Protection of a company's competitive advantage is vital. Therefore, it is necessary that employers understand the options available when evaluating how best to protect their company. One common practice is the non-compete agreement. The following article updates a prior analysis of non-compete agreements in Ohio.
Generally, a non-compete agreement is a contract between an employer and employee where the employee agrees not to compete with the employer after termination of the employment relationship. Be careful, though, not all states permit non-compete agreements, and those that do recognize varying levels of protection to employers. Indeed, in 2016, the White House made a "call to action" for states to reform their restrictive covenant laws. Several states across the country did just that by proposing and passing laws that provide more protection to employees by limiting, or outright banning, certain non-compete agreements. (A list of some of the states that have passed new laws or that have introduced new legislation can be found at the conclusion of this article.) Ohio, however, remains a state that recognizes that non-compete agreements with employees or independent contractors is a valid and enforceable means for employers to protect their economic interests – but, the agreement must be reasonable.
What constitutes a "reasonable" non-compete agreement?
In Ohio, a non-compete agreement is reasonable if the agreement: (1) is no greater than is required for the employer's protection of a legitimate interest; (2) does not impose undue hardship on the employee, and (3) is not injurious to the public. AK Steel Corp. v. ArcelorMittal USA, LLC, 2016-Ohio-3285, 55 N.E.3d 1152, ¶ 11 (12th Dist.) (relying on Raimonde v. Van Vlerah, 42 Ohio St.2d 21, 325 N.E.2d 544 (1975), paragraph two of the Syllabus).
In 1975, the Ohio Supreme Court set forth several factors for examining the reasonableness of a non-compete agreement and those remain the guiding factors today. Raimonde, 42 Ohio St.2d at 25. The factors include the length of time and geographic scope of the restrictive covenant, whether the employee is the sole contact with the customer, whether the skills seeking to be restrained by the agreement were developed during employment, whether an employee came into possession of confidential information or trade secrets during the employment, and whether the covenant seeks to protect against unfair competition as opposed to ordinary competition. Id. No one factor is dispositive. Determining whether a non-compete is reasonable is a highly fact intensive endeavor.
The employer bears the burden of establishing the reasonableness of the agreement. Therefore, be practical when evaluating the scope of restraint to impose on an employee. Consider the legitimate interests that you as an employer may have – are there confidential information, trade secrets, costumer lists, or skills and training acquired during employment? Also, be cognizant of any undue hardship on the employee – although, in Ohio, hardship has to be unduly harsh; not being able to work for a period of time is generally not enough by itself. Finally, consider the sophistication and position of the employee or independent contractor involved. Courts will consider all of these factors. Thus, even if the employee agrees to an overly broad and aggressive non-compete agreement, she may challenge the validity of the agreement later, and a court may find the agreement unenforceable in its entirety.
Trial courts in Ohio have the option to modify an overbroad or unreasonable covenant not to compete, but it is within the court's discretion whether to do so. Rather than risk the court striking down the agreement altogether, or re-writing it so that its worth is severely diminished – particularly in light of the current landscape on non-competition reform throughout the country – put the time in on the front end to consider what exactly needs protection and what is the least restrictive means of affording such protection.
What other terms should be included in a non-compete agreement?
A non-compete agreement can be as simple or involved as necessary to protect the legitimate interests of a business, and how you word the agreement is important. Ohio courts interpret non-compete agreements following ordinary contract interpretation principles, including that any ambiguities will be construed against the drafter. Therefore, you should be careful to use plain and ordinary language when setting forth the specific terms of the non-compete agreement. Typically, even the most straightforward non-compete agreements contain some of the following clauses.
Choice of Law and Forum Selection. A choice of law provision determines which state's law will govern an action seeking to enforce the agreement. A forum selection provision determines the court in which such an action must be brought. In Ohio, these provisions have long been found to be enforceable so long as there is a reasonable basis for the chosen law and forum, they have a substantial relationship to the transaction, and enforcement of the term(s) would not be contrary to a fundamental policy of a state having a greater interest in the case. Schulke Radio Prods., Ltd. v. Midwestern Broadcasting Co., 6 Ohio St.3d 436, 453 N.E.2d 683 (1983), Syllabus.
If, however, the law and forum selected have no substantial relationship to the transaction at issue, then these provisions may not be enforced by the court. For example, California prohibits most non-compete agreements and now it specifically prohibits in employment agreements choice of law and forum selection clauses that call for application of some other state's law. See, California Labor Code § 925. Thus, even if the agreement contained an Ohio choice of law provision, if the relevant acts took place in California and/or substantially affect business in California, then a court is likely to find that California law applies, not Ohio law, because California has a significant interest in the outcome of the case and has a fundamental policy against non-compete agreements. See, e.g., Lifestyle Improvement Centers, LLC v. East Bay Health, LLC, S.D.Ohio No. 2:13-cv-735 (Oct. 7, 2013) (finding that, despite an Ohio choice of law provision, California law applied and the non-compete provision was unenforceable under California law). Other states are similarly voiding choice of law and forum selection clauses in employment agreements, so be sure to keep this in mind, particularly if you have employees working in other states.
Confidentiality. Depending on the nature of the business or employment relationship, the parties may seek to keep the terms of the non-compete agreement confidential. While these types of provisions are fairly straightforward, be careful to allow exceptions necessary to effectuate any term or provision of the agreement, to disclose the agreement to a party's accountant or lawyer for use in connection with providing professional services, and as required by law.
Non-Disparagement. A non-disparagement provision prohibits the parties from bad-mouthing one another. Non-disparagement provisions seem to go hand-in-hand with a non-compete agreement. After all, the overall purpose of the agreement is to protect a company's competitive advantage. What good is it if the employee refrains from working for a competitor if she is bad-mouthing the company all over town? Of course, other laws are available to protect a company's reputation and business interests (e.g., defamation, tortious interference, etc.); however, a non-disparagement clause is a simple way to remind the employee (and employer) to maintain professionalism despite the end of the employment relationship and ensure protection of the company's reputation and competitive advantage.
Opportunity to Review and Consider the Agreement. Even where there is a question whether the employee understood the contents of a non-compete agreement, Ohio law charges the employee with knowledge of the contents of the agreement so long as she read and signed the agreement. Still, given the recent trends in other states that make it a requirement that the employer provide the employee with notice of the non-compete and be given an opportunity to review, it is prudent to include a provision where the parties expressly acknowledge that they have read and understood the agreement, that they have had sufficient time and opportunity to review the agreement, confer with legal counsel if they so desire, and that they fully understand and appreciate the meaning of each of the agreement's terms.
Liquidated Damages. Liquidated damages clauses are not necessarily common practice, but such provisions are worth mentioning here, as they have not been stricken outright in Ohio in the context of a breach of covenant not to compete. Kidney & Hypertension Specialists Chillicothe v. Adena Health Sys., Franklin C.P. No. 12CVH-15862, 2014 Ohio Misc. LEXIS 9317, at *18 (May 6, 2014) (denying summary judgment motion requesting that a liquidated damages provision in a non-compete not be enforced on the basis of unreasonableness). A liquidated damages clause provides that, in the event of a material breach of the agreement, the breaching party is liable for a sum certain, in addition to actual damages and injunctive relief, if so requested. Be careful of these types of provisions – you may be on the receiving end if the provision is mutually applicable to the parties. Careful consideration should be given to whether inclusion of a liquidated damages clause is appropriate.
Severability. A severability clause protects the agreement from complete avoidance should one of the provisions be found invalid. In other words, if any of the provisions of the agreement are rendered invalid by a court, then the parties agree that such a finding will not preclude enforcement of the remainder of the agreement. For example, if a liquidated damages provision was included in the agreement, but the court found it punitive in nature and, therefore, unenforceable, then the remainder of the agreement is still enforceable.
Applicability to Successor and Assigns. Despite the Ohio Supreme Court's decision in Acordia of Ohio, L.L.C. v. Fishel, 133 Ohio St.3d 356, 2012-Ohio-4648, 978 N.E.2d 823 ("Acordia II") (finding that "employee noncompete agreements transfer to the surviving company after a merger has been completed pursuant to R.C. 1701.82(A)(3)" even without the employee's consent), it is still prudent to include specific language in a non-compete agreement regarding its applicability to successors-in-interest. Indeed, if the non-compete agreement is silent as to assignability, some courts will look to whether the agreement employs words that indicate that assignment was contemplated and whether it is necessary to protect the goodwill of the business being sold. See, e.g., Lumenate Techs., LP v. Baker, S.D.Ohio No. 1:14-cv-125, 2015 U.S. Dist. LEXIS 172163, at *40 (Dec. 28, 2015). Additionally, successor businesses should evaluate their non-compete agreements to ensure that they are fully protected. Just because the non-compete may transfer does not mean that the agreement is enforceable. As reiterated in Acordia II, "employees still may challenge the continued validity of the noncompete agreements based on whether the agreements are reasonable and whether the numerous mergers in this case created additional obligations or duties so that the agreements should not be enforced on their original terms." If your business is the successor-in-interest, one option is to require the employees to sign a new non-compete agreement as a condition of their continued at-will employment.
When should I have my employees sign a non-compete agreement?
A frequently asked question is when an employer may ask his employee (or independent contractor) to sign a non-compete agreement. In terms of at-will employees, Ohio courts have found that there is sufficient consideration to support the covenant when it is signed (a) at the outset of the employment relationship (as a condition of employment), and (b) during the employment relationship (as a condition of continued employment or a change in employment terms). In addition, an employer may ask an employee to sign a non-compete agreement after the employee is discharged from employment, but only if sufficient consideration is offered in return. For example, the employer may offer severance in exchange for the employee's agreement not to compete.
A word of caution about severance agreements: if you enter into a severance agreement with an employee who had signed a non-compete agreement at the time of or during employment, be sure that you do not inadvertently render that previously-entered non-compete void. A severance agreement that does not include its own non-compete agreement, or that does not explicitly incorporate by reference a previously entered non-compete agreement (such as one found in the original employment agreement), and that also says that it supersedes all prior agreements has been found to have rendered void and unenforceable the previously entered non-compete. Bortz v. Freedom United States, Summit C.P. No. 2017 06 2566, 2017 Ohio Misc. LEXIS 8036, at *4-5 (Dec. 6, 2017).
If there is any concern regarding competition, then the best practice is to have employees sign a non-compete agreement at the outset of the relationship – either as a stand-alone agreement or as part of the employment contract. The agreement may be revised, supplemented, and amended as the employee changes roles, is promoted, etc. But, again, be careful. An oral extension of a noncompetition agreement may be barred under the statute of frauds if it cannot be performed in a year. Make sure any extension or revision of the agreement is in writing and signed by both parties.
It is also good practice to remind your employees of their agreement not to compete. For example, it may be prudent to have certain employees review and initial the agreement annually. Another option is to incorporate a review and acknowledgement of the agreement into exit interviews. This practice not only reminds the employee of his obligations, but also reiterates to the employee the seriousness of the agreement to the employer.
Non-compete agreements are a useful tool for employers to protect their competitive interests. It is important, though, that these types of agreements are used sensibly. Covenants not to compete are more likely to be enforced if they are narrowly tailored to protect only a company's legitimate, identifiable business interests – not to control a particular industry or prevent former employees from making a living. As this area of the law continues to progress, in Ohio and elsewhere (as shown below in the recent legislation proposed and passed), it is always smart to consult with a lawyer before entering into any restrictive covenant.
Some of the Recent Legislation Proposed or Passed on Non-Compete Agreements in Other States
California: Labor Code § 925 prohibits employers from entering into choice of law and forum selection agreements with employees that require application of some other state's law or litigation outside of the state; the law does not apply to contracts entered into before January 1, 2017, or to those where the employee was represented by counsel.
Idaho: part of I.C. § 44-2701, et. seq. was repealed in 2018; in particular, the statute no longer includes a rebuttable presumption of irreparable harm of loss of key employees; the employer must establish irreparable harm for all former employees in order to obtain injunctive relief for breach of a non-compete agreement.
Illinois: Illinois Freedom to Work Act, 820 ILCS 90/10, makes illegal and void any non-compete agreement with a "low wage worker" (making less than the federal minimum wage or $13 per hour).
Nevada: NRS §§ 613.195 and 613.200 require employers to offer "valuable consideration" in return for a non-compete agreement; they also provide protections for employees who are laid off and for those whose customers choose to follow the employee where the employee did not solicit them).
New Mexico: N.M.S.A. §§ 24 1I-1 and 24 1I-2 prohibit non-compete agreements with physicians and now nurse practitioners; they also now prohibit choice of forum and choice of law clauses in contracts with physicians and nurse practitioners.
Massachusetts: House Bill 4419 (Section 24L, Chapter 149 General Laws) was passed on August 10, 2018, and became effective October 1, 2018; the non-compete law applies to both employees and independent contractors and generally bans non-compete agreements unless, among other things, they are in writing, signed by both the employer and employee, state that the employee has the right to consult with counsel prior to signing, and have a duration of one year or less. The employer must also provide notice of the agreement and if the agreement is signed during employment, it must be supported by independent consideration beyond continued employment. In addition, the law bans non-compete agreements with employees who are non-exempt under the Fair Labor Standards Act and prohibits enforcement where the employee has been laid off or terminated without cause.
New Hampshire: proposed Senate Bill 423 would prohibit non-compete agreements with low wage employees (earning less than $15 per hour or the federal minimum wage). This proposed bill appears to have been killed. The current law in New Hampshire, NH Rev. Stat. § 275.70, requires disclosure of the non-compete agreement to the employee prior to the employee's acceptance of an offer of an employment.
New Jersey: proposed Senate Bill 3518 would impose numerous requirements to make non-compete agreements enforceable, including disclosure of the agreement and its terms in writing before commencement of employment, advisement of the right to obtain counsel, duration not to exceed 12 months, geographical limitation of areas where the employee worked or had material presence for 2 years, limited in scope to the employee's activities, and it cannot contain a choice of law provision.
Pennsylvania: House Bill 1938, Pennsylvania Freedom to Work Act, would ban the use of non-competes and would void forum selection and choice of law agreements with Pennsylvania resident employees.
Vermont: House Bill 556 would prohibit "agreements not to compete or any other agreement that restrains an individual from engaging in the lawful profession, trade, or business."