Non-compete Contract Guide
Entering a non-compete contract with employees can significantly benefit any business. It’s easier to negotiate and sign these agreements when you fully understand their components.
What is a Non-Compete Contract, and How Can it Benefit Your Business?
A non-compete agreement is usually an arrangement between an employee and an employer in which the employee agrees not to work for a competitor. These agreements should be fair for each party, that way, employees are more likely to sign them. If you understand what non-compete contracts are, it’s easier to create and negotiate one that’s valid and beneficial.
What is a non-compete contract?
A non-compete agreement contract (also known as a covenant not to compete or a restrictive covenant) is a legal contract in which one party agrees to not compete with the other party. The agreement can be between employers and employees, independent contractors and the business they work under, or between two companies.
When it’s between an employer and an employee, the employee usually agrees that they will not directly compete with or work for a competitor company if they’re terminated. For the courts to uphold a covenant not to compete (CNC), it must apply to a reasonable geographic boundary and timeframe. Also, there must be a legitimate business interest on the line.
Types of non-compete agreements include:
Getting out of a non-compete contract
There are a few different ways in which an employee can go about voiding a non-compete contract. Typically, when a former employee breaches the terms by working for a competitor company, their previous employer can sue.
However, the employee that violated the agreement can get out being held liable for the following reasons:
Employer breaches the agreement
If an employer breaches the contract by failing to pay all the agreed-upon compensation, fulfilling insurance requirements, or meeting any other obligation, then the agreement will be voided and the employee is relieved from all of their obligations.
No legitimate interest to enforce
A common mistake that employers make is overreaching what’s considered a legitimate business interest. For example, low-level employees such as receptionists or minimum wage workers have no legitimate reason to prevent these employees from working for a competitor company since they likely don’t know any “company secrets.”
Additionally, if a business is phasing out of or abandoning its current industry, they have no legitimate interest in preventing previous employees from working in that sector.
For a non-compete clause to be considered legally valid, it must govern a reasonable period. As a rule of thumb, anything under six months is valid, and anything over two years is invalid. Any time in between those two boundaries must be proven to be reasonable.
The confidential information is publicly accessible
Many businesses collect their sales leads from public sources, including professional directories, phone books, and the internet. So, if an employer claims that they are protecting their confidential client sources, they will have to prove that the information was not available to others in the industry.
Threats to public health and safety
This breach generally applies to physicians, nurses, and anyone in specialized science and health fields. If there is a shortage of healthcare workers in a specific industry or a particular area, an employer cannot enforce the agreement even if they meet all the other requirements.
This is why it’s critical for you, as an employer, to take caution when creating a CNC and ensure that you follow all of the obligations that you agreed upon. If any of the terms are legal violations, your former employee can be released from their duties.
Pros and cons of non-compete agreements for businesses
Restrictive covenants aren’t beneficial in every situation from an employer’s perspective. In fact, you could land yourself in legal trouble and owe money if you try to enforce a CNC with violations, meaning that it’s critical to ensure that you can implement the agreement legitimately.
Some of the pros of CNCs for businesses include:
- Short term protection of trade secrets and other confidential information
- Less of a chance of losing customers when an employee leaves
- Highly-skilled former employees won’t be able to use their skills with a competitor
- Employees are less likely to leave as quickly, protecting the investment put into a company’s workforce
- Non-compete agreements for small businesses allow them to protect themselves while at a disadvantage among larger competitors.
Next, here are some of the cons of non-compete agreements:
- An employee may quit pre-maturely if a CNC is introduced while they’re employed
- Increased risk of legal liability and lawsuits
- The agreement may prove to be unnecessary, thus lowering employee satisfaction
- If the contract unfairly restricts an individuals right to work, it’s unlikely to be upheld in court.
How do non-compete contracts work?
The purpose of a non-compete contract is to allow businesses to protect sensitive information such as customer and client lists, trade secrets, and marketing plans from being exploited by former employees.
These contracts can also prevent former employees from working against your business for a specific time. A restrictive covenant should benefit both the company and the employee, which means offering incentives such as monetary compensation, improved insurance or paid time off.
The stages of creating and managing a non-compete contract
Non-compete agreements are great solutions for companies looking to prevent former employees from engaging in actions that would harm the well-being of their business. However, for the agreement to be enforceable, you must complete each stage properly from creation to finalization.
Creation and drafting
A standard non-compete contract must include the following information to be valid:
Identification of each party
This includes the protected party, the company, and the non-competing party, the employee who’s prohibited from working for a competitor.
The effective date and end date of the agreement
Keep in mind that the agreement should only last for up to two years unless you have a justified reason for a longer duration.
The reason for the agreement
In other words, what are you trying to protect or prevent with the contract? (intellectual property, company secrets, client information, etc.)
The geographic area covered by the agreement
Typically, the restricted party is barred from working for competitors in any state where their previous employer conducts business.
The compensation for the employee signing the agreement
For a CNC to be fair, something must be offered to the employee signing it, whether it’s an initial job over, monetary compensation, a promotion, etc.
Signatures of both the protected party and the non-competing party
For the contract to be legally valid, it must be finalized with the signatures of all involved parties.
Typically, the benefit or compensation for the non-competing party is a job offer. However, when you want a current employee to sign the contract, you must fairly compensate them. When negotiating a non-compete agreement with a current employee, you can offer incentives such as a pay raise, a promotion, or paid vacation time. Of course, they can always come back with a counter-offer if they aren’t happy with the initial compensation offer.
Approval and signing
To finalize a CNC, all involved parties must sign the final version of the document. Before signing, you should ensure that the employee approves of all of the terms and conditions included in the arrangement. If everyone feels that the agreement is fair, both parties can sign and date a physical or digital version.
Enforcing the agreement
Each state has different laws concerning the enforceability of a restrictive covenant. Typically, the courts will not enforce one that is unreasonable and if the harm to the employee is disproportionate to the benefit of the business. Considering the vast variation between each state’s laws, you must familiarize yourself with what’s permitted and unpermitted in your state.
What happens if you break a non-compete contract?
Either side can seek legal remedies in a non-compete breach of contract. In cases of an employer breach, by failing to pay the employee, not providing agreed-upon benefits, or failing to meet any other obligations, then the employee is relieved from their obligations.
If the employee decides to sue and the employer is at fault, then they are responsible for any legal fees incurred by either party and may even owe monetary compensation to the employee. This is why it’s critical to ensure that your final agreement is doesn’t violate any laws and is as detailed as possible.
Using contract management tools to create enforceable non-compete agreements
If your non-compete clause doesn’t violate any state or federal laws and includes all of the necessary components, you can hold the employee to the terms they agreed upon. This is where a contract management platform comes in handy.
Through features such as pre-made non-compete contract forms, the platform will allow you to easily create a lock-tight agreement while ensuring that you don’t miss any essential elements. Contract management software also includes tools to streamline negotiation, management, and signing a non-compete contract.
Beneficial features of contract management software for non-compete contracts include:
- Non-compete contract templates
- Real-time collaboration tools
- Access to previous versions of the document
- Storage on a secure cloud-based repository
- Performance monitoring and oversight