What You Should Know About Noncompete Agreements

What is a noncompete agreement?

A noncompete agreement, also known as a restrictive covenant or a noncompete clause, is a formal contract between an employer and an employee that limits the employee’s ability to engage in competition with the employer during employment and for a designated period after their employment ends. Although the agreement’s details are outlined in the terms, noncompete agreements often restrict the employee from working for a competitor or starting their own competing business immediately after working for your company.

“Business owners work very hard and spend a lot of money to develop their products, form their customer base, build out their partnerships, recruit talent/employees, and develop their proprietary information or intellectual property,” Dani Fontanesi, founder and managing partner of Fontanesi Legal, told us. “They want to know that if they hire an employee, that employee can’t just steal their customers, misappropriate their proprietary information, and start a competing business without doing the hard work of building a business legitimately from the ground up. Noncompetes are intended to protect businesses from this type of behavior.”

How does a noncompete agreement work?

When an employer includes a noncompete agreement in an employment contract, they commit to hiring the employee (or paying them to sign the noncompete clause), and the employee commits to not engaging in competitive business activities during or after the employment relationship ends. Noncompete agreements typically restrict the former employee from conducting competing business only within a designated geographic location and for a limited time.

Enforcing noncompete agreements

Even if employees sign noncompete agreements, enforcement is increasingly complex. Employees may challenge the agreement in court, and newly updated state and federal laws make noncompete agreements difficult to uphold. When drafting noncompete agreements, pay close attention to your state laws and public policy, and consider other protective measures, like a proprietary information and inventions assignment (PIIA) agreement.

Noncompete agreements and PIIAs are typically drawn up by the employer and signed before the employee starts working, as this can affect the agreements’ enforceability. “If an employer wants to have an employee sign a noncompete or PIIA after their employment has already begun, they should consider offering some form of incentive or other consideration for signing the agreement(s) to increase the chance that it will be enforceable,” Fontanesi said.

When drafting noncompete agreements, pay close attention to state laws and recent policy changes. For instance, in California, Minnesota, North Dakota and Oklahoma noncompete agreements are generally prohibited except in narrow circumstances. The enforceability of noncompetes also depends on when and how agreements are signed and whether employees received valid consideration.

If a departing employee violates an enforceable noncompete, litigation may result. However, not all states enforce noncompetes the same way, so it is important to check state laws first.

What should you include in a noncompete agreement?

At a minimum, your agreement should address the following:

• Dates. Specify effective dates for the agreement and the length of the noncompete contract. For example, you may want the agreement to state that the employee can’t secure a position with a competitor within one year of signing the noncompete.
• Nature of the agreement. In this section, include the reasons for the noncompete agreement. For instance, the agreement may state that the employee can’t release proprietary information that would hurt the business.
• Purchase option. Some employers choose to offer a buyout clause to the agreement. In the contract, the company would specify the amount needed to get out of the clause.
• List of inclusions. Here, you want to specify the scope of the noncompete agreement, or what it entails. For example, you may forbid employees from entering into competitive client relationships or from engaging in business with direct competitors.

How effective are noncompete agreements?

Both parties must sign, but notarization is not required. If legally enforceable by the state, noncompete agreements can effectively protect a business’s interests. However, the key to an enforceable noncompete is that the terms must be “reasonable” and not too restrictive.

In determining whether the agreement is too restrictive, Fontanesi said, courts generally consider factors such as the geographical reach of the noncompete, the commercial reach (if it is limited to a narrow market or captures a broad industry), the length of time it extends, and the legitimate business interest of the employer.

Fontanesi provided an example of a noncompete agreement that would be too restrictive and one that likely would be enforceable based on its restrictiveness.

• Noncompete scenario: A noncompete agreement between an employee and a technology company that created a photo-editing app
• Too restrictive: A noncompete that attempted to restrict the employee from working for any other technology company in the United States for 10 years
• Reasonable restriction: A noncompete that restricted the employee from creating a competing photo-editing app or working for a direct competitor that created a photo-editing app in the same state for six months

Noncompete agreement time restrictions

The state you operate in plays a role in the enforceable time restrictions of a noncompete agreement. Fontanesi gave examples of some states that have specific guidelines regarding what constitutes a “reasonable” temporal limitation: 

• Massachusetts: Noncompetes entered on or after Oct. 1, 2018, generally cannot exceed one year.
• Washington: Limits are 18 months unless business need is demonstrated.
• Utah: Effective May 10, 2016, agreements may not extend beyond 12 months.

Some other states, like Florida, have enacted laws indicating that noncompetes are presumptively reasonable if they extend less than two years. 

Noncompete agreement geographical restrictions

Some states have geographical restrictions when it comes to noncompete agreements. For example, they may have guidelines on what is considered a “reasonable” perimeter to restrict the former employee from working in after departure (i.e., an employer might be allowed to restrict competition within their city or state, but not the entire U.S.)

In general, any previously signed noncompete agreements entered out of state will usually not be valid.

Other noncompete agreement restrictions

In addition to time and geographical restrictions, some states impose noncompete restrictions on other categories, such as employee time, compensation threshold, and so on.

“Other states prohibit noncompetes for certain categories of workers — for instance, low-wage or fast-food workers, nonexempt employees, students or younger workers, or employees who have been terminated without cause or laid off,” Fontanesi said.

What is some advice for creating a noncompete agreement?

If your noncompete agreement is written incorrectly or outside of state law, it will do nothing to protect your business. If you want to create an agreement that is enforceable and effective, there are a few additional steps to take.

Consult an attorney to verify state laws. 

Noncompete agreements are state-specific. Some states can even impose penalties on companies that require an employee to sign a noncompete that does not comply with the laws of that state. Therefore, you must be thoroughly informed about the state laws governing your noncompete agreement. Employers should consult an attorney before having their employees sign a noncompete.

“Particularly right now, when many employees are working remotely, it’s important to know that the law of the state where the employee is working may govern the noncompete, rather than the law of the state where the company is located,” Fontanesi said.

Include a severability provision in your agreement. 

Because the effectiveness of noncompete agreements may vary, small business owners should include a severability provision, a clause in the contract that severs any unenforceable provisions. If a provision in an agreement is found to be unenforceable, then the whole agreement can be held invalid without that severability provision.

Consider other protective measures.

In addition to noncompete agreements, companies can consider other protective measures, such as having their employees sign a PIIA.

“A PIIA can protect the company against an employee stealing their proprietary information, including customer lists, contact information of business partners and other valuable or confidential information of the employer,” Fontanesi said. “Other alternatives to consider are nonsolicit agreements, or agreements not to hire or recruit employees.”

What are the pros and cons of noncompete agreements?

Before putting together a noncompete agreement, weigh the advantages and disadvantages of the document.

Advantages of noncompete agreements

The most significant advantage of a noncompete agreement is that it allows you to prevent employees from competing directly with your organization. Consider these pros, too:

• Intellectual property protection: Many companies underestimate the importance of intellectual property, but a noncompete agreement can provide you with some much-needed protection in this area.
• Employee retention: Noncompete agreements can help reduce employee turnover. Keep in mind, you don’t necessarily want to use a noncompete agreement as a way to force unhappy employees to stay with you.
• Customer retention: Noncompetes can prohibit employees from taking your customer or client lists with them when they go, allowing you to retain your customers long-term.
• Trade secret protection: They prevent departing employees from sharing confidential data.
• Allows business continuation: By offering all the aforementioned protections, noncompete agreements can help your business continue to thrive.

Disadvantages of noncompete agreements

The most notable reason to avoid a noncompete is you may dissuade talent from working with your organization. Additional drawbacks of noncompete agreements include the following:

• Legal limitations: Each state has its own guidelines on what is and is not permitted in a noncompete agreement. As a result, you may find that your noncompete has legal limitations.
• Costly to enforce if violated: If you force a worker to sign an illegal noncompete agreement, it may result in costly litigation. Additionally, some states can impose penalties on businesses for implementing noncompliant agreement
• Redundant if nondisclosure agreement was signed: The primary benefits companies typically seek through a noncompete agreement (i.e., business protection) can often be realized through a nondisclosure agreement. If this is the case, your noncompete may be redundant.

The best way to reduce the potential disadvantages of a noncompete agreement is to consult with an attorney before having an employee sign it.. Since each state and locality have different laws and case law affecting contracts, seeking the advice of a legal expert can be invaluable.

Source interviews were conducted for a previous version of this article.