Noncompete Agreement

Noncompete Agreement

A contract limiting a party from competing with a business after termination of employment or completion of a business sale.

Found in some business contracts, noncompete agreements are designed to protect a business owner's investment by restricting potential competition. Generally, businesses pursue these agreements in two instances: when hiring new employees, or when purchasing an established business. The noncompete agreement is a form of Restrictive Covenant, a clause that adds limitations to the employment or sale contract. These agreements protect the business by restricting the other party from performing similar work for a specific period of time within a certain geographical area. First used in the nineteenth century, and common today in certain professions, noncompete agreements sometimes have an uncertain legal status. Courts do not always uphold them. Generally, courts evaluate such clauses for their reasonableness to determine whether they constitute an unfair restraint on trade.

The rationale behind noncompete agreements is an employer's self-interest. Typically, companies invest heavily in the training of their employees. Similarly, they have an interest in protecting their customer base, trade secrets, and other information vital to their success. The noncompete agreement is a form of protection against losses. The company does not wish to invest in an employee only to see the employee take the skills acquired, or the company's customers, to another employer. Thus, when hiring a new employee, the company may make her sign a noncompete agreement as part of a condition of employment. Likewise, the prospective purchaser of an established business may only buy it if the current owner is willing to sign a noncompete agreement.

In practice, such agreements are very specific in several respects. Usually the agreement will define a length of time, geographic radius in miles, and type of activity in which the employee promises to refrain from working after leaving her or his job. This is often the case in businesses that depend on an established group of customers. A hair salon, for example, may require its stylists to agree not to compete against it in neighboring hair salons. Noncompete agreements are also well established in fields where an individual is associated with a product or service. High-profile positions in the media typically require them. A television anchorwoman, for example, will typically be contractually bound not to work for a competing news channel in the same market for a period of time following the termination of her contract.

In legal challenges courts use a standard of reasonableness in deciding whether to uphold a noncompete agreement. Most states use a three-part test: the agreement must be reasonable in terms of length of time, size of geographical territory included, and the business's necessity for the agreement. Covenants restricting the sellers of businesses typically receive a lower level of scrutiny, whereas restrictions on the behavior of former employees are closely scrutinized.

Courts are primarily concerned with preventing unfair restraints on trade. In a free market, most businesses cannot reasonably assert a need to restrict competition. Many states will evaluate each separate part of an agreement using the so-called blue pencil doctrine of severability, under which certain parts of the agreement can be upheld as enforceable and others can be found unenforceable. A few states, however, throw out an entire agreement if any part of it is found to be an unfair restraint on trade.

Further readings

Jordan, Thomas E. 1990. "The Application of Contract Law to Georgia Noncompete Agreements: Have We Been Overlooking Something Obvious?" Mercer Law Review 41 (winter).


Restraint of Trade.

References in periodicals archive ?
The appellate court reversed the trial court's decision that granted a motion for permanent injunction holding that the reduction of the draw was a material breach of contract having the effect of releasing the employee from his obligations under the noncompete agreement.
Another example, TAM 200244028, raised issues about an organization's consulting and noncompete agreement with its CEO and his spouse.
An appellate court has validated a company's noncompete agreement and has upheld an injunction against a former employee who, after being fired, went to work for a competitor.
Appadoo will focus his efforts on researching the international for-profit education markets and developing a business plan for entering these markets once his noncompete agreement with Laureate expires in the fourth quarter of 2009.
Cupids said it had a two-year noncompete agreement with Adam Longstreth, who was the general manager, Stephanie Frakes, who worked in corporate accounting and human resources, and Dustin Bean, a store manager.
Marshall Tanick, a Minnesota-based attorney, offers the following tips for drafting a noncompete agreement.
The IRS also held that a reasonable payment established by clear and convincing evidence under a noncompete agreement is not a parachute payment.
Significantly, the law of trade secrets serves to protect an employer's confidential information even when an enforceable noncompete agreement or a written confidentiality agreement does not exist.
Parkhurst has a noncompete agreement with Marsh Cove Productions of Atlanta, which bought August House.
Corporate items excluded from the determination of segment profit include corporate expense, interest income not attributable to TiO2 operations, securities gains (losses) and noncompete agreement income.
A noncompete agreement can protect a CPA firm from potential losses caused by departing staff with access to business secrets.
The Virginia Court of Appeals has ruled that a company's noncompete agreement is unenforceable and overbroad because it bars all employment with any of the company's competitors.