Legal Ease Articles

Covenants Not to Compete

By Jean S. Perwin

Whether you own a business and have an employee leaving to start a competing business or you’re an employee who wants to leave a company to start your own business, you must face the issue of covenants not to compete. Covenants not to compete are referred to by many names—non-compete clauses or agreements or restrictive covenants. But, they all do the same thing. They impose some kind of restrictions on post employment activity. The theory behind the legal validity of covenants not to compete is this: an employer who hires an employee, trains the employee, gives that employee access to company information whether sensitive or trade secret should be protected from the employee leaving and using that training and information to set up a competing business. On the other side of the issue is an employee’s ability to earn a living. The law is fundamentally uncomfortable with the notion of preventing a person from earning a living. So within these two competing virtues, covenants not to compete were developed. Every state has it’s own laws governing covenants and if you have a problem with a covenant, it is wise to seek counsel in your state about what the state’s law is. But most states follow these general principles regarding the validity of a covenant not to compete. A valid covenant not to compete in the design business must be reasonable in light of the specific type of business, the objectives of the parties and all of the surrounding circumstances. It also must be reasonable as to territorial reach, duration and scope of activity prohibited. In the design business and common and considered reasonable restriction involves customers or clients.

Territorial Restrictions

Restrictions as to where a competing business may operate are generally considered reasonable. But the restriction must be related to the business. So, for example, if the business were purely local, a 50/mile radius restriction would be considered reasonable. If it’s a regional business, a limitation as to specific states might be reasonable. However, with the enormous and prevalent use of the internet in the design business, physical geographic restrictions in a covenant may not work anymore. A former employee could compete with you from another coast.

Duration

Courts have traditionally favored shorter restrictions over longer ones. Many states have per se rules regarding covenants where, for example, a one or two year restriction on employment is per se considered reasonable. But again, reasonableness must be judged in the context of a particular business. In a web design business for example, one year may well be considered unreasonable in light of how quickly the business is changing. Three to six months might be much more reasonable.

Scope of Activity

For designers, the scope of activity restrictions may be the most problematic. They are also the most common. Many covenants will restrict an employee from creating work that will compete with a particular client. Some prevent a former employee from contacting any clients of the firm. Others may prevent an employee from working for clients in a specific industry for the duration of the covenant. All non-competes are negotiable and because they must be reasonable as to time, place and manner, there is room to compromise on both sides. If a restriction seems particularly tough, try to limit the length of time it applies. If the restriction covers the whole world, try to make the geographic restriction more specific. If an employer is primarily concerned about a particular client, try to keep the restrictions to that client alone. Covenants not to compete must have a legitimate business purpose. They must be related to investment in an employee in the form of training, trade secrets, access to client materials. And they must be used only with employees and not with free lance project by project hires.