Don’t make these common mistakes when having your employees sign a non-compete agreement.
Common mistakes employers make with non-competes:
- Only aiming non-competes at preventing competition
- Drafting agreements that last too long or cover too wide of an area
- Not offering any benefits to the employee
- Not complying with state laws
Employers often want to protect their interests when employees move on to other companies, especially during an era rapidly becoming known as the “Great Resignation.” After all, a record 4.4 million Americans quit their jobs in September 2021.
One of the ways to achieve that goal is through a non-compete agreement. However, with such contracts under scrutiny by the courts, state legislatures, and the Biden Administration, drafting a valid non-compete agreement can be difficult.
What is a non-compete agreement?
In general, non-competes are separate contracts or provisions in a contract that forbid employees from working in the same or a similar profession in a specified geographic area for a certain period following the ending of their employment.
Drafting valid non-competes are difficult as some may have unreasonable limitations.
An example of a fairly well-known non-compete agreement involved Amazon. After receiving negative publicity, the nationwide retailer reportedly dropped the non-compete clause in its contracts for warehouse workers, which prevented them from moving to competing companies for 18 months.
The agreements are widespread. A July 2021 Executive Order from the Biden White House on promoting competition in the American economy noted that about half of private-sector businesses require some employees to enter non-compete agreements, affecting 36 to 60 million workers.
Mistakes employers make
Employment law attorneys have identified several mistakes that employers commonly make when putting together non-competes:
- Antitrust issues — non-competes aimed only at preventing competition
- Overbroad agreements — restricts competition for too long and/or for too large a territory
- Lack of consideration — no additional benefit for employees who sign non-competes
- Not up-to-date with state law
- Impact on employee morale
“The biggest mistake I see is having an agreement solely to prevent competition. That’s illegal. It violates antitrust law. It’s the very thing President Biden’s executive order is about,” Florida attorney Donna Ballman, who is also the author of “Stand Up for Yourself Without Getting Fired,” said in an email to Zenefits.
President Joe Biden signed an executive order (EO) in July 2021, asking the Federal Trade Commission (FTC) to limit non-competition agreements. The order aims to promote competition in the American industry.
Non-competes must be in place for reasons other than just preventing competiton.
“For a non-compete agreement to be legal, it must support a legitimate interest other than preventing competition — that could be something like protecting trade secrets or confidential information or extraordinary or specialized training,” Ballman continued. She noted, however, that employers should be aware that some states have banned or placed limitations on non-competes.
Lack of consideration
In legal terms, consideration is anything of value promised by one party in a contract to the other when making the contract. Consideration is needed to make a valid contract.
One of the most common reasons why courts refuse to enforce a non-compete agreement is because employers make the mistake of obtaining the agreement from an already-hired employee without providing the employee with anything of value in return. Generally, such contracts are unenforceable because the employee did not receive any additional consideration, MacElree Harvey Ltd. attorneys Harry J. DiDonato and Robert A. Burke wrote in a blog post.
“Essentially, this means that the employee did not obtain anything of value in exchange for his or her agreement not to compete,” Burke and DiDonato said.
Non-competes obtained from newly hired employees need only state that the employer’s willingness to employ the employee is the value exchanged for the employee’s agreement not to compete, Burke and DiDonato said.
However, additional consideration is needed for employees already on the payroll to make the agreement enforceable. “This additional consideration could be for more money, new job responsibilities and titles, new benefits, etc.,” they said. “The additional consideration does not have to be of tremendous value,” they noted, “But it must provide a benefit that the employee is not already receiving.”
Agreements that are too broad
Non-competes can cover time and geographic territory, but they can’t be too broad in their restrictions on those areas. Courts generally have ruled that non-competes are enforceable as long as they don’t extend too far in the future or cover too wide a geographic area.
A non-compete can’t extend too far into the future or cover too wide of a geographic area.
Jimmy John’s sandwich shops were required to pay a $100,000 settlement in 2016 over improper use of non-competes. The company required all its sandwich makers and delivery drivers to sign an agreement not to work in any store that earned most of its revenue selling sandwiches within a three-mile radius of any Jimmy John’s in the U.S. This was enforced for two years after they stopped working there. The Illinois Attorney General sued the employer, claiming that the agreement was overly broad. The company has since eliminated non-compete clauses in its agreements for all employees.
What is reasonable?
When looking at what is reasonable within a non-compete agreement, you need to look at both time and distance.
“The general rule is that the duration of the agreement should not exceed the time reasonably necessary to protect the employer’s legitimate business interests,” Burke and DiDonato said. “For example, a court will likely refuse to enforce an agreement that prohibits an employee from competing for the rest of his or her life as restricting the employee from competing for an unreasonably long time.”
“What is “reasonable” varies from business to business and requires an individualized assessment of the facts and circumstances surrounding the agreement,” Burke and DiDonato said. “However, the general rule is that a non-compete with a duration of six months is reasonable and enforceable.”
“Different states allow different time limits for non-compete agreements,” Ballman said. “In Florida, six months or less is usually reasonable, and beyond two years is unreasonable. For non-competes between six months and two years, the employer has to prove the length is reasonable to protect a legitimate interest other than preventing competition.”
“The geographic scope of the restriction must also be reasonable,” Burke and DiDonato said. Non-competes usually describe a restricted area in which the employee cannot compete. This restricted area is often based on a specific distance from the employer’s headquarters or facilities. It may even outline a list of towns or counties in which the employee cannot compete.
“While agreements that restrict employees from competing within a few miles of the employer’s headquarters are often enforceable, agreements that prohibit an employee from competing anywhere in the world are often not enforceable,” Burke and DiDonato said.
Ballman adds that defining the prohibited territory to go beyond the area needed to protect a legitimate interest is a common mistake. “For instance,” she said, “If a salesperson’s territory is only in South Florida, and the non-compete bans them in all of Florida, or worse, nationwide, that could be a defense to enforcement of the agreement.”
The judge’s “blue pencil”
Overly broad non-competes may be difficult to enforce.Another issue with a non-compete agreement that is too broadly written is that it can provide an opportunity for a judge to reformulate the agreement in ways that an employer might not want. Some jurisdictions grant judges the leeway to change the agreements.
“Having an overbroad non-compete agreement can cause difficulties in enforcement but may not make the agreement invalid,” Ballman said.
“Many states allow a judge to ‘blue pencil’ an agreement to limit an overbroad agreement, but overbreadth will be fatal in some states.”
Check state law
The non-compete clause or agreement must comply with state law. State legislatures have been active in the last couple of years in approving laws that limit the agreements, especially for low-wage and hourly workers. Some states ban the agreements.
Oregon employers have new restrictions on covenants not to compete starting Jan. 1, 2022, as were employers in Illinois and Washington. Nevada amended its laws on non-competes in 2021, forbidding employers from making non-compete agreements with hourly employees.
Laws restricting non-compete agreements for workers based on income were approved or went into effect in 2019 in:
- New Hampshire
- Rhode Island
Massachusetts, Utah, Idaho, and Colorado passed or amended laws limiting the use of non-competes by employers in their states in 2018.
No federal law
At present, there is no federal prohibition on non-compete agreements. So far, the bills aimed at banning the use of non-competes for low-wage workers have not gained enough support to be made into law. Ballman noted that, at the federal level, the only ban on non-compete agreements is antitrust law.
However, federal limitations could be on the way through agency rulemaking. Burke and DiDonato pointed out that Biden’s July 2021 Executive Order encourages the FTC to curtail the use of non-compete clauses and agreements that unfairly limit worker mobility. However, the FTC has not yet released any rules on the use of non-competes.
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Impact of non-competes on employee morale
Ballman said that employers frequently fail to consider the impact that non-competes can have on employee morale. “Employees hate non-competes. Employers risk serious moral problems by springing them on employees without warning or for little or no legitimate purpose,” she says.
“I know that non-competes are the darling of management right now, but are they the best choice for a business? Trade secret laws already protect confidential information, so it seems that non-competes are mostly unnecessary. They’re also expensive to enforce.”
Non-compete agreements are becoming more common. They were once reserved for high-level employees. However, as they trickle down into all levels of the workforce, employers face new challenges in drafting and enforcing agreements.