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.
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. Ohio is among the states that recognize non-compete agreements as 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. American Bldg. Servs. v. Cohen, 78 Ohio App. 3d 29, 33 (Ohio App. 12th Dist. 1992) (relying on Raimonde v. Van Vlerah).
The Ohio Supreme Court set forth several factors for examining the reasonableness of a non-compete agreement. Raimonde v. Van Vlerah, 42 Ohio St. 2d 21 (1975). These 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, and whether an employee came into possession of confidential information or trade secrets during the employment. Id. at 25.
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. 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 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, 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. Typically, however, even the most straightforward non-compete agreements contain some 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.
If, however, the law and forum selected has no substantial relationship to the transaction at issue, then the provisions may not be enforced by the court. For example, California prohibits most non-compete agreements. Despite 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 California law applies, not Ohio law, because California has a significant interest in the outcome of the case. A recent example can be found at Lifestyle Improvement Centers, LLC v. East Bay Health, LLC, Case No. 2:13-cv-735 (S.D. Ohio 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). Click here for a great analysis of Lifestyle Improvement.
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 carful 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 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, 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. While liquidated damages clauses are not necessarily common practice, such provisions are worth mentioning here. 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 (Oct. 11, 2012) (“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)”), it is still prudent to include specific language in a non-compete agreement regarding its applicability to successors-in-interest. Additionally, successor businesses should evaluate their non-compete agreements to ensure that they are fully protected. Just because the non-compete transfers 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 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. Of course, this assumes that no other employment agreement is in place.
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, 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, it is always smart to consult with a lawyer before entering into any restrictive covenant.