Clients come to me with many misconceptions when it comes to non-competition agreements, or as they are also called, covenants not to compete. Some think they are ironclad. Others think they are not enforceable at all. So are covenants not to compete enforceable? As with most questions in the law, the answer is … it depends.
Each state has its own set of rules when it comes to covenants not to compete. In California, for example, they aren’t valid – period. North Carolina courts, on the other hand, will enforce covenants not to compete if they meet the following criteria:
- In writing;
- Made part of the employment contract;
- Supported by valid consideration;
- Reasonable as to time and territory; and
- Designed to protect the employer’s legitimate business interests.
The first two criteria are fairly self-explanatory. The last three, however, require a bit of interpretation.
Supported by valid consideration:
Consideration is a concept that applies to all contracts, not just covenants not to compete. In order for a contract to be enforceable, each contracting party must receive some consideration for entering into the contract, which means that the contract must bestow on each contracting party some benefit to which that party would not be entitled if not for entry into the contract. In the context of covenants not to compete, the affected employee might receive a new job, a promotion, a raise or a bonus for his or her agreement to enter into a non-compete. All of these are permissible forms of consideration. It’s important to note, however, that continued employment, standing alone, is not sufficient consideration. To sum it up, for an employee to be bound by a covenant not to compete, that employee must receive some new benefit in exchange for entering into the agreement.
Reasonable as to time and territory:
Covenants not to compete cannot be unlimited when it comes to time and territory. In other words, a business cannot subject a former employee to a covenant that would restrict him or her from competing everywhere, forever. Our courts consider five years to be the outside permissible time limit, only enforcing such restrictions in very limited circumstances. The shorter the time period, the more likely a court will find it acceptable. The same goes for territorial restrictions. Courts will also look at time and territorial restrictions together, meaning that the smaller the territorial restriction, the more lenient a court will be on the time restriction, and vice versa.
Designed to protect the employer’s legitimate business interests:
Courts will only enforce restrictions on an individual’s right to work when the employer can show that those restrictions protect a legitimate business interest. Legitimate business interests can include protecting client relationships and confidential information. In crafting covenants not to compete, employers must resist the urge to restrict the employee to any degree greater than that which is necessary to protect legitimate interests. For example, does an employer have a legitimate business interest in preventing an employee from going to work for a competitor “in any capacity”? I often see covenants drafted this way. Taken literally, the covenant would prohibit a sales manager from leaving his job and going to work for a competing business as a custodian. Courts will typically not enforce such a restriction.
The truth is that many judges do not like to enforce covenants not to compete, because doing so often has the practical effect of putting someone out of work. This being the case, businesses wishing to employ effective and enforceable covenants must make sure their agreements are “tight.” Review your existing covenants not to compete. Do they overreach? Could they be revised to lessen their scope of restriction while still protecting your business’ interests? When in doubt, have your agreements reviewed by a competent employment attorney. Getting it right on the front end is the difference between winning and losing once a dispute arises.
This content has been prepared for general information purposes only. This information is not intended to provide specific legal advice. Legal advice is dependent upon the specific circumstances of each situation. The information provided cannot replace the advice of competent legal counsel by a licensed attorney in your state.
Benton L. Toups is a partner at Cranfill Sumner & Hartzog LLP and serves as vice-chair of the Employment Law Practice Group. His practice concentrates on representing businesses in all aspects of labor and employment law. A firm believer in the adage that “an ounce of prevention is worth a pound of cure,” Toups counsels employers on day-to-day issues and assists them in developing and implementing policies to avoid employment litigation. To contact Toups, call (910) 777-6011 or email him at [email protected].