To compete or not to compete: A roadmap for understanding a complicated covenant

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To compete or not to compete: A roadmap for understanding a complicated covenant

30 Nov 2021

Charlie Rosebrough

Charlie Rosebrough is an associate with Shook, Hardy & Bacon LLP in Kansas City, MO. His practice includes business litigation, class action and complex litigation, employment litigation, and policy litigation. Rosebrough handles matters at all stages from initial client counseling to preparation for appeal. He’s a graduate of the St. Louis University School of Law

KANSAS CITY, MO — “Well, it’s a free economy.” That’s what people without technical know-how might say about covenants not to compete.

Then again, those people may be the ones with a finger on the pulse as the national appetite for these types of covenants is fading. Some states, including Oklahoma, North Dakota and California, now have legislation limiting their enforcement, and President Biden’s administration has recently urged the Federal Trade Commission to ban or limit them.

With all this added attention, corporate employers, especially those in the food industry, are left wondering: What is the future of covenants not to compete?

First, it’s crucial to understand that this is an umbrella term. It refers to a set of contract clauses, executed between an employer and an employee, which limits the employee’s ability to work with a competitor after their current role ends.

In detail, there are three common clauses that find their way into covenants not to compete: non-competition clauses, non-solicitation clauses and trade secrets/confidentiality clauses.

A non-competition clause prevents an employee from accepting a job with a competing company. The clause may look something like this: Employee expressly agrees and covenants not to compete directly or indirectly with Employer within a 500-mile radius of any of Employer’s marketing outlets either during the term of Employee’s employment or for a period of five years thereafter.

These clauses are aimed at preventing ex-employees from participating in the industry for a period of time following their employment.

A non-solicitation clause allows an employee to remain active in the industry but prevents him or her from soliciting employees, past customers, vendors or referral sources. It may look like this: During the term of your employment, and for a period of one (1) year immediately thereafter, you agree not to solicit or contact any employee or independent contractor of the Company on behalf of another business.

Generally, employers use these provisions for employees in sales positions or executive-level employees with strong customer relationships.

Provisions addressing trade secrets and confidential information are most common and frequently find their way into standard severance agreements. Here’s an example: Upon termination with the Company, all papers, documents, customer lists, and similar items containing Confidential and Proprietary Information, including copies thereof, shall be returned to the Company.

These clauses protect employers from sensitive documents hopping from one company to another.

In addition to contract provisions that prevent the disclosure of trade secrets, all states contain statutory protections forbidding employees from taking or divulging trade secrets to new employers.

But are they enforceable?

A covenant not to compete is reasonable if it has reasonable time restrictions, reasonable geographic restrictions and if it protects a legitimate business interest.

You may have heard someone say, “You signed a covenant not to compete? Don’t worry, those aren’t enforceable.” To some extent, that’s true. The problem is, one vague exception swallows the rule: Covenants not to compete are enforceable so long as they are reasonable. So, what makes one reasonable?

A covenant not to compete is reasonable if it has reasonable time restrictions, reasonable geographic restrictions and if it protects a legitimate business interest.

A reasonable time restriction refers to how long the covenant not to compete remains in effect. While there is no predetermined number of years that a court will find reasonable, typically anything from one to three years will be enforced.

A reasonable geographic restriction refers to the locale in which the employee cannot compete or solicit. Some covenants not to compete contain no geographic restriction and may be enforced across the country. Others may be enforced only in the employer’s county or city. There is no default reasonable geographic restriction; instead, courts will look at the interest needing protection and attempt to correlate that with the appropriate area.

A legitimate business interest is what the employer would like to be protected. The most common interest is the employer’s relationships with its customers. Courts usually determine an employer that invested time and money in its employees’ customer relationships can protect those relationships by preventing the employee from capitalizing on them with a new company.

When these factors are combined, courts frequently enforce these types of restrictions. And covenants not to compete are particularly important in the baking industry because they are used to protect formulations, designs, promotional strategies, customer relationships and targeted bids — a company’s “bread and butter.” For that reason, employers and employees should take extra caution to ensure compliance.

On the employee side, it is important to understand the contents of the contract and the information to which the employee has access. Every employee contract varies, whether it’s the type of covenant not to compete (non-compete vs. non-solicitation) or in the length and location of enforceability.

For that reason, the first thing each employee should check is the precise language of the agreement. Second, employees should “know what they know.” Courts have held that knowledge such as how the company produces certain products, formulas and designs for certain muffins, and cost positions are all considered trade secrets, which may be protected.

On the employer side, enforceability is key. An employer should review what types of restrictions are commonly enforced in his or her venue and review the type of information that constitutes trade secrets or a legitimate business interest. Frequently, courts will enforce covenants not to compete that apply to competitors dealing in the same market.

The landscape of competition in the commercial baking industry is becoming increasingly complicated, especially in this era of mergers and acquisitions. Understanding covenants not to compete — and their enforceability — is more important than ever for creating a collaborative, innovative environment.

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