As we wait patiently for the comment period on the Federal Trade Commission’s proposal to ban employers from imposing non-competes to close next month, I’m here to tell you now that your business’s non-competition agreements may be dead on arrival anyway.
I’ll explain why.
Most states that greenlight non-competition agreements do so with some guardrails. That is, they need to serve a legitimate business interest by having a reasonable duration and geographical scope.
A recent decision from Delaware, albeit in the context of the sale of a business, is a real wake-up call for businesses that attempt to prevent former employees from working in locations where the company conducts no business.
In this case, a company engaged in “the business of providing workforce training, management, compliance, and consulting services” was sold to a Delaware corporation, and its founder received $10,000,000. Good for him!
In exchange, the founder agreed to a five-year non-competition agreement that applied “anywhere in the world.”
A few months after the sale, he resigned. And a few years after that, he became an investor and board member of a direct competitor in Texas. Unfortunately, that didn’t sit well with the buyer, who sued to enforce the non-competition agreement.
The defendant moved to dismiss the case arguing that the plaintiff failed to state a claim. Why? Because the plaintiff didn’t claim to do business anywhere in the world and, yet, it was trying to prevent him from competing anywhere in the world.
And the court agreed:
The non-compete provision is facially unenforceable due to its unreasonable geographic scope…The reasonableness of a covenant’s scope is not determined by reference to physical distances but by the area in which a covenantee has an interest the covenants are designed to protect. Although relatively broad restrictive covenants have been enforced in the sale of a business context, such covenants must be tailored to the competitive space reached by the seller and serve the buyer’s legitimate economic interests. (cleaned up)
In this case, the covenant was overbroad because it covered areas not essential to protecting the buyer’s legitimate interests in the acquired company. The buyer claimed to operate only nationally. This incongruity with the breadth of the non-compete led the court to deem it unreasonably broad and unenforceable.
And while courts often have the power to reform or “blue-pencil” agreements to supply reasonable limitations, the court declined to do so here, assuming that the buyer was sophisticated enough to get it right the first time.
As I mentioned yesterday, it’s one thing to have overly-broad agreements, but it’s another thing to attempt to enforce them. The buyer found this out the hard way.
Tailor your restrictive covenant agreements to serve legitimate business interests. Consider alternatives to non-competition agreements, such as non-solicitation agreements and nondisclosure agreements, where appropriate. While geography is immaterial to these other options, they must be reasonable in length, may require financial consideration (other than continued employment) to be enforceable, and otherwise comply with state law. (Hint: don’t use Google to find a form. Get help from a lawyer.)