A non-compete clause or covenant not to compete (CNC), is a term used in contract law under which one party (usually an employee) agrees to not pursue a similar profession or trade in competition against another party (usually the employer). As a contract provision, a CNC is bound by traditional contract requirements including the consideration doctrine. The use of such clauses is premised on the possibility that upon their termination or resignation, an employee might begin working for a competitor or starting a business, and gain competitive advantage by abusing confidential information about their former employer's operations or trade secrets, or sensitive information such as customer/client lists, business practices, upcoming products, and marketing plans.

Conversely, a business might abuse a non-compete covenant to prevent an employee from working elsewhere at all. Most jurisdictions in which such contracts have been examined by the courts have deemed CNCs to be legally binding so long as the clause contains reasonable limitations as to the geographical area and time period in which an employee of a company may not compete. Courts have held that, as a matter of public policy, an individual cannot be barred from carrying out a trade in which he has been trained except to the extent that is necessary to protect the employer.

The extent to which non-compete clauses are legally allowed varies per jurisdiction. Some jurisdictions, such as the state of California in the US, do not allow non-compete-clauses at all.

United States

The majority of U.S. states recognize and enforce various forms of non-compete agreements. A few states, such as California, totally ban or prohibit non-compete agreements except in limited circumstances. For this reason, non-compete agreements have been popular among companies with employees working in states where they are allowed.

History

As far back as 1415, English common law had already been "old and settled" that restraints on trade were unenforceable.^[1] That ban remained unchanged until 1621, when a restriction that was limited to a specific geographic location was found to be an enforceable exception to the previously-absolute rule.^[2] Almost a hundred years later, the exception became the rule with the 1711 watershed case of Mitchel v. Reynolds,^[3] which established the modern framework for the analysis of the enforceability of noncompete agreements.^[4]

Enforceability in the Commonwealth of Virginia

In Virginia, the enforceability of covenants not to compete is governed by common law principles. As restrictions on trade, CNCs are not favored by Virginia courts, which will only enforce narrowly drafted CNCs that do not offend public policy.

In Virginia, a plaintiff must prove by a preponderance of the evidence that the covenant is reasonable in the sense that it is: (1) no greater than necessary to protect its legitimate business interests, such as a trade secret; (2) not unduly harsh or oppressive in restricting the employee?s ability to earn a living; and (3) not against public policy. Paramount Termite Control Co., Inc v. Rector, 380 S.E.2d 922, 924 (Va. 1989).

Legitimate business interest

In Virginia, courts weigh the (1) function, (2) geographic scope and (3) duration of the CNC against the employer?s legitimate business interests to determine their reasonableness. See Advanced Marine Enters., Inc. v. PRC Inc., 501 S.E.2d 148, 155 (Va. 1998); Simmons v. Miller, 544 S.E.2d 666, 678 (Va. 2001) (stating that the function, geographic scope and duration of the CNC must be considered together to determine the reasonableness of the restriction). Additionally, CNCs are only reasonable if they prevent the employee from entering into direct competition with the employer and must not encompass any activity in which the employer is not engaged. See e.g. Omniplex World Servs. Corp. v. US Investigations Servs., Inc., 618 S.E.2d 340, 342 (Va. 2005) (?covenants not to compete have only been upheld when employees are prohibited from competing directly with the former employer or through employment with a direct competitor.?); See Motion Control Sys. v. East, 546 S.E.2d 424 (Va. 2001).

Reasonable restriction on employee's ability to earn a living

Second, to enforce the CNC, a Plaintiff must show that it is not unduly harsh or oppressive in restricting the employee's ability to earn a living. In Virginia, a CNC is not unduly harsh or oppressive if balancing its function, geographic scope and duration the employee is not precluded from (1) working in a capacity not in competition with the employer within the restricted area or (2) providing similar services outside the restricted area. See Paramount, 380 S.E.2d at 925.

Public policy

Third, to enforce a CNC, a Plaintiff must show the CNC is reasonable from the standpoint of a sound public policy. Virginia does not favor restrictions on employment and therefore CNCs are generally held against public policy unless they are narrowly drafted as enumerated above. In Virginia, a CNC does not violate public policy if the restrictions it imposes do not create a monopoly for the services offered by the employer or create a shortage of the skills provided by the employee. See Blue Ridge Anesthesia & Critical Care, Inc. v. Gidick, 389 S.E.2d 467, 470 (Va. 1990); Paramount, 380 S.E.2d at 925.

Enforceability in the State of California

Unlike the situation in other states, non-compete agreements are illegal in California and against public policy except in statutorily provided circumstances. (California Business and Professions Code Section 16600). See, e.g., Raymond Edwards II v. Arthur Andersen, LLP, Cal. Sup. Ct. (August 7, 2008)

Out of state agreements are not enforceable

The preeminent court decision discussing the conflict between California law and the laws of other states is Application Group, Inc. v. Hunter Group, Inc., 61 Cal.App.4th 881 (1998). In Hunter, a Maryland company required that its Maryland based employee agree to a one-year non-compete agreement. The contract stated that it was governed by and to be construed according to Maryland law. A Maryland employee then left to work for a competitor in California. When the new California employer sued in California state court to invalidate the covenant not to compete, the California court agreed and ruled that the non-compete provision was invalid and not enforceable in California. Business and Professions Code Section 16600 reflects a "strong public policy of the State of California" and the state has a strong interest in applying its law and protecting its businesses so that they can hire the employees of their choosing. California law is thus applicable to non-California employees seeking employment in California.

Whether California courts are required by the full faith and credit clause of the United States Constitution to enforce equitable judgments from courts of other states, having personal jurisdiction over the defendant, that enjoin competition or are contrary to important public interests in California is an issue that has not yet been decided.

Exceptions - valid non-compete agreements in California

There are limited situations where a reasonable non-compete agreement may be valid in California.

1. If an owner is selling the goodwill in their business. (Business & Professions Code Section 16601).
   
2. When there is a dissolution or disassociation of a partnership. (Business & Professions Code Section 16602).
   
3. Where there is a dissolution of a limited liability company. (Business & Professions Code Section 16602.5).
   

Enforceability in the Commonwealth of Massachusetts

Noncompete agreements will be enforced in Massachusetts in appropriate circumstances. See, e.g., Novelty Bias Binding Co. v. Shevrin, 342 Mass. 714, 716 (1961); Marine Contractors Co., Inc. v. Hurley, 365 Mass. 280, 287 (1974); Edwards v. Athena Capital Advisors, Inc., C.A. No. 07-2418-E, 2007 Mass. Super. LEXIS 378, 4-5 (Super. Ct. Aug. 7, 2007). See also Noncompete Agreements That Don't Mean What They Say.

I. Historical Context

By 1837, Massachusetts had indisputably adopted the analysis established in Mitchel. Alger, 36 Mass. at 53. In 1922, the Supreme Judicial Court eliminated any doubt that restrictive covenants in the employment context would be enforced when reasonable. See Sherman v. Pfefferkorn, 241 Mass. 468 (1922)

II. Current Law

The basic proposition enunciated long ago continues to apply: ?A covenant not to compete is enforceable only if it is necessary to protect a legitimate business interest, reasonably limited in time and space, and consonant with the public interest.? Lunt v. Campbell, No. 07-3845-BLS, *5 (Super. Ct Sept. 2007), quoting Boulanger v. Dunkin? Donuts Inc., 442 Mass. 635, 639 (2004), citing Marine Contrs. Co. v. Hurley, 365 Mass. 280, 287-88, 289 (1974) and All Stainless, Inc. v. Colby, 364 Mass. 773, 778 (1974).

A. Reasonableness

Reasonableness is the touchstone of the analysis and is highly fact-dependent. Edwards v. Athena Capital Advisors, Civil Action No. 07-2418-E (Super. Ct. Aug. 7, 2007) (?Covenants not to compete are valid if they are reasonable in view of all the facts in a particular case.?), citing Marine Contractors. Co. v. Hurley, 365 Mass. 280, 287-288 (1974); All Stainless, Inc. v. Colby, 364 Mass. 773, 778 (1974). The context in which the CNC arises (e.g., employment relationship, contractual relationship, etc.) is a critical factor in the analysis. Sentry Ins. v. Firnstein, 14 Mass. App. Ct. 706, 707 (1982) (quoting Restatement (Second) of Contracts § 188 comment g (1981)); Zabota Community Center, Inc. v. Frolova, No. 061909BLS1, *2 (May 18, 2006). A CNC that is unreasonable because it is too broad, will be scaled back if it is in fact capable of being narrowed. See Edwards v. Athena Capital Advisors, Inc., C.A. No. 07-2418-E, 2007 Mass. Super. LEXIS 378 (Super. Ct., Aug. 7, 2007), quoting All Stainless, Inc. v. Colby, 364 Mass. 778, 778 (1974).

Even when a CNC is limited in duration, geographic reach, and scope, it will be enforced ?only to the extent . . . necessary to protect the legitimate business interests of the employer.? EMC Corp. v. Gresham, No. 01-2084-BLS (Super. Ct. Nov. 2001), citing Novelty Bias Binding Co. v. Shevrin, 342 Mass. 714, 716 (1961); Marine Contractors Co., Inc. v. Hurley, 365 Mass. 280, 287 (1974). Recognized legitimate business interests are generally identified as the protection of trade secrets, confidential information, and goodwill. Marine Contractors Co., Inc. v. Hurley, 365 Mass. 280, 287 (1974), citing All Stainless, Inc. v. Colby, 364 Mass. 773, 779-80 (1974); Sentry Insurance v. Firnstein, 14 Mass. App. Ct. 706, 708 (1982); Lunt v. Campbell, No. 07-3845-BLS, *5 (Super. Ct. Sept. 2007), citing Boulanger v. Dunkin? Donuts Inc., 442 Mass. 635, 641 (2004); EMC Corp. v. Gresham, No. 01-2084-BLS (Super. Ct. Nov. 2001), citing Kroeger v. Stop & Shop Co. Inc., 13 Mass. App. Ct. 310, 316 (1982).

B. Consideration

An otherwise valid CNC must still, like other contracts, be supported by consideration. Accordingly, the Supreme Judicial Court has held that a CNC must be ?ancillary . . . to an existing employment or contract of employment? or some other ?permissible transaction . . . .? Novelty Bias Binding Co., v. Shevrin, 342 Mass. 714, 716-17 (1961). However, consideration can exist regardless of whether the CNC is entered into at the beginning of the employment relationship, during the term of employment, or even at the end of an employment relationship. See Marine Contractors Co., Inc. v. Hurley, 365 Mass. 280, 288 (1974) (?Marine?s interest in protecting its accrued good will from possible incursions by Hurley is not weakened by the fact that it negotiated the agreement not to compete at the end of Hurley?s employment rather than at some earlier time.?); Novelty Bias Binding Co., v. Shevrin, 342 Mass. 714 (1961); Richmond Bros. Inc. v. Westinghouse Bdcst. Co. Inc., 357 Mass. 106 (1970). But see Zabota Community Center, Inc. v. Frolova, No. 061909BLS1, *2 n.3 (Super. Ct. May 2006) (Although the plaintiff cited its mid-employment threat of termination as proof of consideration for the CNC, the court ?exercising its equitable powers, sees it rather differently.?).

Europe

Generally, NCCs are only allowable in Europe if the employer can show a reasonable business interest in having a NCC.

• In Netherlands, non-compete clauses (concurrentiebeding) are allowed regarding issues such as moving to a new employmers and approaching customers of the old company. NCCs have a maximum term of one year. Unreasonable clauses can be invalidated in court.^[5]

• In Germany, NCCs are allowed for a term up to two years. The employer must provide financial compensation for the duration of the NCC amounting to at least half the gross salary.^[6] Unreasonable clauses, for example excluding similar jobs in whole Germany, can be invalidated.

• In Belgium, NCCs are restricted to new employments within Belgium and for no more than one year. The employer must pay financial compensation for the duration of the NCC, amounting at least the same gross salary.^[7]

• In Spain, NCCs are regulated by article 21 of the labor law. NCCs are allowed up to two years for technical professions and six months for other professions.

• In France, NCCs must be limited in time to a maximum of two years and to a region where there the employee's new work can reasonably be seen as competitive. The region can be a city or the whole country, depending on the circumstances. The employer can be forced to pay financial compensation, typically 30 percent of the last salary, depending on the circumstances surrounding the termination of the employment. An NCC may not unreasonably limit the possibilities of the employee to find a new employment.

• In Romania, NCCs are regulated by article 20-4 of the labor code and restricted to two years for managing positions and six months for other positions. The employer must pay financial compensation for the duration of the NCC, amounting to at least 25 percent of the last salary.

External links

• California Non-Compete Agreement Law and Cases
• Employlaw.com - Discussing California Noncompete Agreements
• LEGAL ISSUES - The Fine Line in Noncompetes
• Hypothetical and Issues Involved in Enforcement of Non-Competes
• Noncompetes: A Tale of Two Companies - Why your noncompete agreement must be properly crafted. By Russell Beck
• Noncompete Agreements That Don't Mean What They Say By Russell Beck

References

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