Articles

NUANCES OF NONCOMPETES

Attempting to prevent your employees from competing with you seems almost un-American. Consumers and businesses alike depend on vigorous competition among companies to assure widespread choice, competitive pricing and high quality products and services. Likewise, the ability of employees to go out on their own to start fledgling businesses or to join other established enterprises is a chief characteristic of our vigorous, mobile society.

But attempting to restrict competition by former and present employees is as American as apple pie. This is usually accomplished by contracts containing non-compete clauses, often known as restrictive covenants. These provisions generally prohibit or limit employees from engaging in competitive practices ― particularly from soliciting customers or using sensitive information gained from previous employment.

Non-compete clauses are especially prevalent in start-up companies, small businesses and high-tech enterprises, all of which are heavily dependent on a loyal and knowledgeable work force. Non-compete clauses also are used by established businesses to prevent employees from engaging in competition or appropriating confidential information for their own use or use by competitors. In addition, non-compete clauses are frequently included in business acquisitions to proscribe competitive practices by the former owners.

If used effectively, non-compete clauses can protect, preserve and promote the success of a business. If misused, however, they can be a bane to business and an invitation to prolonged and unpleasant litigation.

Peonage or Propriety?

Agreements limiting competition have been around for many years in Minnesota. The earliest traces of these restrictive clauses date back to lawsuits in the 1880’s. Over the years, Minnesota court rulings have expressed a schizophrenic attitude, reflecting a mixture of both antipathy and admiration for non-compete clauses.

The law is generally supportive of restrictive covenants entered into as part of a business transaction, particularly in connection with the sale of a business. But the courts are much more reluctant to enforce restrictive covenants if used by management as a means to limit competition by employees. A 1968 ruling by the Minnesota Supreme Court illustrates this disfavor, characterizing non-compete clauses as vestiges of “industrial peonage without redeeming virtue in the American enterprise system.”

This hostility is based on an aversion to stifling competition. Non-compete clauses often are tainted because of the perception that they are extracted by overreaching management, exercising unfair bargaining power over vulnerable employees.

There is some truth to these observations. Generally, management has much more leverage than employees in negotiating non-compete clauses. Restrictions on future employment usually arise at the beginning of an employment relationship, when employees have little bargaining power to resist these terms. Moreover, most employees do not seriously contemplate the possibility of leaving employment at the outset of the relationship and, therefore, are not overly concerned about specific terms that might circumscribe their future employment prospects.

The “industrial peonage” rhetoric, however, frequently gives way to the reality of the business world. Courts recognize the propriety of non-compete provisions to protect businesses from unfair competition by departing employees who might misappropriate trade secrets or other confidential information or unfairly solicit former customers to their own benefit.

The Rule of Reasonableness

Skirting a balance between these concerns has led the legal system to a middle ground in evaluating non-compete clauses. Courts usually uphold restrictive covenants if they are “reasonable.” What constitutes a “reasonable” restriction will vary depending on the circumstances. Courts tend to examine several factors in deciding whether a clause is reasonable in a particular setting. These factors include:

1. Consideration. A non-compete clause is invalid in Minnesota if it is imposed without consideration. Under the doctrine known as “independent consideration,” an employer may not impose a non-compete clause upon an employee, even if the latter agrees to the provision, unless the employee gets something of value in return for the agreement to limit competition. A non-compete clause may be included in the initial employment contract. But, if the employee already has started working, an employer is prohibited from changing the terms of the employment relationship by imposing a non-compete clause unless a substantial benefit is given to the employee, such as a bonus, an increase in salary, promotion or other benefits. Mere continuation of employment is not considered adequate to justify imposing a new non-compete clause on existing employees. The issue of consideration varies considerably from state to state. What is true in Minnesota may not be true elsewhere.

2. Geographic limitations. Non-compete clauses that are limited in geographic scope are more likely to be upheld than those that are widespread or unlimited in scope. Restrictions to particular market areas or distances, such as 50 miles or less, generally pass muster. Clauses lacking geographic limitations or extending over a broad territory are looked on with disdain.

3. Time duration. Similarly, courts are fond of non-compete clauses that are limited in time. As a general rule, a two-year limitation is regarded as reasonable. Longer time periods are frowned on by courts and are less likely to be upheld in litigation.

4. Solicitation. Courts are prone to uphold clauses barring solicitation of customers with whom the former business has an ongoing relationship or with whom the departing employee dealt with directly. Restrictions in regard to contacting customers who are current customers of the business or who were customers during a relatively recent time period also are generally proper. Broader restrictions on solicitation of individuals who may have been prospects but never were customers, those who were customers in the distant past or customers with whom the departing employee had little or no direct contact are less likely to be upheld.

5. Trade secrets. Restrictions on taking or using “trade secrets” often are included in non-compete clauses. These limitations may include everything from price lists or formulas to marketing practices. Great precision is required in defining specifically what types of information may not be taken or used by departing employees. General references to technology or know-how may be too ambiguous to be enforced. Narrowly drawn clauses that specifically describe the trade secrets that are to be protected are more likely to be valid.

6. Other opportunities. Non-compete clauses generally shouldn’t bar an employee from any reasonable opportunity to use his or her skills. Clauses that effectively prevent an employee from engaging in any trade or practice for which the employee is suited may be too harsh and, hence, unenforceable.

A number of other factors also are taken into consideration by courts in deciding whether to uphold, modify or validate non-compete clauses. The degree of harm that may occur to an employer, the degree of knowledge or know-how possessed by the employee, the respective bargaining power between parties, the length of the employment relationship and the customs and practices in each industry are among the factors that are included.

7. Non-compete Nuances. Nuances of non-compete clauses may depend on the profession. Lawyers, for example, are prohibited by their ethical rules from imposing any non-compete clauses on employees.

Similarly, physicians are restricted, although not prohibited, by their professional ethics from entering non-compete clauses. A 1986 edict by the American Medical Association “discourages” non-compete clauses among medical professionals, regarding these devices as “not in the public interest.” Accountants and other licensed professionals also face limitations or bans an restrictive covenants in some jurisdictions.

Not only do types of permissible restrictions differ among professions, but they vary from state to state. The ambivalence expressed by courts in Minnesota pales in comparison to outright hostility to non-compete clauses in some states. In Wisconsin, for example, a specific statute prohibits most non-compete clauses, except in narrowly defined circumstances.

In Minnesota, if a non-compete clause is unreasonable in certain respects, the court applies the “blue pencil” rule and rewrites the clause to make it acceptable. This represents an attempt to salvage restrictive covenants whenever possible.

In Wisconsin, on the other hand, a clause that is at all unreasonable will not be saved by judicial craftsmanship. A slight taint in a non-compete clause may doom the entire arrangement in that state because courts don’t rewrite agreements that are offensive in any respect.

8. Non-compete Tips. Despite many pitfalls, non-compete clauses can be effective. Use these suggestions to make them work for you:

• Written Agreements. Non-compete clauses should appear in written employment agreements or other contracts, preferably agreed to at the beginning of employment. Courts are reluctant to enforce non-compete terms that aren’t in writing. If non-compete terms are added to the employment relationship after the employee begins working, the contract should indicate that the employee is receiving additional consideration, such as a boost in salary or other benefit, to compensate for the non-compete clause.
• Clarity Counts. Restrictive covenants must be clearly written. Ambiguous clauses will be interpreted unfavorably by courts. Documents should specifically state what types of conduct are prohibited. If restrictions in dealing with customers are desired, describe customers specifically, preferably by name or by another identity. An addendum may be included with a contract naming the prohibited customers or otherwise sufficiently describing them in the event of future disputes.
• Stick to Essentials. Limit scope of non-compete clauses to essentials and avoid overkill. Confine clauses to a relatively concrete geographic territory (for example 50 miles) or to a specific market territory or area. Keep the time period relatively short, usually no greater than two years. Avoid clauses that totally stifle employees from using any of their skills for gainful employment or suppress gainful activities that are of no substantial economic consequence to the employer.
• Employee Awareness. Include in the document language showing that the employee is aware of the non-compete clause, has bargained or negotiated for it, and understands its implications. A clause, such as the following, might help in the event of subsequent legal challenge:

“This non-compete clause is entered into knowingly and voluntarily by the employee and employer, and both parties intend to be bound by this clause.”

• Speed Kills. Act quickly if a non-compete clause has been, or is about to be, violated. Courts may grant injunctions that are lethal to wrongful competition if employers move swiftly when there is threatened or actual competition contrary to the terms of non-compete clause. An employer who acquiesces or allows an employee to compete for a while and then tries to combat the competition might waive his rights by waiting too long.
• Litigation Leverage. Even if it’s not legally valid, having a non-compete clause may be advantageous for management. The existence of a restrictive covenant in an employment contract may deter an employee from engaging in freewheeling competition or at least may limit the vigor of that competition. Using a non-compete clause also can given an employer significant strategic leverage in achieving a settlement if an employee leaves a company and hopes to compete without risking a lawsuit.

If you follow these tips, non-compete clauses can be an effective means for regulating your work force without running afoul of legal restrictions. While not as tantalizing as apple pie, a non-compete clause is definitely more palatable than allowing employees to use the skill, know-how and information they gained from employment to compete against the hand that formerly fed them.

NON-COMPETE TIPS & TRAPS

There are a number of Tips & Traps that can help or hinder employers and employees in connection with non-compete agreements. Here are 12 tips, six for employers and six for employees, in dealing with non-compete agreements and avoiding some of the traps that might befall them.

Employers

• Make sure that non-compete agreements are discussed with prospective employees before they begin work. Under Minnesota law, employees may be able to challenge non-compete agreements if they are not disclosed to the employee before they accept the job offer. Providing an employee with a copy of the non-compete form can be useful in proving that the employee was furnished the document before accepting a position.
• Make sure than a new employee signs a non-compete agreement on the very first day of employment. In Minnesota and many other states, although not all of them, a non-compete agreement is not valid for a new employee unless it is signed when the employee actually begins working, and not a day later. For employees who are currently working, a non-compete agreement must be given in exchange for “independent consideration,” which generally means some increase in salary, a bonus, or other consideration that the employee is not entitled to receive. The “independent consideration” should be recited in the body of the non-compete agreement. Also, make sure to keep two copies of the non-compete agreement, one in the employee’s file, and one in a separate file, making sure that a fully-executed, dated agreement is available in the event of subsequent litigation.
• Avoid over-reaching terms. In some states, courts may invalidate an entire non-compete agreement if any term is excessive or unreasonable. This encourages employers to use restraint in terms imposed in non-compete agreements, especially the duration of the post-employment restrictions. Other states, such as Minnesota, follow the “blue pencil” rule, which allows judges to modify terms that are deemed unreasonable in order to salvage the non-compete agreement. In these states, employers do not have to be as circumspect in limiting the scope of non-compete provisions.
• Include attorney’s fee provisions in the event the employee breaches the agreement. Courts may not fully enforce such clauses, but they give additional leverage to employers in the event the employee seeks to dispute a non-compete provision and, in some cases, if the employer fails in non-compete litigation, the inclusion of an attorney’s fee provision may result in a judgment against an employee for sum, or all, of the employer’s legal fees.
• Exclude non-compete provisions from arbitration clauses. Many employment agreements have arbitration clauses which require the parties to arbitrate, rather than to litigate, employment disputes. However, it is much more difficult to impose a non-compete clause in an arbitration proceeding. Therefore, employers may wish to exclude from the scope of arbitration clause, any matters relating to non-compete agreements. This can be done by specifically stating in an arbitration clause that the employer is not obligated to arbitrate any breach of a non-compete agreement and may pursue such claims separately in litigation without resorting to arbitration. This provides a significant advantage to employers seeking to enforce non-compete agreements, which generally can be done more readily through litigation, rather than arbitration.
• Include clauses that indicate that the employee has fully read the agreement, understands the terms, and feels that the non-compete provisions are fair and reasonable. Having such a clause in an arbitration agreement can be a factor in diffusing a subsequent claim by an employee that the employee was not aware of the non-compete agreement or was coerced into signing it.
• In addition to restricting post-employment competition, include clauses to protect confidential data. Employees should be restricted from taking or using confidential data, such as customer lists, pricing information, business plans, formulae, and other proprietary data.

Employees

• Seek legal counsel. Employees should consult with an attorney before signing a non-compete agreement in order to understand their rights and obligations under the agreement, determine the validity of various clauses, and ascertain whether it might be helpful to have an attorney to try to negotiate particular provisions.

• Prior to negotiating a non-compete agreement. While employees often have limited strategic ability to negotiate non-compete clauses, they need not accept whatever is proposed by employers. They may have some leverage, in circumstances, to try to achieve modifications of terms in non-compete agreements, especially the duration of the restrictions after employment ends.
  
• Try to avoid signing until after employment begins. Because non-compete agreements generally are not valid for new employees unless they are signed on the first day of employment in Minnesota and many other states, an employee may avert the onus of a non-compete agreement by not signing the agreement until after the employment begins. An employee may eschew signing an agreement at least for a few days after employment begins. By doing so, the employee may subsequently be able to challenge the imposition of a non-compete agreement that was not signed on the first day of employment.
  
• Ask for clarification. Non-compete agreements often are somewhat vague and ambiguous, containing general terms that need clarification. Employees should ask employers to clarify particular terms and add definitions or addendums to define or clarify clauses that are generalized.
  
• Refrain from conveying post-employment information. Employees generally do not have an obligation to tell employers about their future employment plans. When asked, they should refrain from telling employers that they plan to engage in competitive activities because, if they do so, the employers may pursue legal action swiftly. While employees should not be deceptive, or lie, they can refuse to divulge post-employment information if doing so would jeopardize their new positions.
  
• Tell future employers about non-compete provisions. If an employee has a non-compete agreement, a future employer should be told about it. Failing to tell a future employer about a non-compete agreement may result in losing the job if the former employer seeks to enforce the agreement and the new employer was not aware of the existence of the agreement at the time of the hiring of the employees. Employees should be candid in discussing non-compete agreements with new employers so that they are not surprised in the event that the former employer pursues legal action. The new employer may even agree to support the employee, and provide the financial assistance in the event of litigation, provided the employer is informed of the non-compete agreement before the hiring occurs.

The law firm of MANSFIELD TANICK & COHEN, P.A. has four facilities in the State of Minnesota. The firm’s headquarters are in the U.S. Bank Plaza South building in downtown Minneapolis. The firm also has satellite offices in the Spruce Tree Center at the intersection of University and Snelling Avenues in St. Paul; a west suburban office on Highway 100 and Cedar Lake Road in St. Louis Park; and in downtown Bemidji. Please contact the law firm at 612.339.4295 for more information about non-compete matters.