Asset Protection through Noncompetition Agreements
By Daniel K. Burke
Does your business need covenants not to compete? Consider this scenario. You’ve just received an e-mail from your top salesperson, informing you that she’s leaving the company and going to work for your competitor. As with most businesses, your company’s existing and repeat customers are its lifeblood. As with most businesses, your company relies on its sales representatives to establish, grow and maintain relationships with its customers. If your sales representatives leave, what’s to stop them from taking your customers along with them? What will prevent them from raiding your company’s other employees? What will keep them from using your company’s confidential information against it?
In most situations, the frustrating answer to these questions is: not much. However, you and your company can largely avoid this all-too-common conundrum and instill a measure of certainty with a carefully crafted covenant not to compete.
What is a covenant not to compete? A covenant not to compete—or noncompetition agreement—is a contract between an employer and its employee. It is designed to protect the employer’s business interests by preventing a former employee from utilizing for his own benefit—or for the benefit of a competitor—relationships formed and maintained on behalf of the employer or from information the employee obtained in the course of employment.
There are generally two types of restrictions found in most noncompetition agreements. First, employers may impose geographic restrictions, which prevent the former employee from engaging in competitive activities within certain geographic areas. Second, employers may insist on customer-based restrictions (also known as non-solicitation provisions), which preclude the former employee from engaging in competitive activities with respect to certain of the employer’s customers.
Who should sign noncompetition agreements? Generally, a company should give serious consideration to requiring any employee who is responsible for establishing, maintaining and/or growing customer relationships to sign a covenant not to compete. This certainly includes sales representatives, but it could also include executives, office staff, delivery personnel and many other types of employees. Further, because noncompetition agreements can be coupled with anti-raiding, confidentiality and other important and generally applicable restrictions, it would be prudent to insist that all employees sign covenants not to compete.
What are the requirements for an enforceable covenant not to compete? Under Indiana law, covenants not to compete in the employment setting are considered restraints on trade and are generally disfavored by the courts. However, Indiana courts will enforce noncompetition agreements if they are reasonable, which means that it imposes restrictions that are specific and no greater than necessary to protect the employer’s legitimate business interests.
An employer’s protectable business interests include preservation of relationships with its customers, protection of the business “good will” the company has developed over time and securing confidential information obtained by the employee, e.g., financial, marketing, or customer information. The restrictions contained in a covenant not to compete must be no broader than necessary to protect one or more of these business interests.
An enforceable covenant not to compete must be clear and impose no greater restrictions than necessary to protect the employer’s business interests. Geographic restrictions generally must be limited to those areas in which the former employee did business on behalf of the employer or within a reasonable distance from the employer’s primary place of business. Customer-based restrictions generally only apply to current customers and may need to be limited to those customers with whom the former employee had regular contact or from whom he or she learned confidential information during his or her term of employment.
An enforceable noncompetition agreement must be for a reasonably limited duration. The determination of whether or not the duration is reasonable depends on the facts of each particular case. Although not in all cases, courts generally enforce restrictions lasting for two years or less. In some circumstances, much longer restrictions may be enforceable.
An enforceable covenant not to compete agreement must be reasonable with respect to the scope of activity restricted and cannot restrict a former employee from working for a competitor in any capacity. In other words, the agreement cannot restrict activity beyond the scope of the former employee’s employment. For example, a sales representative cannot be restricted from working for a competitor as a janitor or in some other capacity that would not encroach on the former employer’s business interests.
Contact Hoover Hull LLP today to learn more about our employment law or business litigation practice, or to discuss any questions you may have about whether your company should have a noncompetition agreement or whether your company’s existing noncompetition agreement provides adequate protection of its business interests.
This article was first published in the Spring 2011 issue of the Hoover Hull LLP newsletter.