Covenants Not to Compete May Not Have the Bite You Think They Do
A covenant not to compete (or “non-compete agreement”) is an agreement not to compete with a former business partner, employer, customer, vendor or any other party with whom you have a current business relationship. The purpose of a covenant not to compete is to ensure that the party with whom you are doing business does not use information, access or even experience he or she gained as a result of your business relationship to compete against you in the marketplace. A covenant not to compete is a form of “restrictive covenant.” There are several other types of restrictive covenants that are often used in lieu of or in addition to a non-compete agreement, including covenants prohibiting solicitation of employees, covenants prohibiting solicitation of current and/or former customers, and confidentiality agreements. A well-drafted employment or consulting agreement typically includes all of these types of covenants.
Covenants not to compete typically last for the duration of the contract between the parties, plus a period of time after termination of the agreement. Thus, the covenant not to compete typically “survives” termination of the underlying business arrangement. Without such a “tail” on the covenant, the covenant would have no bite – an employee could jump ship and go to work for a competitor the day after leaving his employment. Including a “tail” makes it more difficult for an employee to leave and compete against his former employer because he would have to wait for a certain period of time before engaging in competing activities. These types of “tails” are also typically used in invention disclosure and intellectual property assignment clauses, to prevent employees from conceiving of an idea during their employment but waiting to reduce it to practice until they leave. Without such a “tail,” an employee could conceive of an invention related to the employer’s business, intentionally fail to disclose it, voluntarily resign, and then reduce the invention to practice the next day. The “tail” makes it more difficult for employees to circumvent these types of intellectual property disclosure and assignment clauses because they have to wait for the full “tail” period before reducing the invention to practice if they want to avoid assignment of their patent rights to their former employers.
The enforceability of “tails” and similar restraints in the context of covenants not to compete depends on state law. Employment and consulting agreements typically stipulate that a certain state’s law will apply, which helps the parties in anticipating whether and to what extent a non-compete agreement will be enforced.
In California, for example, covenants not to compete are generally unenforceable unless they are in the context of a Share Purchase Agreement or the dissolution of a partnership. See Bosley Medical Group v. Abramson, 161 Cal. App. 3d 284 (1984). Although not as strict as California courts in interpreting covenants not to compete, the Washington Supreme Court late last year made it more difficult for non-compete agreements to be enforced under Washington law. Specifically, the court held where an employer seeks to have an existing employee sign a covenant not to compete, the agreement must be supported by sufficient “independent” consideration. Examples of independent consideration include increased wages, a promotion, a bonus and a fixed term of employment. Labriola v. Pollard Group, Inc., 152 Wash. 2d 828 (2004).
Montana recently joined the ranks of those states in which it is becoming increasingly difficult to enforce a covenant not to compete. In Montana Mountain Prods. v. Curl, 112 P.3d 979 (Mont. 2005), reh’g denied, 2005 Mont. LEXIS 231 (June 7, 2005), the Montana Supreme Court held that a covenant not to compete was not reasonable (and was, therefore, unenforceable) because it precluded the employee from pursuing her trade within a 250-mile radius of where she lived. Curl’s work involved finishing watchbands and luggage tags for Montana Silversmiths. There were only two companies who provided this service to Montana Silversmiths. One of these companies was located in Columbus, Montana, where Montana Silversmiths was located, and the other was located in Absarokee, Montana, which is between 10 and 15 miles from Columbus. According to the court, Curl’s professional skills were apparently so narrow that the only type of job for which she was qualified was finishing products for Montana Silversmiths. A more expansive interpretation of the “pursuit of trade” might have allowed for other, similar types of skilled labor. The court’s narrow interpretation of the “pursuit of trade” to mean the particular job in which the employee works makes it almost impossible to enforce a covenant not to compete under any circumstances.
While it still makes sense to include an adequately circumscribed covenant not to compete in an employment agreement, the best way to protect yourself from competition by your employees is to treat them fairly and generate loyalty through incentives and acknowledgment. In theory at least, covenants not to compete are still enforceable under Montana law if they are restricted with respect to time or place, based on sufficient consideration, and reasonable, i.e., not so large in scope that they interfere with the interests of the public.