By Lawrence Hoffman
PART V NON-COMPETITION AGREEMENTS
Employee non-competition agreements (NCAs) are a highly controversial topic in the field of labor and employment law. NCAs are not categorically unenforceable, but they are often subject to statutory limitations, particularly outside the U.S., and are always subject to careful judicial scrutiny to protect employee mobility. Generally stated, non-competition agreements will be enforceable only if the employer can demonstrate that they meet legitimate needs of the business and the restrictions are reasonable in relation to those needs. Adequacy of the consideration to the employee may also be an issue.
Non-competition agreements usually address one or more of the following topics:
- Confidentiality of trade secrets and other confidential business information;
- Working for a competitor or starting one’s own competing business;
- Solicitation of customers of the former employer;
- Doing business with customers of the former employer under any circumstances; and
- Poaching employees of the former employer.
The first of these has been addressed in Part IV of this series. We will discuss the others below.
Factors that are considered in determining the reasonableness of a restriction include:
- Duration of the restrictions;
- Geographic limitations;
- The nature of the prohibited activities;
- Consideration and compensation.
Enforceability in the United States:
It is often said that non-compete agreements are not enforceable under California law. There are, however, three exceptions stated in the Cal. Bus. & Profs. Code §§ 16601-16602.5. In particular, a non-competition provision may be enforceable against the seller of a business, a former business partner, or a former member of a limited Liability Company. However, the restriction must be limited to the geographical area in which such persons had been conducting business. The restriction may remain valid as long as the successor or surviving business continues to operate in that area.
Note also that California allows protection of trade secrets under its version of the UTSA. Therefore, restrictions that are otherwise unenforceable, e.g., non-solicitation of customers or other employees or the employer, may be upheld to the extent that they involve misappropriation of the employer’s Trade Secrets.
Another point should be kept in mind in the case of companies not domiciled in California. Sometimes, a provision specifying the law under which the agreement is to be interpreted and/or the forum in which litigation must be brought can result in application of laws less restrictive than that in California. Further general discussion of this topic may be found here and here, but counsel familiar with the law in the employer’s home jurisdiction should always be involved in an attempt to utilize such provisions.
Elsewhere in the U.S., restrictions on non-competition clauses vary from state to state. Apart from California, Louisiana, Alabama, Florida, Oregon and Michigan are said to have the most restrictive laws.
Time limits are an issue that must be addressed in fashioning a non-competition agreement. Two-year periods have been upheld in most states.
Typically, geographic restrictions must relate to where the employer’s business is conducted. However, in the modern high-tech and digital world, this becomes a complicated issue. A company may have facilities in more than one location and its customers may be world-wide. Employees may telecommute from several different jurisdictions.
In such situations, limiting the geographical area in which the non-compete is applicable will probably not accomplish anything. This problem has arisen in litigation, and the result will depend on the facts. The employer will have to demonstrate that under the circumstances, a narrow geographic restriction would not protect the employer’s legitimate interest.
Defining the prohibited activity is essential. To be reasonable, it must relate to competitors in the specific business of the employer, e.g., with reference to the employers products or services.
The question of consideration arises when an NCA is entered into after employment has begun and is separate from an initial employment agreement. If the NCA is part of the initial agreement, the employment, salary, and other benefits are considered to be adequate consideration for the NCA provisions as well.
If the NCA needs to be a separate later agreement, adequate consideration will need to be provided for. As we will see below, this is dealt with in many countries by requiring the employer to pay the employee during the period of non-competition. In the UK, this is sometimes accomplished by terminating the departing employee’s work activities but keeping him on the payroll, effectively preventing him from competing during the idle period. There is no similar practice in the U.S.
A final thought – California is not the only place where choice of law and litigation forum provisions should be included. The references to this in the discussion of California law are relevant wherever the U.S. the employer is located.
Outside the United States:
In most countries, NCAs are given greater respect than in the U.S., but they are usually regulated to some extent by statute.
Israel: At the most restrictive end of the spectrum, the law of Israel treats NCAs as unenforceable except in a few special situations. Most practitioners regard NCAs as unenforceable except under specific limited situations. Even in these, restrictions on employee mobility will be scrutinized under reasonableness standards like those described in connection with U.S. laws.
NCAs can be enforced if necessary to protect trade secrets and other confidential information when the departing employee is likely to use the information in his new employment or business.
An NCA is also likely to be enforced if it can be demonstrated that departing employee has breached a duty of good faith, e.g., acted maliciously with the intent to harm his former employer. A court could treat, blatantly soliciting the employer’s customers, or taking setting set up his own competing business during the time of his employment.
Where the employee has received special compensation, separate to his salary, to sign the NCA, it will also likely be enforced. Note that this is not required under Israeli law as it is in some other countries as noted below, but the courts will give weight to the fact that such compensation is being paid as a salary after the end of his employment and throughout the non-compete period, assuming the additional compensation is reasonable.
Finally, an NCA will be enforced when an employee has received special training beyond normally given and, in return, the employee agrees to continue his employment for an agreed period and not to compete with the employer for an agreed period thereafter.
As to these exceptions, the law does not specify standards of reasonableness, nor is its application limited to any particular type of employees. However, the nature of the former employee’s duties will enter into the reasonableness determination.
China: NCAs are enforceable in China, but only as to senior management, senior technicians and other personnel who have a confidentiality obligation. A ‘senior technician’ is someone engaged in technology research and development, and who has fairly comprehensive access to the company’s technological information.
Issues sometimes arise as the definition of “other personnel who have a confidentiality obligation.” As to this, courts consider factors such as:
- The employee’s compensation;
- The employee’s job title and responsibilities;
- The likelihood of the employee’s gaining access to and making use of the confidential information;
- The existence of a confidentiality agreement;
- Possible financial hardship of the employee during the non-competition period.
In all instances, periods of non-competition are limited to up to two years. However, the employer must pay the former employee ‘reasonable’ compensation during the idle period.
On January 31, 2013, by the Supreme People’s Court issued a Judicial Interpretation on Labor Disputes. The following provisions of the Interpretation pertain to NCAs:
- When the NCA does not specify the amount of compensation, the employer is required to pay monthly compensation equal to 30 percent of the employee’s average monthly salary in the preceding 12 months (but not less than the local minimum wage).
- If the employer terminates the employment contract for a legally insufficient reason, the NCA remains binding upon the employee unless the parties agree otherwise.
- If the termination is wrongful, the employee may terminate the NCA if the employer fails to pay the compensation for a period of three months.
- An employer may terminate the agreement by paying the required monthly amounts to the termination date plus an additional 3 months of compensation to the employee.
- If the NCA requires the employee to pay liquidated damages in the event of a breach of the agreement, (e.g., because it is often difficult to establish the employer’s actual damages from such a breach) even if the employee has paid the liquidated damages amount with the objective of releasing himself from the obligations under the agreement, the NCA will remain in force at the employer’s option.
With regard to the liquidated damage amount, this will ordinarily be determined by the employer, or perhaps by agreement between the parties. However, the reasonableness of the amount will be subject to consideration by the court, and may be decreased if it is considered unfair to the employee.
Geographic restrictions as to non-competition are also subject to court review as to reasonableness. Factors to be considered include the employer’s business scope, size, industry, and the employee’s position. Practitioners recommend that an expansive scope be specified since the courts usually reduce the scope if it is considered to be too broad, and enforce the NCA as so modified.
There are no EU Directives governing NCAs and thus national law in each country needs to be considered. NCAs are generally enforceable throughout Europe, but the permitted content varies in some important respects. Note that collective bargaining agreements sometimes contain provisions that concern NCAs. These must be complied with. Typically, the employee must acknowledge that such provisions have been brought to his attention.
Generally, in case of violation by a former employee, the former employer will be entitled to damages and an injunction. The new employer can also be liable for damages if it knowingly hires someone subject to an NCA.
As in other parts of the world, the laws in all European countries require that protection of an employer’s legitimate interests be balanced against the economic and other rights of the employee. Also, the terms of NCAs are always examined for reasonableness in light of the specific facts. Issues that are considered include:
- Employee’s Duties – restrictions cannot be imposed on employees whose duties do not relate to legitimate business interests of the employer.
- Time – maximum limits range from two years in most countries to one year in the UK. Unlimited NCAs are not permitted anywhere.
- Competitors – must be limited to the employer’s actual business activities.
- Geographical Scope – limited to where the employer does business.
- Activities – employment or contractual relations with competitors can always be restricted. In some countries, certain other activities can also be restricted as discussed below.
- Compensation – required except in the UK. Amounts required or regarded as reasonable are based on 25-50 percent of the employee’s last annual salary. There is no statutory minimum in France, but 30 percent is reported to be reasonable according to some court decisions. In Germany, the statutory minimum is 50 percent. NCAs that do not provide for compensation are unenforceable.
Examples of application of these general considerations in several countries are presented below.
NCAs are not regulated by statute in France but by court decisions against a background of general law and the concepts of freedom of commerce and employment.
For an NCA to be enforceable, the employer must be able to show that allowing a former employee to compete could reasonably result in risk to relationships with existing clientele, or danger of disclosure of trade secrets. NCAs cannot be imposed on employees who do not fall in these categories.
As to geographic and time limits, court will often reform the contract to be more reasonable rather than declare the agreement unenforceable.
The requirement for compensation was introduced into French law in 2002. NCAs entered into before that date which do not provide for compensation are often enforced but compensation is ordered. Newer NCA’s that do not provide for compensation are not enforceable.
Penalty clauses, providing for employee compensation to the employer of a specified amount in case he violates the NCA, are permitted.
The employer can waive or renounce the non-competition clause if this is stated in the agreement. This will relieve the employer of the obligation to pay compensation. The waiver can be at a specified time. If the time is not specified, it must at the time of termination.
If there is no NCA, the employee is free to work for a competitor but will still be subject to the requirements of other laws, such as laws protecting Trade Secrets and against unfair competition. Possibly, that could apply to solicitation of customers of the former employer.
NCAs are governed by statute. They are permitted even with managing directors and the like, who are not considered to be ‘employees’ as such. The maximum duration is two years and must be reasonable in geographic scope. They are deemed effective as of the date of termination, without regard to the reason for termination.
Compensation must be provided for. The minimum amount is based on 50 percent of the employees most recent compensation, including benefits.
A contractual penalty to be paid by the employee is permitted. The employer will not be required to pay the compensation during a period of violation.
Absent an NCA, a former employee can compete, subject to other laws, e.g., as to Trade Secrets, unfair competition, etc.
The major conceptual difference between the UK and elsewhere in Europe is that compensation is not required. Another difference is that the maximum duration is only 12 months as compared to 24 months elsewhere.
NCAs are subject to strict requirements for reasonableness as scope as elsewhere in Europe. NCAs can prevent the ex-employee from approaching other employees or customers of the former employer as well or working for a competitor.
UK law specifies minimum periods of notice that must be given by an employer when an employee is dismissed according to the duration of employment. It also provides a minimum notice that must be given by an employee voluntarily terminates his employment. Longer periods can, however, be specified in the employment contract.
The notice period allows for inclusion in the contract of a so-called ‘garden leave’ (or ‘gardening leave’) provision that is often used as an adjunct to non-compete provisions. A garden leave clause allows the employer to require the employee to spend all or part of the notice period at home. The employee is not permitted to perform his usual duties nor contact coworkers or customers. Often the employee’s access to the employer’s computer systems is also terminated.
During the garden leave period, the employee continues to receive his usual salary and benefits.
The garden leave clause can prevent disruptive conduct by a terminated employee as a retaliation for the termination, permits a successor to develop relationships with the employee’s customers and contacts. It also isolates the terminating employee from the employer‘s existing trade secrets and other confidential information as well newly developed information. As in the case of other MCA provisions, the duration of garden leave is subject to a test of reasonableness. A very long period is likely to be reduced by a court if challenged. The employer could possibly also argue that the continued compensation during a substantial garden leave period provides compensation for the non-competition clause.
A final warning – in May 2016, the UK Department for Business innovation & Skills issued a Call for Evidence related to Non-Compete clauses. The document seeks information from which to understand these clauses are used and the effect they are having on start-ups, employers, and workers.
Conceivably changes in the law might result, but to date, there does not appear to have been any report or public follow-up and no legislative action has been taken.
NCEs are the most problematic mechanism that can be used to protect a company’s IP and other interests. It must be carefully drafted to assure its reasonableness and to properly take account of variations in nation laws.
This article is intended only as general information and is not and should not be considered as legal advice. You should consult with a lawyer who is familiar with your specific situation and the law pertaining to IP ownership and non-competition agreements where your employees will be located to review or draft the employment agreement provision concerning these matters. An IP specialist.