A non-compete agreement is a legal document stipulating that one party will not compete in the same industry or geographical area with another party. Often, this agreement is signed at the time a company hires an employee. It can also be used between companies and vendors, freelancers, and entered into after an employee has already worked with the company for any amount of time.
Generally, this agreement protects a business’ relationships with customers and their intellectual property. This keeps a former employee or contractor from taking contacts or information they learned through the company and opening their own business. It also protects the company from having former employees take contacts or information and going to work for a competitor.
When to Use a Non-Compete Agreement
This agreement goes into effect once the employee or contractor severs ties with the company. There are a few ways that a company can draw up non-compete agreements and a few scenarios in which they would be useful.
- When a new employee is hired: Often a non-compete agreement is part of the hiring package. It is only recognized legally if there is a value placed on it for the employee. In other words, the employee needs to be offered some form of payment for their agreement. In a case where the agreement is signed at the time of hiring, the offer of employment and salary is sufficient incentive to make the agreement legally binding.
- When a company finds they need the agreement due to the sensitive nature of information an employee sees: Companies may ask employees to sign this agreement at any time. However, the employee must be compensated in some manner for this to be a legally binding contract. As a current employee is already receiving a salary/paycheck, the job itself isn’t sufficient. Offering a one time monetary payment is one solution. A raise and/or promotion would also serve as sufficient payment.
- When purchasing a company from a previous owner: Often the owner of a company represents a good deal of the company’s own worth. The individual’s knowledge of the industry and relationships are integral to that company’s success. When purchasing a company, it’s important to use this agreement to ensure that the previous owner doesn’t open a new company that competes with the company you’ve purchased, or take a position in another company within the territory and time allotted in the agreement.
Non-Compete Agreements to Protect Confidentiality
There are a few reasons that a company would want to use one. One particularly important reason is to protect the company in the case that an employee who has access to sensitive information leaves.
For example, a high ranking employee who has relationships with the firm’s most important customers could leave and possibly solicit those customers to follow. That same employee would also have access to proprietary information, creative or intellectual property, and internal information that would pose a risk in the hands of competitors.
Part of the agreement stipulates that employees can’t divulge this sensitive information to a competing entity. In many cases, it would give a time period (usually one or two years) during which the departing employee cannot work for a competitor. The time frame ensures that time sensitive information can’t be divulged to any competition.
Why You Need a Non-Compete Agreement
Employees are the most valuable part of your company. Depending on the level and specialization of the employee, they often know your business and industry intricately. This knowledge helps them to make your company successful. But given to a competing entity, it could prove to be a distinct disadvantage to your organization.
Without a non-compete agreement in place, a key employee could leave and would likely stay in the area and in the same industry. While companies can’t stop employees from moving on or working in the field, they also shouldn’t risk intellectual property or insider knowledge being used against them.
Here are some possible outcomes without this agreement in place:
- An employee could leverage their knowledge of your company to secure a high ranking position with your direct competition: As shady as this sounds, it happens. Employees can, and should, look out for their own best interest. That would include looking for the highest-paid position in their industry. A solid business practice is in paying employees fairly for their contribution and in making sure staff is satisfied with the company. This agreement would ensure that high ranking employees couldn’t use knowledge of your company to secure employment with direct competitors.
- An employee could use knowledge gained through your company to open their own competing enterprise: Many employees may want to be their own boss. While there’s nothing wrong with employees having long-term goals for their own industry growth, your company can’t afford to teach people the industry just to have them turn around and use that knowledge to directly compete with your interests. Without a non-compete agreement, an employee could open their own firm in the same area, using connections and knowledge they gained while working for your firm.
- An employee could leave and hire away key employees: Without this contract, an employee who leaves to take a position in another company or to form their own company might also court employees from your own company to leave with them. Remember, these are colleagues they have developed a relationship with and the outcome could be disastrous to your firm.
Most Common Uses of Non-Compete Clauses
Traditionally, these agreements were created for high ranking employees and those with specialized knowledge of your business. More and more, companies are using them for a larger swath of their staff. Often new hires will need to sign one in order to secure the position.
Non-compete agreements need to be very specific in what they prohibit. A company can’t stand in the way of a former employee’s ability to earn an income – that wouldn’t be enforceable, nor should it be. For this reason, the contract needs to specify a region and specific industry or type of position that the staff member couldn’t take up directly after leaving.
Because these agreements have become more universal for employees that are not management or higher, many jurisdictions are very careful about the wording and legality of agreements. Courts lean heavily toward the employee in these cases because it’s clear that the employee can be seriously harmed by an unfair agreement.
This is why, when drafting one, it’s important that you’re very specific and that all the laws are followed exactly. These are agreements are an excellent way to protect business interests. But they need to be fairly drafted so employee rights are also considered.
Specific state provisions
These agreements are not the same in different states and jurisdictions. For example, Illinois and North Carolina have very specific provisions you need to be mindful of:
For instance, Illinois recently passed the Illinois Freedom to Work Act which prohibits companies from enforcing non-compete agreements with low wage employees. The state of Illinois reasons that these agreements were created in order to protect companies from theft of intellectual property and relationships particular to high ranking staff members. Using the same agreement with low wage staff members imposes undue hardships on the employee.
If you had one in the city of Chicago, it might only include companies within city limits and not the extended suburbs. The time limit on the agreement should also be reasonable – usually one year or two year terms.
In the state of North Carolina, the enforcement of these agreements is very particular. The court will not rewrite one to make it enforceable. Other states will often work with rewriting the agreement so that it’s legally binding and fair. In this state, an agreement found to be unenforceable cannot be saved, which means it’s completely void.
What Should be Included in Your Non-Compete Agreement
An enforceable agreement needs to be drafted carefully. Agreements that are too wide geographically or restrictive without clear reasoning may not be enforced should the situation ever arise. Here are some things that must be considered:
- Compensation: In order for the agreement to be legal, the employee needs to be paid something of value. This might simply be a matter of the salary and benefits they receive when they’re hired. If they are already employed or are working in a freelance capacity, other payment may be necessary. This could include a promotion and raise or a specific sum.
- Geographic Region: A non-compete can’t indicate that an employee can never work anywhere in the world. The geographical region that’s restricted should be specific. If your business is local only, they should not be precluded from working in another location.
- Industry: The agreement should specify the industry, type of work, or competitors. Employees often leave to work in a different industry or in a position with a company that is not in competition.
- Employee Specialization: The agreement should be specific to the employee. Any employee can be an asset to another company due to their own hard work and diligence. The agreement should specify industry knowledge or specialized skills that the company provided them with that can’t be used elsewhere – such as a customer mailing list or intellectual property.
- Assignment Provision: If you use this contract in your business, you should include an assignment provision. This means that if the business is sold, the employees are still bound by the non-compete to the new owners.
These are a few of the areas that should be addressed in your agreement. It’s important to be as specific as possible in drafting these agreements. This might include updating as employee knowledge and positions advance.
Sample Non-Compete Agreement
The sample non-compete agreement below details an agreement between ‘ABC, Inc.’ and an employee, ‘Ferne Xiu.’ In case Ferne Xiu terminates her employment, she agrees to not engage in any related business as ABC, Inc., to not induce any other employees to also terminate their employment, and to not solicit any business from ABC, Inc.’s clients.