Tuesday Apr 29, 2014 by Thomas McHugh - Attorney, Rubin and Rudman, LLP
Non-compete agreements, also known as covenants not to compete, are contracts between an employer and employee pursuant to which employment, business, and other professional restrictions are placed on the employee for a specified time period in a specified geographic area after an employment relationship ends. Non-compete language may look like the following:
Such non-competes are typically contained as a provision of an employment agreement or signed as a stand-alone agreement, and many times can lead to disagreements, confusion, and, increasingly, costly litigation.
Not surprisingly, employers frequently use non-compete agreements to “protect” their business from competition, as well as protect their customers, clients, vendors, and others from solicitation from recently departed employees, who may leave and go to work for the employer’s competitor or even start their own business in the same field. Massachusetts courts consider non-competes often and have generally upheld them, although many have been struck down and ruled unenforceable or partly unenforceable, mainly for the reasons discussed below. In balancing the need of the employer for protection against the limitation imposed on the employee to work and make a living, and determining whether such a non-compete will be upheld, the Massachusetts courts consider whether the restrictions are: (1) reasonable in scope, length of time, and geographic area; (2) protective of a legitimate interest of the employer; (3) supported by adequate consideration; and (4) in the public interest.
This business alert provides some “best practices” for employers and discusses some of the pitfalls and challenges that employers may face with regard to non-competes. The final section provides information related to recent legislative developments in Massachusetts which may change the landscape of non-competes dramatically, perhaps sooner rather than later.
Remember to be reasonable
Massachusetts courts, like the courts in many other states, will only enforce a non-compete if, and to the extent, it is reasonable in scope, duration and geographic area. The type of activities that an employee is prohibited from participating in after employment ends should be tailored to cover the job that the employee performed for the employer. Enforcing a prohibition of an automobile salesman from working in the automobile industry would be problematic for a court to enforce. Prohibiting an auto salesman from working in auto sales would be tailored.
As to duration, the shorter the time period, the more inclined a court would be to enforce it. A one (1) year restriction is more likely to be acceptable to a court, but an employer may want two (2) years if an employee was high level and had access to the employer’s trade secrets, intellectual property, customer lists, supplier lists, prospective customers, and other confidential and proprietary information. The more valuable the information that needs protection, the more likely a court will enforce the length of time of the non-compete to protect the employer and its good will, its relationship with its customers, and the marketplace.
The same holds true for the geographic scope of the non-compete. The scope usually consists of the area served by the employer and the employee, such as the New England states. Expanding the area beyond that, such as to areas not yet served by the company or to areas that the company plans in the future to expand into, are likely to be scrutinized by a court and the employer will need to argue that the expansion was necessary to protect its confidential information, good will, or other interest. Overly expansive areas such as “the United States” will most likely be rejected by courts, as they are too broad and certainly impede upon the employee’s ability to make a living. In the world of non-competes, employers want to define what they are trying to protect and not leave anything in the agreement open to interpretation by the employee or a court. The key is to always be reasonable given the specific facts and circumstances of a situation.
One area where a court generally upholds non-competes is in the context of the sale of a business. Usually, in the sale context, the non-compete was negotiated between the parties, a portion of the purchase price many times was allocated to the non-compete covenant, and receipt of the proceeds of the sale cushion the requirement that the seller find immediate employment. Courts have been more willing to enforce a non-compete whereby an individual sells his company and is then prohibited from opening a competing shop next door. Of course, it is prudent practice for buyer to insist on such protection prior to closing the purchase of a business. If an employer only wants to protect confidential or proprietary information, a non-disclosure agreement may be a better path to follow, an area which is not discussed herein.
Best practice: Limit the scope of the non-compete to the areas of greatest concern and be particular, if appropriate. Limit the duration of the non-compete to one (1) or two (2) years. One (1) year will be more acceptable to a court, but an employer must be able to argue why a longer period is necessary in a given case. Limit the geographic scope to the area that is necessary. Employers must remember to consider what they are trying to protect with the use of a non-compete and be sure that the agreement is tailored to accomplish that goal. Going beyond that may leave the non-compete open to a court refusing to enforce it or at least part of it.
As a quick note, remember to have the non-compete signed. Some employers presume that the non-compete has been signed, but get an unpleasant surprise when they check their files.
Remember the interest that you are trying to protect
As discussed above, an employer must have a legitimate business interest that it is trying to protect through a non-compete. For example, an employer’s business interest could be stopping the employee from using the employer’s trade secrets in the field or seeking to prohibit the employee from exploiting the employer’s good will with its customers after the employment relationship ends. Determining whether a legitimate business interest which deserves protection exists will be looked at by courts on a case by case basis, but employers want to make sure that they have a legitimate one before requiring a non-compete. Failure to do so could render the non-compete unenforceable.
Remember to be “considerate”
In Massachusetts, a non-compete agreement entered into without consideration will be unenforceable. Consideration is basic and necessary element for contracts, and it is defined as an inducement for the parties to enter into an agreement. It is something of value that each party gives up in order for the agreement to be binding. For example, with regard to an employment agreement, the employer enters into the agreement to benefit from the services of the employee, and the employee enters into the agreement for payment by the employer for services. Non-compete agreements are no different; you have to give something to get something. Many times a non-compete is provided as part of the employment agreement when the employee first starts work. Consideration here is not a question, as described above. However, if a non-compete is signed after the employment commences, real, additional valuable consideration must be provided in order for the non-compete to be enforceable. If an employer requires its employee who has been working for some time to then sign a non-compete, something of value must be provided by the employer, such as a bonus, a real promotion, a raise, or other payment. Failure to do so will render the non-compete unenforceable.
There is also an added wrinkle here: if an employee signs a non-compete and then his or her responsibilities for the employer materially change, a new non-compete must be signed with adequate consideration. This can prove to be a real trap for employers. For example, at her initial hiring, an employee signs an employment agreement, which contains a non-compete, to serve as employer’s Treasurer. Pursuant to the non-compete in the employment agreement, she cannot work for one (1) year after the employment ends in finances for similar employers within ten (10) miles of the employer. After three (3) years with the employer, she is promoted to Vice President and along with this promotion, her salary, bonus structure, responsibilities, and hours all changed. The previous non-compete in the employment agreement will no longer be enforceable, and the employer should enter into a new non-compete with her, which, again, must be supported by adequate consideration. Many employers will simply rely on the non-compete signed previously, which may be to their detriment.
Best practice: Remember, a non-compete is an agreement, and in order to be enforceable, it must be supported by consideration. An employer must give something to get something. It is a good idea to have the non-compete signed at the initial hiring. If it is signed later, consideration must be provided. If there is a job promotion or any other material change in an employee’s job responsibilities, a new non-compete must be entered into when the promotion or raise goes into effect.
Remember to stay updated
Employers must stay up to date in the non-compete area, as new court decisions and legislative initiatives may severely affect current non-compete agreements or agreements an employer intends to enter into in the future. A non-compete signed in the past may no longer be adequate or sufficiently protect the interests that the employer initially sought to protect. Employers must make sure that their legal or human resources professionals keep up to date of any developments.
Hiring employees subject to a non-compete
Employers should also be aware of the potential dangers of hiring a new employee who is subject to a non-compete. If the former employer views the new employment as a violation of the non-compete, it may seek either an injunction against the new employee to stop working or a claim against the new employer for tortious interference with a contract. This matter is not discussed in detail herein, but it is raised to employers’ attention.
Best Practice: Inquire whether the potential employee is subject to any restrictive covenant, including a non-compete.
The Future of Non-Competes in Massachusetts: “The Times They Are A-Changin’”
The above review is an overview of the current status of non-competes in Massachusetts, but will any of it matter in the future? Currently, that is difficult to answer, as there is increasing momentum to enact a law that would render all non-competes unenforceable in Massachusetts, except in limited circumstances. This notion has been discussed in Massachusetts for several years and seeks to make Massachusetts more like, and competitive with, California, particularly in the technology and medical fields. Under California law, non-competes are essentially illegal, except in concert with the sale of a business, as discussed above. The argument for abolishing non-competes is, in part, that employees not subject to non-competes are able to start new companies, with venture investors providing new capital to grow the businesses and create jobs.
Governor Patrick recently came forward and stated that he supports the elimination of non-competes in Massachusetts, as he views them as a barrier to innovation by preventing talented individuals from moving between companies and/or creating their own start-ups. The Massachusetts business community might disagree with that, contending that they have legitimate needs to protect, as discussed above.
Governor Patrick recently proposed new legislation, entitled “An Act to Promote Growth and Opportunity”, which contains the following, in pertinent part, at Section 11:
Under this proposal, almost all non-competes would be void and unenforceable in Massachusetts, regardless of reasonableness or the legitimate business interest the employer was seeking to protect. However, the legislation would not affect, in part, prohibitions on soliciting employer’s customers or other employees through non-solicitation agreements, or the disclosure of confidential information through non-disclosure or trade secret agreements, which provides some protection to employers and their businesses.
Notably, the legislation further states that the prohibition applies to all such non-competes whether they were entered into prior to or after the enactment of the law. If the above becomes law, any non-compete is Massachusetts will be rendered unenforceable, even if it has already been signed. If the proposal passes the Massachusetts legislature, current indicators point to Governor Patrick signing it. As to whether this will be enacted any time soon, as they say, the jury is still out.