June 3, 2013
by: Arend J. Abel, Attorney
Business owners invest a great deal of time and money in developing customer relationships. That investment can be placed at risk when key employees who have been servicing customers leave to work elsewhere. The valuable relationships they have built can easily be leveraged to move customers to the competition unless the business owner take appropriate measures to protect the business.
Similarly, a person buying an existing business is investing money to acquire the customer lists and relationships as well as inventory and product. Buyers can be placing their investment at risk if they allow the seller to remain free to re-start the business and compete for the seller’s former customers.
So how can business owners or buyers protect themselves?
The law has developed two types of contractual provisions designed to protect business owners and buyers from the above risks:
1. Agreements not to compete, and
2. Agreements not to solicit particular customers
These provisions are sometimes referred to as “covenants” not to compete and not to solicit, or sometimes just as “non-competes” and “non-solicitation” provisions. A business owner should give careful consideration to these types of provisions anytime a new key employee is hired, particularly one with customer relationship responsibilities. It is also possible to have existing employees sign non-compete or non-solicitation provisions as a condition of continued employment.
Non-competes and non-solicitation agreements can also be signed when a business is purchased. These agreements can restrict former business owners from re-starting the business and competing for their former customers.
Courts have imposed strict limitations on non-compete and non-solicitation agreements allowing provisions to the extent that they protect a legitimate interest of the party who benefits from the covenant. However, the agreement must also be reasonable in terms of (1.) geographic scope, (2.) time, and (3.) activities restricted.
For example, if a business operates only in a particular county, a court might find that a provision barring an employee from competing in the entire state is unreasonable. Similarly, a court could find that a five-year restriction barring an employee from competing is too long. Likewise, if an employee worked only in a particular part of the business where he had customer contact, a court could reject a restriction preventing the employee from working in another capacity in a competing business. In any of these circumstances, the court could hold that the non-compete or non-solicitation is unenforceable.
Typically courts will more readily enforce restrictions connected with the purchase or sale of a business, on the theory that the seller of the business received a substantial benefit in exchange for the restriction. Without the restriction, courts reason, the buyer of the business could be deprived of the benefits of the purchase transaction–namely that sellers will use their relationships to re-start the business and compete directly with their former company putting the new owner’s investment at risk. Thus, courts are likely to tolerate longer term and more comprehensive restrictions.
Courts are also more likely to enforce restrictions that prohibit former employees from soliciting customers with whom they had contact during their employment.
Depending on how the restrictions are written, courts can strike down some portions and enforce others. For example, a court might strike down an overly broad restriction on competition, but uphold a restriction against soliciting customers with whom an employee had contact while working with an employer. Similarly, if multiple geographic areas, such as counties, are separately stated, a court may find that a restriction against competition is valid in some counties but not others.
Business owners should carefully consider what type of restrictions may be necessary in a non-compete or non-solicitation agreement to protect their legitimate business interests without being too broad in scope. It is important to hire an attorney skilled in drafting non-compete and non-solicitation provisions to ensure that, if some portions of the covenant are struck down, other provisions that protect the business interests can be upheld. Likewise, if non-compete and non-solicitation provisions are breached by a seller or departing employee, a business owner should be sure to engage an attorney who is skilled at litigating such provisions.
The last thing a business owner wants is to find out that a contract the owner thought provided protection is completely invalid, leaving ex-employees or sellers of the business free to compete for valuable customers.
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