners should use one or more of these covenants are equally diverse.

1. Enhance the value of your company if you think you may sell someday – If you think someday you may wish to sell your business, it is important to protect the value of your company by requiring employees to sign restrictive covenants.  When someone purchases a business, they want to know that they will get what they pay for.  If they believe key employees with access to customers and relationships may not stay on board after a merger or acquisition, they may balk at the price or even walk away.  You may think that you can always sign employees up to a non-compete later, but such afterthought covenants present their own challenges.  You can protect the value of your company and its assets by using appropriately tailored non-compete agreements.

2. Qualify for trade secret protection – Generally speaking, any valuable business information that you try to keep secret from competitors is subject to trade secret protection.  But to state the obvious, to be a trade secret, the information must in fact be secret.  When determining whether information should be entitled to trade secret protection, courts look at many factors including the extent to which the owner of the secret took reasonable steps to preserve its secrecy.  A widely recognized precaution includes requiring employees to agree not to use or disclose confidential information.  In addition, if customer information is a trade secret, a covenant not to solicit customers (i.e., a non-solicitation agreement) may well be appropriate.

3. Protect your customer relationships –Small businesses tend to place client relationships in the hands of fewer employees.  Consequently, when an employee resigns, the client relationship may walk out the door with the employee.  Just as importantly, you may need time to rebuild your clients’ confidence and to show that your other employees are equally capable of serving their interests.  Clients are the lifeblood of any business; but this is particularly true for small businesses.  A small business simply cannot afford to lose its clients. 

4. Enhance client confidence – Would you do business with a company if you felt your personal financial information was at risk?  Of course not.  Your clients feel the same way.  If your clients entrust their personal or business information to you, they want to know that your employees are not going to take it when they leave.  Requiring employees to sign restrictions on their use and disclosure of confidential information is a good way to make your clients confident that their data is safe in your hands.

5. Protect your investment in training – Training employees is a worthwhile expense, and the training resources you provide may even help you to attract talented employees.  But steps should be taken to prevent your competitors from swooping in to hire your employees after you invest the time and expense to train them.  For this reason, courts commonly recognize that employers have a legitimate interest in protecting their investments in specialized training.

6. Clarify expectations with employees – Do your employees realize that you expect them to leave behind the information you entrusted to them if they decide to move on to a new job?  Do they understand that the relationships you paid them to cultivate and maintain belong to you?  The best time to clarify expectations with your employees is before a dispute arises.  Doing so may influence a departing employee’s conduct and provide you with the leverage you need to protect your company.

7. Shape ground rules for potential litigation – Litigation against departing employees can be expensive, but when your business is on the line, you may have little choice but to protect your interests through legal action.  Although no contract can eliminate the expense associated with litigation, careful forethought can help to minimize your costs.  Restrictive covenants are a perfect opportunity to reach agreement with employees about some of the ground rules that will apply if litigation becomes necessary, such as whether you are entitled to recover attorneys’ fees and costs if you prevail, whether lawsuits should be filed in a local forum, and whether you are entitled to certain remedies such as an injunction or liquidated damages.

8. Deter competitors from hiring your employees –  Deterring competitors from hiring your employees is not a sufficient fact in and of itself to warrant the imposition of a restrictive covenant.  In fact, courts will not enforce restrictive covenants if they serve no purpose other than to restrict competition.  But assuming you have a legitimate purpose for requiring employees to sign such agreements – such as a need to protect confidential information or customer relationships – sending a message to your competitors that you are prepared to protect these interests is a nice side effect.

In short, there are advantages to using non-compete agreements that may not be apparent until it is too late.  Small business owners should think about protecting their business in advance.  Please let me know your thoughts in the comment section below.

Many employers with offices or employees located in multiple states use the same non-compete/confidentiality agreement in each state in which they do business.  Typically, the form of the non-compete/confidentiality agreement originated in the employer’s home state, and the employer went on to use this same agreement wherever the employer does business.  However, these employers may find out too late that a non-compete/confidentiality agreement enforceable in their home state may not be enforceable in another state.

State law on the enforceability and interpretation of non-compete/confidentiality agreements differs from state to state, and what is entirely reasonable in one state may be viewed as entirely unreasonable—and unenforceable—in another state.  If you do business in multiple states and want to effectively protect your customer good will and confidential and proprietary information, we recommend that you review the enforceability of various provisions of your non-compete/confidentiality agreements under the laws of each of the relevant states.

There are many ways in which relevant laws, and courts’ views, differ in various states on the enforceability and interpretation of non-compete/confidentiality agreements.  Some of the more important variables include—but are not limited to—what constitutes adequate consideration, whether the court will edit or amend an overbroad agreement to bring it within permissible state law restrictions, the extent to which an employer may enforce an agreement against an employee terminated without cause, and whether the court will grant injunctive relief in addition to liquidated damages.

Consideration:  All agreements must have adequate legal consideration to be enforceable.  Courts in some states hold that consideration for a non-compete/confidentiality agreement does not exist—and therefore that the agreement is not enforceable—unless the employer provided separate monetary compensation or the parties entered into the agreement at or near the inception of employment.  On the other hand, courts in other states hold that continued employment by itself (even without separate monetary compensation) is an adequate form of consideration that will support enforcement of a non-compete/confidentiality agreement.

Editing an overbroad agreement:  Courts in some states will amend or edit an overly broad non-compete/confidentiality agreement to bring it into compliance with state reasonableness requirements, while courts in other states will not.  The approach can vary from state to state, with courts in some states following a strict blue pencial approach (i.e., striking unenforceable, severable language), while other states permit courts to exercise their equitable discretion to modify covenants.  Still yet, courts in other states may decline to enforce the entire agreement even if only one term or provision is slightly overbroad (e.g., geographic scope).

Termination without cause:  State law—and court temperament—varies on the issue of enforceability when an employer terminates an employee’s employment without cause.  Courts in some states refuse to enforce restrictive covenants against employees who have been separated from employment through no fault of the employee.

Injunctive Relief/Liquidated Damages:  Many non-compete/confidentiality agreements contain both liquidated damage and injunctive relief provisions.  Courts in some states will not grant injunctive relief if the agreement also contains an enforceable liquidated damages provision.  In this view, an adequate “legal” remedy exists in the form of monetary damages, and therefore equitable relief in the form of an injunction is not be available.

If you have employees in multiple states, and you want to effectively protect your legitimate business interests against employee defections to competitors, you should take steps to tailor your non-compete/confidentiality agreements to ensure that they will be enforceable to the greatest extent permitted in each state in which you do business.