Most states allow at-will employment, which means employees can leave you anytime to pursue other opportunities. But what happens if those opportunities directly compete with your business? One way to avoid this scenario and protect your company is to have employees sign noncompete agreements when hired. However, before you make every employee sign one, you should understand the legal restrictions and limitations of noncompete agreements.
A noncompete agreement, also known as a restrictive covenant or a noncompete clause, is a formal contract between an employer and an employee that limits the employee’s ability to engage in competition with the employer during employment and for a designated period after their employment ends. Although the agreement’s details are outlined in the terms, noncompete agreements often restrict the employee from working for a competitor or starting their own competing business immediately after working for you.
“Business owners work very hard and spend a lot of money to develop their products, form their customer base, build out their partnerships, recruit talent/employees, and develop their proprietary information or intellectual property,” Dani Fontanesi, founder and managing partner of Fontanesi Law / Advisory, told us. “They want to know that if they hire an employee, that employee can’t just steal their customers, misappropriate their proprietary information, and start a competing business without doing the hard work of building a business legitimately from the ground up. Noncompetes are intended to protect businesses from this type of behavior.”
When an employer includes a noncompete agreement in an employment contract, they are committing to hiring the employee (or paying them to sign the noncompete clause), and the employee is committing to not engage in competitive business activities during or after their employment relationship is terminated with the company. Noncompete agreements typically restrict the former employee from conducting competing business only within a designated geographic location and for a limited time.
However, according to Kelly Williams, founder of Slate Law Group, “The key to the restriction is that the time and location must be reasonable.”
Even if you have employees sign noncompete agreements, be aware that they aren’t always easy to enforce. Employees often challenge the agreement in court, and some state laws make noncompete agreements difficult to uphold. When drafting noncompete agreements, pay close attention to your state laws and public policy, and consider other protective measures, like a proprietary information and inventions assignment (PIIA) agreement.
Noncompete agreements and PIIAs are typically drawn up by the employer and signed before the employee starts working, as this can affect the agreements’ enforceability.
“If an employer wants to have an employee sign a noncompete or PIIA after their employment has already begun, they should consider offering some form of incentive or other consideration for signing the agreement(s) to increase the chance that it will be enforceable,” Fontanesi said.
If a departing employee violates an enforceable noncompete agreement, the employer can seek litigation against them. However, not all states enforce noncompetes the same way, so it is important to check state laws first.
At a minimum, your noncompete agreement should include the following details:
Both parties must sign a noncompete agreement, but it does not need to be notarized. If legally enforceable by the state, noncompete agreements can effectively protect a business’s interests. However, the key to an enforceable noncompete is that the terms must be “reasonable” and not too restrictive.
In determining whether the agreement is too restrictive, Fontanesi said, courts generally consider factors such as the geographical reach of the noncompete, the commercial reach (if it is limited to a narrow market or captures a broad industry), the length of time it extends, and the legitimate business interest of the employer.
Fontanesi provided an example of a noncompete agreement that would be too restrictive and one that likely would be enforceable based on its restrictiveness.
The state you operate in plays a role in the enforceable time restrictions of a noncompete agreement. Fontanesi said the following states have specific guidelines regarding what constitutes a “reasonable” temporal limitation:
Some other states, like Florida, have enacted laws indicating that noncompetes are presumptively reasonable if they extend less than two years.
To ensure the time frame of your noncompete agreement falls within state guidelines, to check the laws in both the state where your business is located and the state where the employee is located (if they are working remotely from a different state). In general, most states do not favor noncompetes, but some enforce them as long as they are reasonable.
Some states have geographical restrictions when it comes to noncompete agreements. For example, they may have guidelines on what is considered a “reasonable” perimeter to restrict the former employee from working in after departure (i.e., an employer might be allowed to restrict competition within their city or state, but not the entire U.S.)
In general, any previously signed noncompete agreements entered out of state will usually not be valid.
In addition to time and geographical restrictions, some states impose noncompete restrictions on other categories, such as employee time, compensation threshold, and so on.
“Other states prohibit noncompetes for certain categories of workers — for instance, low-wage or fast-food workers, nonexempt employees, students or younger workers, or employees who have been terminated without cause or laid off,” Fontanesi said.
Additionally, some states ban noncompete agreements altogether. California, Minnesota, North Dakota and Oklahoma essentially prohibit noncompete agreements in the employment context, with narrow exceptions.
On January 5, 2023, the Federal Trade Commission (FTC) proposed prohibiting noncompete agreements on a federal level; a final ruling is expected in the spring of 2024. On May 30, 2023, the National Labor Relations Board (NLRB) announced that most noncompete agreements violate the National Labor Relations Act (NLRA).
If your noncompete agreement is written incorrectly or outside of state law, it will do nothing to protect your business. If you want to create an agreement that is enforceable and effective, there are a few additional steps to take.
Noncompete agreements are state-specific. Some states can even impose penalties on companies that require an employee to sign a noncompete that does not comply with the laws of that state. Therefore, you must be thoroughly informed about the state laws governing your noncompete agreement. Employers should consult an attorney before having their employees sign a noncompete.
“Particularly right now, when many employees are working remotely, it’s important to know that the law of the state where the employee is working may govern the noncompete, rather than the law of the state where the company is located,” Fontanesi said.
Because the effectiveness of noncompete agreements may vary, Williams advised small business owners to include a severability provision, a clause in the contract that severs any unenforceable provisions.
“Usually, if a provision in an agreement is found to be unenforceable, then the whole agreement can be held invalid, unless there is a severability provision,” Williams said. “Thus, if you are unsure of the effectiveness of including a noncompete, you may still include one in your agreement alongside a severability provision without running the risk of invalidating your whole agreement. If the noncompete is found to be invalid, [the unenforceable portion] will be severed from your agreement while maintaining the rest of the agreement in full force.”
In addition to noncompete agreements, companies can consider other protective measures, such as having their employees sign a PIIA.
“A PIIA can protect the company against an employee stealing their proprietary information, including customer lists, contact information of business partners and other valuable or confidential information of the employer,” Fontanesi said. “Other alternatives to consider are nonsolicit agreements, or agreements not to hire or recruit employees.”
Before putting together a noncompete agreement, weigh the advantages and disadvantages of the document.
The most significant advantage of a noncompete agreement is that it allows you to prevent employees from competing directly with your organization. Consider these pros, too:
According to the law firm Gammon and Grange, the most notable reason to avoid a noncompete is you may dissuade talent from working with your organization. Additional drawbacks of noncompete agreements include the following:
The best way to reduce the potential disadvantages of a noncompete agreement is to consult with an attorney before having an employee sign it.
“Each state and locality have different laws and case law affecting all aspects of contracts, and as such, seeking the advice of a legal expert will ensure you the best possible outcome and adherence to the law,” said Williams.
Source interviews were conducted for a previous version of this article.