Articles

Eric Johnson

Enforceability of Noncompete Agreements

Limitations Every Employer Should Know:

 

A “noncompete” agreement is a contractual provision in which an employee agrees not to compete with his or her employer or work for a competitor after termination of the employment relationship.  Such an agreement may be part of an initial employment contract or a severance contract, or it may be its own separate agreement entered during the course of employment.  Minnesota courts have generally restricted enforcement of noncompete agreements, but may be expanding the limits of such agreements in certain circumstances.  Employers seeking to enforce or avoid noncompete agreements should be aware of such limitations.

 

Noncompete agreements are traditionally disfavored for two reasons: (1) the policy that an employee should be free to sell his or her own labor at will; and (2) the public interest in unimpeded trade.  Courts recognize that because an employer typically has an economic advantage over an employee, the employee may feel forced to give up the right to work in the field in which the employee is most qualified.  Thus, restrictive language in noncompete agreements is construed narrowly and against the employer that drafted the agreement.

 

The main consideration in determining whether a noncompete agreement is enforceable is whether the agreement reasonably balances the employer’s legitimate business interests with the employee’s freedom to choose his or her employment.  Interests that justify enforcement of noncompetes include protecting the employer’s overall business and good will and guarding the employer’s confidential information such as trade secrets and customer lists.  But, a court will not enforce a noncompete that unreasonably restricts a former employee’s ability earn a living.  The well-recognized test in Minnesota for the “reasonableness” of a noncompete agreement considers three factors: (1) the nature and character of the employment relationship; (2) the time restriction; and (3) the geographic restriction.

 

Under the “nature and character of the employment” factor, courts examine the level of access the employee had to the employer’s existing trade secrets, business strategies, and customers.  In one case, the Minnesota Supreme Court enforced a noncompete agreement against a 13-year employee who had access to his former employer’s clients and secrets and attempted to open a directly competing business.  But, in other cases, courts have not enforced noncompetes against lower-level employees who had limited knowledge of their former employers’ confidential information.

 

Time and geographic restrictions are generally enforced only the extent they are necessary to protect the employer’s legitimate business interests.  Thus, whether a restriction is “reasonable” will often vary based on the employer.  In one decision, the Minnesota Supreme Court described a reasonable time restriction as either “the length of time necessary to obliterate the identification between the employer and employee in the minds of the employer’s customers, [or] the length of time for an employee’s replacement to obtain licenses and learn the fundamental of the business.”  The court concluded that a one-year restriction would be reasonable in either scenario.  In another case, the court enforced a noncompete agreement under which the employer sought to prevent a former employee from selling competing products for two years in the geographic regions in which the employee had sold for the employer and another previous employer.  Although courts will not automatically invalidate noncompete agreements that lack a geographic limitation (and thus apply everywhere), the breadth of such a restriction will likely draw closer scrutiny.

 

One other factor affecting enforceability is whether or not the noncompete agreement is supported by consideration—that is, whether the employee gains anything in exchange for the promise not to compete.  When a noncompete agreement is part of the initial employment contract, no consideration is required beyond the offer of employment.  But, when a noncompete is signed during the period of employment, something more than continued employment, such as promotion, greater responsibility, or increased job security, is necessary in most cases.  Once consideration for a noncompete agreement is shown, courts do not evaluate whether the consideration is adequate.  This is because parties are free to enter an agreement based on whatever terms they see fit.

 

When a court determines that a noncompete agreement is unreasonably broad, it may either invalidate it or modify it.  A court will often modify an agreement by removing unreasonable terms and, if necessary, replacing them with terms that balance the employee’s freedom to work with the employer’s right to protect its business.  In one case, an employer sought to enforce a noncompete that prevented former employees from working in the employer’s business for five years within a 50-mile radius of Minneapolis, St. Paul or Duluth.  The court concluded that the restriction was overly broad and modified it to ban only solicitation of the employer’s current clients for one year in Hennepin County.  In another case, in which a noncompete clause was part of a broader employment contract, the court held that the noncompete clause could be severed from the rest of the contract only if the parties intended the contract’s individual provisions to be severable and if the noncompete clause was not an essential part of the contract such that the parties would have agreed to all of the other terms in the absence of the noncompete.  Thus, unless the parties expressly deem the provisions of a contract to be severable from the whole, an unenforceable noncompete clause may jeopardize enforcement of other provisions.

 

Two types of relief are typically available for breach of a noncompete agreement.  First, either an employer or an employee may recover monetary damages for the other party’s breach.  For example, an employee may be entitled to compensation where her former employer enforces a noncompete agreement but refuses to pay an agreed upon amount in exchange for the employee not competing.  On the other hand, an employer may receive a money award when it shows that a former employee has already harmed the employer’s business by breaching a noncompete agreement.

 

The second type of relief is an injunction—i.e., an order prohibiting a party from breaching a noncompete agreement, and is more commonly sought by employers.  An injunction may be either temporary or permanent, and a court will grant one if it finds, after trial, that the noncompete clause is enforceable and that irreparable harm will result unless an injunction is issued.  An employer may also seek a temporary restraining order or preliminary injunction prohibiting a former employee from breaching a noncompete while the trial is pending.  A court will grant preliminary relief if the employer, in addition to showing that it will suffer irreparable harm if the noncompete is not enforced, demonstrates that the balance of several factors, including the likelihood that it will succeed at trial, favors the employer.

 

Former employers and employees are not the only ones who may incur penalties for breaches of noncompete agreements.  In the 1998 case of Kallok v. Medtronic, Inc., the Minnesota Supreme Court held that a new employer may be liable for procuring an employee’s breach of a noncompete entered with a former employer.  The court ruled that a former employer may recover against a new employer if it shows that: (1) a valid noncompete agreement existed; (2) the new employer knew about the noncompete agreement before hiring the employee; (3) the new employer procured the employee’s breach by offering him employment; (4) the new employer failed to take reasonable steps to determine whether the noncompete prevented the employee from accepting the offer of employment; and (5) the former employer incurred financial costs in protecting its rights under the noncompete agreement.  The court in Kallok found that the new employer had unlawfully procured its employee’s breach of a noncompete agreement and awarded the former employer a sum equal to the attorney fees it incurred in enforcing the agreement.  Accordingly, a business hiring a new employee should always, before making the hire, determine whether the employee is subject to a noncompete agreement.  If such an agreement exists, the business should make a thorough investigation of whether hiring the employee would procure a breach of the agreement.  Such an investigation should include seeking an opinion from an attorney.

 

In sum, noncompete agreements are enforceable to the extent they balance the employer’s right to protect its business with the employee’s freedom to work.  Reasonable time and geographic restrictions are permitted, but courts may invalidate wholly unreasonable agreements or modify terms that exceed what is necessary to safeguard the employer’s interests.  Monetary or injunctive relief may be awarded for breaches by either party, including against persons not parties to the agreement who nevertheless procure a breach.  For all of these reasons, employers should, with their attorneys, carefully scrutinize noncompete agreements before making relevant hiring or other employment decisions.

 

By: Eric Johnson

Published in Business North, April 2012.