When an employee works for a business, the employee often gains access to the business's proprietary property or trade secrets, such as pricing or customer lists. These trade secrets are often extremely valuable assets, which companies should seek to protect.
Businesses must understand how to properly and effectively protect their proprietary information and trade secrets. One way to do this is to include non-compete and non-solicitation clauses in employment agreements. However, many states deem non-compete and non-solicitation clauses unenforceable unless they meet specific requirements.
This article discusses both clauses and how to effectively draft both kinds of clauses to ensure a company's proprietary information is properly protected.
If you have any questions about what you should include in your non-compete language, our experienced transactional and business lawyers here at Newburn Law can help answer any questions you might have. We have years of experience drafting these clauses to protect businesses and their proprietary information.
What is the difference between a non-compete clause and a non-solicitation clause?
The primary difference between these clauses is the following:
- A non-compete clause prevents the employee from working for a competitor after leaving their employment.
- A non-solicitation clause prevents a person from taking customers and employees away from a business after leaving the company, known as "poaching."
The laws related to non-compete and non-solicitation clauses represent a balancing act between protecting businesses from losing trade secrets or other proprietary information and protecting workers' rights to earn a living.
What Is a Non-Compete Clause?
Non-compete clauses are relatively common clauses within employment agreements. When an employee signs a contract with a non-compete clause, the employee essentially agrees that when the employment is over, the employee will not work for a competitor 1) for a certain period of time, or 2) in a certain geographical territory, or 3) in a particular market. This clause often applies irrespective if the employee quits or the company fires the employee.
Many state legislatures have found that limiting employees' opportunities to work through a non-compete clause is unjust. Therefore, when a business includes a non-compete clause in its employee agreement, the company must ensure that it is not too limiting that a court will deem it unenforceable.
Companies can require both employees and independent contractors to sign agreements with non-compete clauses. However, these clauses must be certain requirements to be enforceable.
What Is a Non-Solicitation Clause?
Non-solicitation clauses are also common clauses within employment agreements. When an employee signs a non-solicitation clause, the employee agrees that, when the employment is over, the employee will solicit a company's employees, customers or clients after leaving the company.
Typical non-solicitation clauses state that the employee won't take the employees, customers or clients away either for the employee's benefit or a new employer's benefit.
For example, a local termite company may require its employees to sign an agreement that contains a non-solicitation clause, as the customer list could be vital to the company's sustainability. Losing just a few hundred customers could significantly reduce the company's revenue. A company like this may ask its employees to sign a non-solicitation clause to retain as many customers as possible.
Conditions Non-Compete Clauses Must Meet
Generally speaking, in order for a non-compete clause within a contract to be deemed valid, the clause must meet the following standards:
- Be reasonable in the scope of time that the non-compete clause limits the individual;
- Be reasonable in the range of geography that the non-compete clause specifies for the individual;
- Have ‘consideration' at the time the agreement is signed; and
- Protect the legitimate business interest of the company.
However, these requirements vary from state to state so it is important to seek legal counsel for your given situation.
Reasonable in Scope
This requirement essentially states that companies cannot implement unreasonable standards within the non-compete clause. For example, a typical 'reasonable' non-compete clause can be anywhere from six months to two years or for however long is deemed reasonable to protect confidential information. If the clause is longer than the reasonable scope of duration, then it will be deemed unenforceable.
The geographical area will typically depend on the scope of services or the types of goods the company provides. If the company offers services or goods only in a limited area, the clause should not include a limitation on areas outside where the company offers the services or goods.
Consideration essentially means an exchange of money or another form of compensation for the services the individual will provide. The consideration must be of value for the employee or independent contractor.
Protecting Legitimate Business Interests
The company must be able to show that they have a legitimate business interest in the trade secrets or confidential information they are trying to protect. The company must show that:
- The company took reasonable measures to protect such information; and
- The information provides the company with a competitive advantage in its industry.
Conditions Non-Solicitation Clauses Must Meet
Similar to non-compete agreements, non-solicitation clauses must meet certain conditions to be enforceable. Some of these conditions include:
1) First, the company must have a specific business reason for the non-solicitation clause, such as trade secrets or a confidential customer list. A court will likely find it unenforceable if a company cannot show a specific business reason for the clause.
2) The non-solicitation clause cannot prevent customers, clients, or employees from leaving a business independently to join another company. In other words, as long as the customer, employee, or client is going on their own accord, the employees aren't being “poached” by the person who signed the non-solicitation agreement.
3) The company must prove that it invested time, money, and energy into creating its client list. Further, the customer list database must include information that is not generally available to the public.
For example, if a company compiled its customer list by merely looking up numbers from the local telephone book, that information would not be protected by a non-solicitation clause.
4) Finally, the non-solicitation clause should not prevent an employee from being able to obtain other employment. This is specifically prevalent in industries with smaller customer bases. The agreement cannot include a standard non-solicitation clause but rather should specify, in particular, any restrictions for the employee.
Again, these requirements can vary from state to state.
Why Would a Company Want to use these Clauses?
Some businesses own valuable confidential information and trade secrets they have accumulated over time. Trade secrets may include customer lists, price lists, internal processes created specifically by the company, algorithms, and other crucial elements of the business. Companies want to retain this information to maintain their competitive edge within their industry.
When an employee works at a company, the employee gains access to this information throughout the scope of employment. If the company did not require the employee to sign a non-compete or non-solicitation clause, and if the employee then leaves the company, the employee may share those trade secrets with a competitor or solicit the company's customers and/or employees.
Why Do Courts Reject these Clauses?
Within the United States, our economy is run by encouraging innovation and competition. However, courts recognize that businesses have the right to protect their valuable proprietary information and trade secrets. Therefore, in most states, courts must balance the interests of individuals seeking to work with those of businesses seeking to maintain their competitive edge.
In many jurisdictions, courts view restrictive covenants that do not meet the standards described in this article to limit an individual's right to work. Courts will, therefore, reject non-compete clauses when they're too restrictive in time, territory, scope, and/or reasonableness. Essentially, when the clauses place too many restrictions on the employee's right to work, the courts may deem them unenforceable.
The longer the employee cannot work for a competitor, and the larger the territory where the employee is prevented from doing so, the more likely a non-compete clause will be struck down.
Courts reject non-solicitation clauses for many of the same reasons they reject non-compete clauses—that is, where the clauses make it too hard for a business's former employee to earn a living or where the clause unfairly limits the employee's ability to attract new customers legitimately.
Enforceability of Non-Compete and Non-Solicitation Clauses
The enforceability of non-compete and non-solicitation clauses is a matter of state law. Each state has developed its own case law related to non-compete and non-solicitation clauses, and the states' laws vary. Some states require shorter periods and a smaller territory to uphold a non-compete clause as enforceable.
Each state differs in how they treat non-compete causes, so it is crucial to consult with an experienced attorney to understand how you should be drafting your non-compete clause in an agreement.
Since non-solicitation clauses prevent poaching of employees and customers, rather than restricting the right to work, these clauses tend to be upheld more often than non-compete clauses. However, some states limit the enforceability of non-solicitation clauses. Therefore, again, you must consult with a lawyer who understands the nuances of drafting these types of clauses before inserting them into your agreements.
Colorado's New Law
In May 2022, Colorado legislation enacted a law that bans non-compete clauses based on income and other factors. The law essentially amends Colorado's non-compete statute to remove many exceptions to Colorado non-compete clauses.
Therefore, if a worker makes less than six figures annually, HB-22-1317 says that non-compete clauses in contracts are unenforceable between employers and employees. This new law applies to employment contracts that have been signed or are renewed after the legislation's effective date of August 10, 2022.
However, this does not mean that all non-compete clauses will be accepted for individuals who make more than six figures. The new law states that two exceptions exist where non-compete clauses may be enforceable if all of the standards are met:
- "Highly compensated employees" (HCEs), those who earn more than $101,250, but only where the restrictive covenant protects trade secrets; and
- Non-solicitation covenants of customers can only be signed by employees who earn more than 60% of the HCE salary threshold.
The new bill requires the employer to provide a separate, written notice to the employee regarding the non-compete covenants, which the employee must also sign.
Further, these restrictive covenants must also meet the same standards we described in this article regarding reasonableness and necessity.
Mistakes to Avoid/Guidelines and Tips for Drafting a Non-Compete or Non-Solicitation Clause a Court Won't Reject
Since state laws govern the enforceability of non-compete and non-solicitation agreements, a business first needs to find out the rules in the state where the clauses within the contract may be challenged. Therefore, it is important to contact an employment or business law attorney for advice before adding these clauses to your business's employment agreement.
Generally, however, as noted, follow the points below to make sure your non-compete or non-solicitation clause is upheld:
- Ensure you provide consideration for the employee, meaning you must give them something of value in return for signing the agreement containing the restrictive covenants.
- Be sure to draft the clause only to restrict the employee for the amount of time considered reasonable for your purposes.
- Be sure to limit the scope of geography only to the territory you operate your business in.
- Do not use a one-size-fits-all approach. Be sure to tailor your restrictive covenants for your company's specific needs within your company's industry.
- Allow the employee to assign the agreement with your approval. Assignment provisions are crucial in enforceability when transferring non-competes when selling the contract.
- Accurately include your choice of law provision for what jurisdiction will govern the terms of the agreement, thus, which court will have jurisdiction to determine the enforceability of your contract.
- Always have measures in place to protect your trade secrets and confidential information. This element is crucial when attempting to enforce a restrictive covenant. You must show that you took the steps necessary to protect this information yourself, which is why the clauses are also included – to further its protection.
- Make sure your clauses meet the standards that your jurisdiction requires.
The more a restrictive covenant restricts the workers' right to work, the less likely a court will find it enforceable.
If you have any questions about drafting your non-compete and non-solicitation clauses, contact our experienced lawyers here at Newburn Law today for a free consultation.