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Covenants Not to Compete

What Is a Covenant not to Compete?

Generally by signing a covenant not to compete, an employee agrees that if she leaves the employer, she will not go to work for the employer's direct competitors. The employee will sometimes receive compensation for signing the agreement. Covenants not to compete are also known as “non-compete clauses.”

Businesses that typically use Covenants not to Compete include those dealing with:

  • Highly confidential materials
  • Client demographic/information databases which an employee can access
  • Businesses with a direct competitor
  • Trade secrets
  • Trademarks and copyrights

Typical Restrictions in a Covenant not to Compete agreement may relate to:

  • Time – After the employee leaves the former employer, the employee must refrain from working for the competitor for a certain period of time
  • Type of business – Working in certain industries and businesses, related to that of the employer, may be prohibited
  • Location – The employee may not be able to work for a competitor within a specified geographic location

Are Covenants Not to Compete Enforceable?

It is difficult to determine whether a judge will enforce a non-competition agreement. While the secrets of an employer are valuable, the legal system also places value on an individual's freedom to pursue other employment. To be enforceable Courts usually require that a covenant not to compete be reasonable.

A convent not to compete will be considered unreasonable (i.e. not enforceable) when: 

  • It lasts for too long. Depending on the trade of the employer, a court will determine how much time is appropriate.
  • The geographic area it covers is too large.
  • The types of business it covers are too far-reaching. The covenant usually prohibits employment in companies related to the employer's industry.
  • The employer does not have a legitimate business interest in enforcing the covenant not to compete.

New York Law on Covenants Not to Compete

Covenants not to compete are written agreements signed by employees at their employer's request, before or after they are hired, which may limit the employee's ability to take certain types of jobs in the future. These covenants are also referred to as non-compete clauses (included in larger employment contracts), non-competition agreements, and restrictive covenants.

More specifically, the covenants not to compete may keep employees who have quit or been terminated from taking jobs with competing businesses. The idea behind the covenants is that employees gain knowledge of the company they work for, and, upon leaving that company, their employer has an interest in keeping that employee from working for a competitor and using the knowledge they gained about their former company, which could put that company at a disadvantage.

The type of information they might be privy to while working at a company includes: business models, manufacturing processes, methods used in marketing and advertising, details about specific products, and lists of clients or customers along with their contact information.

Covenants not to compete attempt to restrict employees from working for competitor companies, often companies within a certain geographic area that is close to the employer they signed the covenant with. The covenants also typically restrict employees for a certain number of years.

Is there a Public Policy Against Covenants Not to Compete?

Covenants not to compete have been around for hundred of years, but they have often been rejected in whole or in part by the courts. Public policy favors economic freedom and an employee's right to earn their livelihood, and discourages restraint of trade. This public policy certainly holds true in New York today.

Although New York has no statute making covenants not to compete illegal, judges may decide for themselves, based on certain generally accepted criteria, whether a covenant that is brought to court should be struck down.

Are Covenants Not to Compete Legal in New York?

Yes, an employer can require you to sign a covenant not to compete as a condition of employment. However, not all covenants are enforceable. They must be narrowly tailored so that they are not unreasonable. In general, the language of the covenant must meet the following criteria:

  1. The employer is protecting a legitimate interest;
  2. The covenant does not create undue hardship for the employee;
  3. The covenant isn't harmful to the public interest (public policy); and
  4. The covenant is reasonable in the time period for which it restricts the employee, and in the geographic area it restricts.

Covenants that fail to meet the requirements may be struck down by a court. Of course, once the agreement is signed, and employee must take it to court in order to have it (potentially) struck down, which can be burdensome in itself.

Sometimes, a covenant not to compete may be struck down only in part. For instance, the time and geographic area may be unreasonable, if the employer attempts to restrict the employee from working for a competitor across the country, or for a period of 20 years. In those types of cases, a judge may decide that the covenant may stand, but the time/geographic restriction must be modified so it is not as restrictive or burdensome. This is referred to in New York as the “blue pencil rule.”

Overall the court tries to balance the interests of the employer against the interests of the employee, and attempts to preserve the employer's interests without causing undue hardship to the employee.

How Do You Draft a Covenant Not to Compete?

Employers in New York should exercise caution when drafting covenants not to compete. They should be very specific about the type of proprietary information they seek to protect. They should be short and to the point and clear in meaning, and not meant to confuse the employees who read them.

They should also, as mentioned above, be reasonable in the geographic area and time period in which they restrict their employee's ability to seek work in the future. New York has been forward-thinking in its public policy interest in allowing employees to seek their own livelihood and is now less likely to uphold overly restrictive covenants.

It is also unlikely that a court will enforce a covenant not to compete for an employee who works in a lower-level position, as opposed to someone in a higher-level position with more access to proprietary information.

Am I Required to Sign a Covenant Not to Compete?

As mentioned above, an employer may require you to sign a covenant not to compete. However, it is very important to be aware of any covenants you sign. Sometimes they are buried in an employment contract, and you may not take much notice.

Upon leaving that employer, you may later find that the covenant is overly restrictive and makes it difficult to find a new job. In that case, you would likely have to take the matter to court in order to get relief.

Covenant Not to Compete in Franchise Agreements

In a business franchise, one party allows another to use their company's marketing techniques, materials, and logos in order to start another branch of the company. The most common example of this would be fast-food chains and retail department stores. The head company is called the franchisor, while the party starting the new branch is called the franchisee. The franchisee purchases rights to use the material and business processes from the franchisor.

Business franchise opportunities are considered to be a straight-forward way in which to start business, because the business owner simply must follow the guidelines provided by the franchisor. However, various franchise disputes can still arise, such as:

  • Trademark or copyright violations, such as using the franchise logo for personal use;
  • Unauthorized disclosure of trade secrets;
  • Failure to follow company policies;
  • False advertising or unfair business marketing practices; and
  • Breach of business contracts, which will be further discussed below.

Most franchise disputes involve the franchisee failing to adhere to the guidelines and intentions of the franchising company. However, some cases may involve other types of violations, such as when the franchisee is suing the franchisor because they refuse to provide them with promised payments or benefits.

A franchise agreement is the contract which establishes the relationship, rights, and obligations of the franchisor and franchisee. Generally speaking, the franchise agreement provides the following information:

  • The franchise fee;
  • Restrictions placed on the business management structure of the franchisee;
  • The cost of inventory;
  • The income that the franchisor requires, as well as their payment schedule;
  • Length of the agreement; and
  • A termination clause, such as how some franchisors require that if your franchise does not make a specified income, the franchise will be terminated.

A franchise agreement may also be associated with a distribution agreement. A distribution agreement is a contract between suppliers and distributors of a product, also referred to as distributor agreements. They may involve other parties as well, such as manufacturers. A distribution agreement allows a distributor the rights to sell and market a supplier's products.

Distribution agreements between suppliers and distributors vary greatly based on the needs and goals of each specific distributor and supplier partnership. Generally speaking, such agreements focus on the supply and distribution of a specific product.

In many cases, distribution agreements may also be classified as exclusive dealing contracts. What this means is that the supplier and the distributor agree to work only with one another, and as such will not work with any other parties. Depending on the specific business goals of the parties involved, this could be the more desirable outcome compared to others.

Is A Covenant Not To Compete Enforceable In A Franchise Agreement?

The enforceability of a non-competition covenant in a franchise agreement largely depends on whether the court views a franchise contract as a sale of business, or an employment relationship. Most courts determine that it is closer to a sale of a business, because no side has a significantly stronger bargaining position, and therefore they will allow more significant restrictions associated with covenants not to compete.

In other cases, the courts will only determine if the agreement is reasonable based on its terms and the interests of the parties, as was previously mentioned. Additionally, some states have statutes that impact the enforceability of agreements not to compete.

In terms of potential legal penalties, distributor agreements are subject to contract laws. As such, a violation of a distributor agreement is generally addressed under breach of contract laws. Legal remedies may refer to monetary award damages, such as:

Equitable remedies are issued by a court when a legal remedy will not sufficiently remedy the damage that was done. An example of this would be remedies such as specific performance, reformation, or rescission.

Other examples of damages could include:

  • Expectation;
  • Reliance;
  • Consequential;
  • Punitive damages;
  • Contract rescission, which is the cancellation of the contract; and/or
  • Contract reformation, which is the re-writing of a portion of the contract in order to reflect the parties' specific needs.

Which type of remedy that will be prescribed by the court will largely depend on the type of violation involved. An example of this would be how monetary damages are only available for specific types of contract breaches, while rescission may only be prescribed for other types of breaches.

How Can A Lawyer Help Me With My Issues on Covenants Not To Compete?

The rules which govern covenants not to compete can be especially complex and difficult to understand. It is imperative when writing a covenant to ensure that it is something that a court will enforce.

Before signing anything that may restrict your future employment access, it is wise to have an attorney review the document. An attorney can also help draft a covenant not to compete, or negotiate the terms of such a covenant. An experienced business lawyer can advise you on whether you can sue an employee for breaching a covenant not to compete, or whether you can go work for a competitor.