Non-compete Agreements Need a Geographic Location

In a lawsuit between an employer and an employee, a non-compete agreement that restricted employees from “working for companies competitive with the employer” and “in locations where they employee marketed or sold products” was not reasonable in geographic scope nor was it defined well enough to be enforced. The court rendered it unenforceable leaving the employer without a remedy. This is one more reminder that non-compete agreements must be reasonable in both time and geographic scope. The guiding principle is the least restriction on the employee’s ability to obtain new job and reasonably necessary to protect the employer’s interest.

It may be a good idea to review your company documents with your attorney to be sure they will be enforceable when you need them.

Understanding Legal Agreements

The nature of agreements can often be difficult to identify. To determine the essence of the agreement, what it really is, it is important to look at the substance of the agreement, not its title. For example, it can be difficult to discern between a lease on equipment and a finance agreement. A lease is a contract in which the temporary right to use an asset is conveyed for a specified consideration. The key is that ownership is not conveyed; rather, only the right to use the asset for a specified period. At the end of the period, all rights return to the lessor.

A finance agreement is an installment payment agreement where title reverts to the lender if there is a default in the promise to pay. Title in the property is vested in the borrower, not in the lender. A security agreement gives the lender a lien on the equipment until the debit is paid. Accounting and tax rules require that in a lease, the asset must be implicitly identifiable and the consideration must be reasonably certain. In other words, it cannot be so contingent or variable that its value cannot be determined at any point in time.

To identify if an agreement is a lease, the substance of the agreement must be analyzed to determine:

  • whether the contract is only fulfilled if the specified asset is used by the lessee (or at least if the lessor agrees not to exercise use or control over it); or
  • whether the lessee controls the right to use the asset for the specified period of time; that is, to decide how it will be used and receiving the benefit of such use.

Another example is a trademark or patent license or an assignment. Similar to a lease, a license is the right to use the intellectual property rights for a specified period for a specified compensation rate. In an assignment, the key is that less than full, unconditional ownership is transferred. If the owner retains some right in the asset, however remote (for example, if the contract gives the owner-seller a right of reversion or cancellation), under any condition, full, unconditional rights are being conveyed. It may be a limited use of the asset in certain territories or industries. While the owner-licensor retains the right to use the asset in certain business fields or geographic areas, you must carefully look at a contingent “sale” where the transfer only occurs under certain conditions to determine whether it is truly an assignment or a license. This will be important to understanding what rights you have to convey, encumber and enforce the asset again potential infringers. An experience attorney is a valuable resource for explaining your rights in any agreement.

When to consider a non-disclosure or non-compete agreement

If you are an employer for a business which grants its employees access to sensitive information or relies on proprietary information, you may want to consider a non-disclosure or non-compete agreement for your employees and consultants that have access to this information. This not only protects the information of your clients, but it also protects the investment you have made in developing the information that gives you a competitive advantage in the marketplace. You invested time and financial resources in developing information – why let your competitors benefit from your hard work and investment?

A non-disclosure agreement is a contract that prohibits the employee from divulging sensitive information learned while employed at the business. This type of work often includes many things. A few examples are handling credit information, internal vendor lists and pricing schedules, managing e-mail exchange servers or public relations duties involving hiding clients’ damaging secrets.

A non-compete agreement is a contract in which the employee promises not to work for competitors for a pre-agreed period of time after the current employment terminates in order to protect the business’s proprietary information. A non-compete agreement is often used for employees who work with client lists or trade secrets that the employer wants to keep from competitors, or when the employee possesses a unique talent or skill that would give competitors an unfair edge. It is important to balance the interest between the employee’s right to earn a living and the employer’s right to protect its proprietary information. To be enforceable, the courts generally must be sure that the restrictions are reasonable in terms of both geographical (distance) and time limitations.

These promises concerning non-disclosures or non-competes are commonly called “restrictive covenants’, and like all contracts, they require that both parties receive something of value. In many cases, the employee agrees to the restrictive covenants in exchange for employment at a particular salary. This is why most non-disclosure and non-compete agreements are drawn at the beginning of employment. Generally, both parties must be exchanging something of value to change the agreement between them. While some have successfully argued that continued employment is a benefit when the general rule is employment at will, others have successfully defended on the basis that you cannot change the agreement on an already existing job mid-employment; however, in these cases, you could offer a bonus or a promotion.

Non-disclosure and non-compete agreements are first and foremost deterrent mechanisms, but there are times when a breach of contract occurs and enforcement is necessary. The first step to enforcing a non-disclosure or non-compete is to send a Demand letter. The letter has four key points: (1) remind the breaching party of the existing contract and its terms; (2) explain where the breach occurred; (3) demand the breaching party comply with the terms within a certain amount of time (for example, 10 days); and (4) Warn of the legal consequences for failure to comply.

Unfortunately, Demand letters are often ignored, and court relief becomes the next available option. Breaking a non-disclosure agreement generally means that the breaching party has already disclosed the information, so the most commonly sought legal recourse is monetary relief. The plaintiff is responsible for convincing the court that the sum of money sought represents the total damages resulting from the breach.

Non-competes are enforced with court injunctions that force the breaching party to cease the breaching and infringing action or face contempt of court. In the state of New York, non-compete agreements are particularly difficult to enforce, as the courts have a strong policy against preventing people from being able to work, and a non-compete essentially limits a former employee’s prospects for future employment. In order to be considered enforceable, the non-compete must either protect particular trade secrets or confidential client lists or protect the employer from competitors by employees with special skills. The non-compete must also be reasonably in duration and limited to a relevant geographical area. All of these criteria are, of course, highly debatable and heavily litigated. It is important to seek experienced legal advice when drafting agreements for your employees and consultants to ensure that that they are enforceable.

Why have a contract?

Most people know to use a contract to protect themselves in business. But what exactly is a contract, and how does it protect you and your business?

A contract is a legally enforceable agreement between two or more parties (individuals, businesses, organizations or government agencies) to do or refrain from doing a particular thing in exchange for something of value. Whenever anyone buys, sells, leases, rents or licenses something, a contract is involved. Contracts are so common that you may not even realize that you are acting under a legally enforceable agreement. For example, contracts are not limited to written agreements. Under many circumstances, a verbal contract is binding. There may be a constructive contract created under provisions of state or local laws. When you buy an item from a store, you are buying the item subject to terms of their pricing, return policy and warranty. You may not have signed anything agreeing to the store’s policies; however, you are deemed to have impliedly accepted them if they inform you of the policy. Your notice may be on the back of a receipt or on giant posting at the checkout. It may also be posted on the company website.

A contract consists of an offer and an acceptance. Contracts are valid and binding the moment that an offer is accepted. The terms of the contract (i.e. the who, what, where, when and how of the agreement) define the binding promises or covenants of each party to the contract. If the deal is premised upon certain conditions or assumptions, the contract should state who “guarantees” what. These are usually referred to as “Representations and Warranties”. What happens when the representations or warrantees turn out to be untrue? This is where the true value of a contract is realized. When a contract has been breached, the contract should state specifically what happens.

For example, you purchase a business in which the owner declares $50,000.00 in profits per month, but you discover that it only profits $10,000.00 per month.  Since you relied on the profit that was represented in the contract, the sale of the business was based on a fraudulent representation, and you may have remedies against the seller.

For any deal worth over $500, it is a good idea to have something in writing.  This is particularly important when the deal is made between friends. All too often, deals become costly litigation nightmares because the terms of the agreement were not spelled out clearly enough. Contracts are written to protect parties when things go wrong.

A law suit is often needed to enforce a contract when one party does not uphold its end of the bargain, or when the parties do not agree on what was actually meant in the contract. There are alternatives to law suits to enforce a contract, such as binding arbitration, in which an agreed-upon third party presides over a hearing between the two parties.  Sometimes there is also the option of renegotiation to address a change in circumstances.

It is easy to stipulate the agreements, but the value of the contract, and the most difficult part to mete out, is what happens when things don’t go as planned. Predicting every possible breach and the consequences is where the protection is.  Contract without “Damages” (the consequences of a breach) is basically worthless. Just the act of drafting a contract between parties is a valuable use of time. While negotiating a contract, the parties learn how to communicate and interact with each other and learn what each party’s expectations are in the relationship.

One important thing to note: contract law varies from state to state. Always make sure you know what federal, state and local laws apply to the contract. If the contract involves parties from different states or countries, the contract should state which laws apply. In New York State, for example, certain contracts are required to be written, and are considered unenforceable if they are not. This is called the Statute of Frauds. Contracts subject to the Statute of Frauds are: promises made in the consideration of marriage, agreements that cannot be performed and completed within one year, the transfer of real estate, the sale of goods worth $500.00 or more, promises to pay the debt of an estate from an executor’s private funds, and suretyship (someone who promises to pay the debt of another).

The most important thing to do is read a contract fully before signing it. Be sure to ask questions and consult an attorney if you have any questions. Attorneys will often charge only a nominal fee to review a contract, only a fraction of what it might cost you to get out of it. Plus, an attorney can help analyze the situation and prepare a contract that best protects the client. This includes knowing what is essential in order to address the client’s needs and intentions and to make the contract enforceable. For example, in New York State, you cannot prevent someone from doing something (called ‘injunctive relief’), unless it is stated in the contract. Additionally, you typically cannot get attorney’s fees associated with enforcing a contract, unless the contract specifically provides for this stipulation. An attorney, then, may be the best option for providing peace of mind by ensuring your business deals are adequately protected.