A non-compete clause or covenant not to compete (CNC), is a term used in contract law under which one party (usually an employee) agrees not to pursue a similar profession or trade in competition against another party (usually the employer). As a contract provision, a CNC is bound by traditional contract requirements including the consideration doctrine.
The use of such clauses is premised on the possibility that upon their termination or resignation, an employee might begin working for a competitor or start a business, and gain competitive advantage by abusing confidential information about their former employer’s operations or trade secrets, or sensitive information such as customer/client lists, business practices, upcoming products, and marketing plans.
Conversely, a business might abuse a non-compete covenant to prevent an employee from working elsewhere at all. Most jurisdictions in which such contracts have been examined by the courts have deemed CNCs to be legally binding so long as the clause contains reasonable limitations as to the geographical area and time period in which an employee of a company may not compete. Courts have held that, as a matter of public policy, an individual cannot be barred from carrying out a trade in which (s)he has been trained except to the extent that is necessary to protect the employer.
The extent to which non-compete clauses are legally allowed varies per jurisdiction. Some jurisdictions, such as the state of California, invalidate non-compete-clauses for all but equity stakeholders in businesses.
The most litigated issue in employment contracts is the legality of so-called “restrictive covenant” provisions, such as a non-compete clause which bars an ex-employee from going to work for a competitor. Courts are often reluctant to enforce these restrictive covenants if they impose an unreasonable hardship on the ex-employee. They are strictly scrutinized as to their “reasonableness” in light of the facts and circumstances presented in each case.
Whether a non-compete is legally enforceable will be determined by state law. Generally, the law of the state where the employee is located will apply. A contractual agreement as to which state law applies may be ineffective.
Non-competes have to be reasonable to be enforceable. Reasonableness is determined by the courts based on the specific facts in each case. Primary attention is given by the courts to:
- the geographic scope of the non-compete,
- the duration of the non-compete, and
- the type of activity the ex-employee is precluded from engaging in.
Non-competes are more likely to be upheld if the geographic scope is smaller, the duration is shorter and the type of activity is narrower (e.g., sales position only, versus working for a competitor in any capacity). They are also more likely to be upheld if the employee is only prohibited from soliciting the employer’s established customers.