Articles Posted in Covenants not to Compete / Non-Compete Agreements

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A free market requires a free labor market, and yet many of the politicians who claim a free market as a central component of our democracy actively work against the formation and maintenance of a free labor market.

A free labor market means workers are free to work for the companies they want to work for, doing the kind of work they want to do, but many companies have been using things like non-compete agreements and anti-poaching restrictions to keep workers from leaving to work for competitors.

The problem with such restrictions is that a labor market in which employees have more options is a more competitive labor market. When employees have the option to leave to work for another company that’s offering them more money, they have the opportunity to either leave their current employer in favor of higher wages or to stay and negotiate higher wages with their current employer. More freedom means more bargaining power, but companies have been actively working to restrict that freedom – and by extension, that bargaining power.

Anti-poaching restrictions have become the latest method companies have used to try to keep employees right where they want them. Fast food restaurants, in particular, have been using anti-poaching clauses in their contracts with franchisees in order to make sure franchisees don’t poach employees from each other. Such clauses usually forbid franchisees from hiring applicants who are current or recent employees of the parent company or any of its other franchisees without the express permission of the current or previous employer. Continue reading

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While it’s always a good idea to put agreements in writing, taking that step isn’t always enough to guarantee that everyone involved will continue to abide by the terms of the contract, even if they all sign their names to it. When one or more parties violates the agreed-upon terms, you can sue them for breach of contract and get the court to issue an injunction requiring them to abide by the terms of the contract, but sometimes even that isn’t enough. Below are just a few examples of what can happen when people insisted on having it their own way.

A Salesman’s Gotta Sell

John Osborne worked as a salesman selling business forms for Uarco, Inc. The employment agreement he signed with the company included a non-compete clause that said Osborne would not sell business forms for any of Uarco’s competitors. After Osborne’s employment with Uarco ended, he went to work selling similar business forms for one of Uarco’s competitors. Uarco sued him for breach of contract and succeeded in obtaining an injunction from the court that, in part, forbade Osborne from reaching out to certain customers of Uarco for a period of two years. But the injunction had a loophole that let Osborne sell to a customer of Uarco if the customer expressed a desire to purchase business forms in an open bid situation (meaning different vendors submit a request for proposal and the customer goes with the lowest price).

Uarco then accused Osborne of being in contempt of court by violating the injunction when he contacted Uarco customers. When the court looked into the accusations, it found that Osborne had violated the terms of the injunction more than 100 times. Osborne admitted to contempt on two counts but claimed the rest of the customers did not fall within the limitations of the court’s injunction against him. The court disagreed and imposed further injunctions of an additional 190 days against him, as well as monetary sanctions.

Osborne appealed that decision and the case went before the Supreme Court of Kansas, which upheld the lower court’s ruling of the extended injunction and also awarded Uarco almost $10,000 to cover their legal costs in filing the lawsuit and arguing their case and an additional $10,000 fine. Continue reading

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Almost everyone who has signed an employment agreement in the United States has most likely signed a noncompete agreement. They are agreements included in the contract that state that the employee will not work for a competitor of the employer in the event their employment is terminated for any reason. They usually include a geographical and a time requirement. For example, most such agreements restrict the employee from working for a competitor within five or ten miles of the employer for six months or a year after termination of employment.

Each state has their own laws governing employment contracts and noncompete agreements. California is the strictest and won’t uphold any noncompete agreements at all. Most courts will enforce noncompete agreements, as long as they protect only the employer’s “reasonable” business interests.

Courts recognize that employers have a legitimate business interest in their employees. They devote significant time and resources to training those employees, not to mention the trade secrets and clients those employees have access to. Noncompete agreements are a way for businesses to protect themselves from competitors who might try to poach employees, but courts will often refuse to enforce a noncompete agreement if the judge thinks it’s too restrictive. Continue reading

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As this blog has discussed, non-compete agreements have become increasingly prevalent in recent years. However, they have also grown in severity in some companies, such that they frequently impose undue hardship on an employee’s search for future employment. As a result, courts in some states have grown increasingly unfavorable towards non-compete agreements. California courts, for example, are hard pressed to enforce any non-compete agreements.

If an employee breaches a non-compete agreement, the former employer can take the employee to court for breach of contract, but these lawsuits can be long and costly. While employees often rely on the allegation that the non-compete agreement imposed undue hardship, many courts rely on a three-pronged system to determine the validity of a non-compete agreement, of which undue hardship is only one consideration.

Completing the test of validity therefore requires the court to consider all the facts of the case. This can lead to very lengthy discovery, making the lawsuit even more costly. After all that, there is never a guarantee that a court will rule in the company’s favor, and even if they do, a customer lost is unlikely to come back.

For these reasons, alternatives to non-compete agreements have been proposed, although they still have yet to achieve the same popularity in American businesses. The first alternative is garden leave contracts. In these agreements, the employee agrees to give the employer notice of a certain amount of time before leaving the company. This is what is known as the garden leave period, but the employer continues the pay the employee a salary during this period. Garden leave contracts have two advantages over non-compete agreements:

1) If an employee fails to abide by the agreement it would not only prove breach of contract but also break the common law of duty of loyalty. In this case, an employer would not only be able to collect on salary paid during this period, but might be able to recover punitive damages as well.

2) It undercuts one of the main defenses that employees use when they breach their non-compete agreements: undue hardship. When an employee is still receiving a salary, undue hardship becomes significantly more difficult to prove.

As with non-compete agreements, the length of the garden leave period must be reasonable. Also, while it might be tempting for employers to reduce garden leave pay to a percentage of the employee’s normal salary, such a reduction risks inviting a court to apply higher scrutiny to the clause, which leads to the possibility of the court dismissing the agreement as invalid.

Another option is to replace the non-compete agreement with a safety net payment. Safety net payments are similar to garden leave agreements with the main difference of applying after the employee and employer have broken off all relations with one another. Once payment is made, the employee agrees to refrain from certain competitive actions, such as contacting specified customers. In this case, the safety net payment does the same thing as the garden leave payment does as far as ensuring that an employee cannot claim that the contract imposes undue hardship in their search for new employment.

Some companies have chosen to make payments like this staggered over a certain period of time, such as six months or one year. If the employee breaches the contract, the employer can then stop future installments of the safety net pay. However, employers must be careful to specify in the contract that a breach on the part of the employee will result in termination of all future payments. Otherwise, the cessation of installments could result in the employer getting taken to court for breach of contract.

The third and final alternative to non-compete agreements is client purchase agreements. These agreements do not expressly prohibit competition, but they do enact punishment in the event that the competition happens. In these arrangements, an employee agrees to pay the employer if she chooses to participate in certain competitive behaviors, such as by working with specified customers.

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As the popularity of covenants not to compete increases, the competitive practices which are prohibited by those agreements also seem to grow. However, there are laws in place which ensure that covenants not to compete that are deemed too stringent cannot be upheld in a court of law. One of the most common limitations on covenants not to compete is the one which states that the agreement must be broad enough only to cover the company’s legitimate business interests and no more.

Another very common limitation that courts consider is whether or not the agreement poses undue hardship on an employee. When cases of disputed covenants not to compete reach a court, it is the court’s duty to balance the needs of the business to protect their legitimate business interests with the needs of the employee to find work. If a covenant not to compete is too broad, it may make it inordinately difficult for an employee to find any work at all after her employment with the company comes to an end.

One such case in which a court found that the covenant not to compete was overly broad is the case of Orca Communications Unlimited LLC v. Ann J. Noder et al. In this case, Orca Communications, a public relations firm located in Arizona, hired Noder to be its President. Prior to taking this job, Noder had had no experience with public relations. She learned everything about the business while working for Orca.

Noder signed a Confidentiality, Customer and Employee Non-Solicitation, and Non-Competition Agreement which prevented her from advertising, or soliciting or providing conflicting services for any company which competes with Orca. After Noder left Orca to start her own public relations firm, Orca sued her for breach of contract.

The Agreement further prevented Noder from convincing any former or current or prospective customer of Orca to end its relationship with Orca. This was one of the main areas of Agreement with which the court took issue. To prevent Noder from enticing away from Orca a current Orca customer is to protect Orca’s legitimate business interests. However, to prevent Noder from doing so with companies which have never had any business dealings with Orca, the court found to be overly broad and imposed undue hardship on Noder in her efforts to find gainful employment after her time at Orca.
The Agreement also contained a confidentiality provision which prohibited Noder from using or disclosing any of Orca’s confidential information without Orca’s consent. “Confidential Information” was defined as knowledge or information which is not generally known to the public or to the public relations industry or was “readily accessible to the public in a written publication.” However, the Agreement did cover information which was only available through “substantial searching of published literature” or that had been “pieced together” from a number of different publications and sources.

This provision of the Agreement the court also found to be too broad. To protect company trade secrets is well within the limitations of protecting a company’s legitimate business interests. However, even if one has to conduct substantial research to gain knowledge, that knowledge is still considered to be in the public domain and therefore cannot be covered under a confidentiality agreement.

The trial court found that the Agreement was overly broad and dismissed the case. Orca appealed and the Arizona Court of Appeals upheld the ruling of the lower court and dismissed the case.

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