In the Trenches: How iron-clad is a non-compete agreement?

Feb. 21, 2014
In this edition of In the Trenches, Acme learns what happens when good employees leave.

Mike “Slick” Sells, Acme’s high-powered sales rep, serviced Acme’s two largest accounts, GiantCo and BigCo, among other customers. Slick landed the massive accounts and, in his eight years at Acme, has been compensated handsomely in exchange. His employment contract provided for a $160,000 base salary, 20% commission, and performance-based bonuses. In exchange, the contract also included confidentiality, non-competition and non-solicitation provisions to ensure that Acme’s interests were well-protected and that its star sales pro would remain loyal to the company. Specifically, Slick was prohibited from working for an Acme competitor anywhere in the country for three years after leaving. The agreements contained noncompetes of three years’ duration anywhere Acme did business.

For reasons unknown to Acme Sales Manager Barry Nobetter, Slick recently had a falling out with Hank Hansey, the head of purchasing at BigCo, and Hank demanded that Slick be taken off the account. When Barry told Slick the news, Slick threw a fit. He insisted he was still entitled to a cut of the commissions on the BigCo sales, having lured its trimethyl flubdub business from WackMe, Acme’s key competitor. Barry refused; it was a precedent he was unwilling to establish among the sales force. Outraged, Slick stormed out the door, yelling “I’m out of here, and I’m taking GiantCo with me.” The next day, Slick came in only to drop off his Acme laptop — but not before he had copied Acme’s customer list and pricing info to his home computer.

Two days later, Barry got a call from Joe Jacobs, purchasing chief at GiantCo. “Listen, Barry, we’re going to go another way for our flubdub supplier,” Joe said. “A startup outfit has made us a heck of an offer.”

Barry was distraught. He made a few phone calls and, sure enough, discovered that Slick had turned up at some new manufacturer in Texas. “Don’t worry about it,” Ken Stickler, Acme’s attorney, reassured him. “We’ve got an iron-clad non-compete. Slick will never work in this industry again.”

Are Acme’s interests protected?

A labor and employment analyst’s response:

An iron-clad non-compete won’t bring back one of Acme’s largest customers once it’s been poached. But such an agreement, if enforceable, can allow for recovery of damages in the form of lost sales and can prevent future hemorrhaging of customers at the hands of Acme’s former sales rep.

Whether a non-compete agreement is enforceable, though, depends in no small measure on what state law applies. In this case, the law of the state where Acme’s corporate headquarters are located, or the state where Slick was employed, would likely apply. While some jurisdictions readily enforce non-compete agreements, other states, such as California, look upon such contracts as improper restraints on trade and refuse to enforce them in most circumstances. The majority of states will enforce non-competes, though, provided their terms are reasonable.

Even in those states that willfully enforce non-compete agreements, courts strictly construe such contracts against the employer, which means Acme will bear the burden of establishing that the agreement, in particular, the restrictions it imposes on Slick, is reasonable as to duration, scope of activity, and geographic reach, such that Slick would not be prevented altogether from earning a livelihood. A reasonable non-compete, in the eyes of the law, restrains a former employee only to the extent necessary to protect the employer’s legitimate business interest and no more. Also, courts won’t enforce a non-compete agreement in a manner that insulates an employer from competition altogether; such a contract will only protect an employer’s legitimate business interests. “Protectible” interests include customer relationships — especially well-established, long-term relationships — and customer lists; business goodwill; and trade secrets or other confidential information.

Acme’s customer relationship with GiantCo would be protectible, particularly given the time and effort apparently expended in nurturing that business relationship and the ongoing nature of the GiantCo’s needs. Acme’s customer lists and pricing information would also fit the bill. The key question: Is a three-year restriction on working for an Acme competitor anywhere in the United States reasonable to protect those interests?

A reasonable geographic restraint would encompass only the area serviced by Acme. Thus, to enforce a nationwide restriction such as that imposed on Slick, Acme would have to demonstrate that the company, or Slick, operated on a national scale rather than in a local or regional market. The facts suggest that Acme would have little difficulty meeting this burden here. Moreover, in certain contexts, a blanket prohibition on working for any competitor, in any capacity, might be rejected as overbroad, but that would not likely be the case here, given the particular role Slick played at Acme. Slick exerted considerable influence over Acme’s customers, most likely sufficient to justify a restraint on his working in the presumably small trimethyl flubdub industry. As to the duration of the restriction, three years is generally the outer enforceable time limit, but numerous courts have enforced restraints of this length on sales professionals. Finally, courts also consider the likely harm to the former employee who is restrained by the non-compete agreement. Here, the fact that Slick is a high-level professional with readily transferrable sales skills suggests the former employee would have little trouble earning a living despite the contractual constraints imposed. This bodes well for Acme’s bid to enforce the restrictive covenant.

With the non-compete agreement, Acme could probably secure an injunction barring Slick from competing, in accordance with the terms of their contract. Acme would also be able to seek damages for lost sales and other losses incurred from the unfair competition, if proven, including loss of goodwill or the reduced value of the company’s proprietary information. Yet Acme may also have other legal means of protecting its interests, including causes of action for breach of a duty of loyalty, particularly if Slick had begun hatching his plan to take GiantCo while still employed by Acme. A claim for misappropriation of trade secrets might be worth pursuing, as well, based on the pricing information that Slick took with him. In addition, Acme should consider naming Slick’s new employer as a defendant in its lawsuit. And, in the future, the company should request that its sales reps sign confidentiality agreements, as well, providing another avenue of recourse against a departing employee who pockets valuable customer and pricing information.

Lisa Milam-Perez, J.D., labor and employment analyst
Wolters Kluwer Law and Business, (773) 866-3908

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