What is a Covenant Not To Compete?
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A covenant not to compete, or a non-compete clause, is an agreement in which one party agrees not to work for the other party’s direct competition in a specified area for a certain amount of time. While a covenant not to compete is generally found in an employment contract, it can be found in contracts for the sale of a business as well.
Covenant Not To Compete By State
While courts do not like covenants not to compete because they restrict competition, courts will often enforce them if the covenant meets certain legal standards. Each state has its own laws, which determine an enforceable covenant not to compete. However, while some states define an enforceable covenant not to compete more narrowly than other states, most follow similar criteria in determining whether the covenant is legally enforceable.
Covenant Not To Compete in Employment
In the employment context, an enforceable covenant not to compete must generally protect a legitimate business interest of the employer. However, this does not mean that an employer may prevent the employee from working for a competitor, just because there will be a loss of business for them. The employer must have specific business interests at stake, such as the prevention of their competition learning their trade secrets.
Customer relationships may also be considered a legitimate business interest. This means that a covenant not to compete may legally prohibit an employee from bringing the customers from their old job, to their new one. As with any enforceable contract, a covenant not to compete must also be supported by consideration. When an employee signs a covenant not to compete before they begin their employment, the employment is the consideration.
When a covenant not to compete is signed after employment, it also must be supported by consideration, such as a promotion. Finally, a covenant not to compete must not unduly burden the employee’s right to make a living. This means that the covenant must be reasonable in its scope and duration. For example, if a covenant not to compete denies the employee the right to work for any competitor in the regional area, a court is more likely to find that this covenant is more reasonable than one that denies the employee the right to work for any competitor in the entire United States. However, this factor can vary greatly depending on the employee’s type of business or industry.
Covenant Not To Compete in the Sale of a Business
A covenant not to compete may also appear in some contracts for the sale of a business. In these circumstances, the buyer will have the seller sign an agreement that states that they will not open a competing business within a regional area, within a specific duration of time.
Generally, a legitimate business interest will also make a covenant not to compete enforceable in the context of a sale of a business. Further, courts tend to construe this more liberally in these types of contracts than they do in the employment context. These covenants must also be reasonable however, and not unduly infringe on the seller’s right to make a living.
If you have further questions about a covenant not to compete or you would like to learn about the particular laws in your state, you should consult an experienced business attorney for more information.