Covenants Not to Compete

by Jim Slaughter

Updated from "Anti-Competitive Pacts: When Are They Reasonable" in The Business Weekly of the Greensboro News & Record

Covenants not to compete, or anticompetitive agreements, are contracts that an employee will not compete against an employer following employment. A former employee found violating such a covenant can be order by a court to pay damages as well as to stop the competing enterprise. Early English law prohibited such agreements as against public policy. In those days, individuals were apprenticed to certain trades and could only work in the field of their apprenticeship. To restrain a person from fully practicing in his profession could prevent the person from making a living. As a result, covenants not to compete were unenforceable for several centuries.

Many states, such as North Carolina, now enforce covenants not to compete in certain situations. The operative question now is not whether there is a restraint of trade, but whether the restraint is reasonable under the circumstances.

The examples that follow reveal some of the specifics of covenants not to compete.

(1) When John was hired, he agreed orally not to compete against his employer for a period of one year if he left the company. John leaves the company several years later.  Is the contract not to compete enforceable?

No. Covenants not to compete must be in writing. The North Carolina statute governing anticompetitive agreements provides that no contract "limiting the right of any person to do business anywhere in the State of North Carolina shall be enforceable unless such agreement is in writing duly signed by the party who agrees not to enter into any such business within such territory." In other words, the employee must have signed the agreement, but the employer is not required to have signed.

(2) Two months after joining his new firm, John's employer asks him to sign a covenant not to compete if he leaves the company. The terms provide that John will not compete against the company for one year within 10 miles of the home office. John agrees to the terms and signs the document. Is the contract enforceable?

No. Generally, covenants not to compete are entered into at the time and as a part of the contract of employment. If a covenant is entered into at any other time, the employee must be given something in return for signing the document. The reason for this is that a covenant, like any other contract, must have consideration to be valid. Consideration simply means that both parties must be getting something in return for something else. When entered into as part of the original employment, the consideration for signing the covenant not to compete is the job itself. If the anticompetitive agreement is signed following employment, then there must be a change in compensation, duties, or nature of the employment to support the agreement. Forcing an employee to sign a covenant not to compete under the threat of being fired is insufficient consideration and is invalid.

(3) Mary signs a valid covenant not to compete as part of her original employment. The terms of the agreement provide that she will not be employed by anyone in a competing business within a radius of 350 miles for a period of two years following employment. Mary quits and goes to work with a competitor 100 miles away. Is the agreement enforceable?

Maybe.  As described above, the operative question on whether to enforce anticompetitive agreements is whether the restraint is reasonable under the circumstances. Courts will enforce such agreements so long as they are no broader than reasonably necessary to protect the employer's business and so long as they do not impose undue hardship on the employee. The former employer has the burden to show the reasonableness of a covenant not to compete.

Courts usually look to several factors in determining the reasonableness of a covenant not to compete, including

  • the nature of the business
  • the nature of the employee's duties
  • the territory encompassed by the covenant, and
  • the length of time of the covenant.

These factors are not independent and unrelated aspects of a covenant not to compete. On the contrary, each factor is considered in determining the reasonableness of the other factors.

Suppose a salesperson has confidential information regarding customers over a large territory that could damage the company for several years. A broad anticompetitive agreement that prevents the salesperson from competing in a large area for several years might be a reasonable restraint. On the other hand, a broad covenant not to compete might be unreasonable if the employee has no special knowledge or skills. Although reasonableness must be determined on a case-by-case basis, some generalities can be seen. The time and area of the restriction should be no more confining than the employer can demonstrate a need for. An employee in one case agreed not to engage in a similar business in the United States as an employee of a competitor. The courts held the agreement unreasonable and oppressive on the employee, unnecessary for the protection of the employer, and void as being a restraint of trade.

If a court deems a covenant not to compete unreasonable, the entire document usually fails. Courts try not to get into the business or rewriting contracts. (However, a court may be able to "blue pencil" the agreement to strike out unreasonable parts if the agreement has distinctly separable parts.) After all, if an employing company draws up a anticompetitive agreement that is unduly restrictive as to an employee, it has little right to complain if the court invalidates the entire document.

Articles are intended to provide general information and are not legal advice or a legal opinion. Specific questions should be directed to an attorney at Law Firm Carolinas or to another lawyer.

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