In contract law, a non-compete clause (often NCC), or covenant not to compete (CNC), is a clause under which one party (usually an employee) agrees not to enter into or start a similar profession or trade in competition against another party (usually the employer). Some courts refer to these as "restrictive covenants." As a contract provision, a CNC is bound by traditional contract requirements including the consideration doctrine.
The use of such clauses is premised on the possibility that upon their termination or resignation, an employee might begin working for a competitor or start a business, and gain competitive advantage by exploiting confidential information about their former employer's operations or trade secrets, or sensitive information such as customer/client lists, business practices, upcoming products, and marketing plans.
However, an over-broad CNC may prevent an employee from working elsewhere at all. English common law originally held any such constraint to be unenforceable under the public policy doctrine. Contemporary case law permits exceptions, but generally will only enforce CNCs to the extent necessary to protect the employer. Most jurisdictions in which such contracts have been examined by the courts have deemed CNCs to be legally binding so long as the clause contains reasonable limitations as to the geographical area and time period in which an employee of a company may not compete.
The extent to which non-compete clauses are legally allowed varies per jurisdiction. For example, the state of California in the United States invalidates non-compete-clauses for all but equity stakeholders in the sale of business interests.
As far back as Dyer's Case in 1414, English common law chose not to enforce non-compete agreements because of their nature as restraints on trade. That ban remained unchanged until 1621, when a restriction that was limited to a specific geographic location was found to be an enforceable exception to the previously absolute rule. Almost a hundred years later, the exception became the rule with the 1711 watershed case of Mitchel v Reynolds which established the modern framework for the analysis of the enforceability of non-compete agreements.
Canadian courts will enforce non-competition and non-solicitation agreements, however, the agreement must be limited in time frame, business scope, and geographic scope to what is reasonably required to protect the company's proprietary rights, such as confidential marketing information or client relations and the scope of the agreement must be unambiguously defined. The 2009 Supreme Court of Canada case Shafron v. KRG Insurance Brokers (Western) Inc. 2009 SCC 6, held a non-compete agreement to be invalid due to the term "Metropolitan City of Vancouver" not being legally defined.
The 2000 Ontario Court of Appeals case Lyons v. Multary established a general preference towards non-solicitation over non-competition agreements, regarding the latter as "much more drastic weapons" and held a non-competition agreement to be invalid when a non-solicitation agreement would have been sufficient to protect the company's interests.
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For an employee who has the obligation to protect the employer's confidentiality and trade secrets, the employer and the employee may agree on the inclusion of non-competition clauses in the employment contract or a separate non-disclosure agreement. In the event that the employment contract has been terminated or has expired, during the agreed non-competition period, the employer shall pay compensation to the employee on a monthly basis. If the employee breaches the non-competition agreement, he/she shall pay damages to the employer as agreed.
The personnel subject to non-competition agreement shall be limited to the employer's senior management, senior technicians and other personnel with a confidentiality obligation. The scope, area and term of the non-competition agreement shall be agreed by both the employer and the employee, and such agreement must not violate the laws and regulations.
Upon termination or expiration of the employment contract, the term of non-competition for any of the persons as mentioned in the preceding clause to work in any other employer producing or engaging in products of the same category or engaging in business of the same category as this employer shall not exceed two years.
If the parties have reached an agreement on non-competition and compensation, unless another agreement is in place, the employer is entitled to ask the employee to comply with the non-competition obligations when the employment contract is ended, and the People's Court shall support this request. The employee, after complying with the non-competition obligations, is entitled to request the agreed compensation from the employer, and the People's Court shall support this request.
If during the period of non-competition, the employer asks to terminate the non-competition agreement, the People's Court shall support said petition. When terminating the non-competition agreement, if the employee requests the employer to pay an extra 3-month non-competition compensation, the People's Court shall support said request.
When the non-competition obligation has been agreed, but the compensation for the duration after the termination or expiration of the employment contract has not been determined, if the employee has performed the non-competition obligations, and requests the monthly compensation which is equal to 30% of his/her average monthly salary of the twelve months previous to the termination or expiration of the employment contract, the People's Court shall support said request.
If the 30% average monthly salary of the twelve months previous to the termination or expiration of the employment contract as mentioned in the preceding clause is lower than the minimum wage of the region where the employment contract is performed, the employer shall pay according to the minimum wage.
When an employee violates this Law to terminate the employment contract, or violates the stipulations of the employment contract about the confidentiality obligation or non-competition and any loss is caused to the employer, the employee shall be liable for damage compensation.
If an employer and an employee have agreed upon both a non-competition agreement and compensation in the employment contract or confidentiality agreement, and if after the termination or expiration of the employment contract, the employer has not paid said compensation for three months due to its own reasons and the employee requests termination of the non-competition agreement, the People's Court shall support such request.
After an employee violates the non-competition agreement and pays liquidated damages to the employer, if the employer requests the employee to continue to perform non-competition obligations as agreed, the People's Court shall support such request.
Generally, CNCs are allowed in Europe only if the employer can show a reasonable business interest in having a CNC.
In Belgium, CNCs are restricted to new employments within Belgium and for no more than one year. The employer must pay financial compensation for the duration of the CNC, amounting at least half of the gross salary for the corresponding period.
In France, CNCs must be limited in time to a maximum of two years and to a region where the employee's new work can reasonably be seen as competitive. The region can be a city or the whole country, depending on the circumstances. The employer must pay financial compensation, typically 30 percent of the previous salary. A CNC may not unreasonably limit the possibilities of the employee to find a new employment.
In Germany, CNCs are allowed for a term up to two years. The employer must provide financial compensation for the duration of the CNC amounting to at least half the gross salary. Unreasonable clauses - for example, excluding similar jobs throughout the whole of Germany - can be invalidated.
In Italy, CNCs are regulated by articles 2125, 2596, and 1751 bis of the civil code.
In the Netherlands, non-compete clauses (non-concurrentiebeding or concurrentiebeding) are allowed regarding issues such as moving to a new employer and approaching customers of the old company. Unreasonable clauses can be invalidated in court.
In Portugal, CNCs are regulated by article 136 of the labor code and restricted to two years extendible to three years in cases of access to particularly sensitive information. The employer must pay financial compensation for the duration of the CNC but the law doesn't specify anything regarding the amount of the compensation.
In Romania, CNCs are regulated by articles 21-24 of the labor code and restricted to two years. The employer must pay financial compensation for the duration of the CNC, amounting to at least 50 percent of the last 6 months salary.
In Spain, CNCs are regulated by article 21 of the labor law. CNCs are allowed up to two years for technical professions and six months for other professions.
In the United Kingdom, CNCs are called restraint of trade clauses, and may be used only if the employer can prove a legitimate business interest to protect in entering the clause into the contract. Mere competition will not amount to a legitimate business interest.
In Crown dependencies, as there are no directly relevant laws it is generally accepted that UK Crown law applies but in the case of intellectual property many financial and other institutions require employees to sign 10 year or longer CNCs which could be seen to apply even if they leave the country or enter an unrelated field of work.
Section 27 of the Indian Contract Act has a general bar on any agreement that puts a restriction on trade. On this basis, it would appear that all non-compete clauses in India are invalid. However, the Supreme Court of India has clarified that some non-compete clauses may be in interest of trade and commerce, and such clauses are not barred by Section 27 of the Contract Act, and therefore valid in India. Notably, only those clauses backed by a clear objective that is considered to be in advantage of trade and commerce survives this test. For instance, a co-founder of a startup who signed a non-compete clause can be held to it, but if a junior software developer or a call center employee signs a non-compete clause with the employer, the same may not be enforceable.
According to Section 27 of the Contract Act, 1872, any agreement that restrains a person from exercising a lawful profession, trade or business is void. However, courts of Pakistan have made decisions in the past in favour of such restrictive clauses given that the restrictions are "reasonable". The definition of "reasonable" depends on the time-period, geographical location and the designation of employee. In the case of Exide Pakistan Limited vs. Abdul Wadood, 2008 CLD 1258 (Karachi), the High Court of Sindh stated that reasonableness of the clause will vary from case to case and depends mainly on duration and extent of geographical territory
The majority of U.S. states recognize and enforce various forms of non-compete agreements. A few states, such as California, Montana, North Dakota, and Oklahoma, totally ban non-compete agreements for employees, or prohibit all non-compete agreements except in limited circumstances. For this reason, non-compete agreements have been popular among companies with employees working in states where they are allowed. They are very common among commercial radio stations and television stations, especially for radio personalities and television personalities working for media conglomerates. For example, if a radio or television personality quits, is laid off or fired from one station in the media market they work in, they cannot work for another competing station in the same market until their contract expires with their former employing station.
As of 2018, non-compete clauses cover 18 percent of United States workers, and this is down from 38 percent of workers. While more prevalent among higher-wage workers, non-competes covered 14 percent of workers without college degrees in 2018. In March 2019, the U.S. Federal Trade Commission was under pressure by politicians, unions, and advocacy groups to ban non-compete clauses. A related petition estimated that "one out of every five U.S. workers -- or about 30 million -- is bound by such an agreement."
Non-compete agreements are automatically void as a matter of law in California, except for a small set of specific situations expressly authorized by statute. They were outlawed by the original California Civil Code in 1872 (Civ. Code, former § 1673), under the influence of the American legal scholar David Dudley Field II.
A leading court decision discussing the conflict between California law and the laws of other states is the 1998 decision Application Group, Inc. v. Hunter Group, Inc. In Hunter, a Maryland company required that its Maryland-based employee agree to a one-year non-compete agreement. The contract stated that it was governed by and to be construed according to Maryland law. A Maryland employee then left to work for a competitor in California. When the new California employer sued in California state court to invalidate the covenant not to compete, the California court agreed and ruled that the non-compete provision was invalid and not enforceable in California. Business and Professions Code Section 16600 reflects a "strong public policy of the State of California" and the state has a strong interest in applying its law and protecting its businesses so that they can hire the employees of their choosing. California law is thus applicable to non-California employees seeking employment in California.
Whether California courts are required by the Full Faith and Credit Clause of the United States Constitution to enforce equitable judgments from courts of other states, having personal jurisdiction over the defendant, that enjoin competition or are contrary to important public interests in California is an issue that has not yet been decided.
There are limited situations where a reasonable non-compete agreement may be valid in California.
The enforceability of non-compete agreements in the state of Florida is quite common. Some law firms build their law practice around these agreements and represent employees, employers and potential new employers of an employee currently bound by a non-compete agreement. The agreement is not allowed to be overly broad and generally difficult to enforce if it is for more than two years. However, Florida courts will rarely refuse to enforce a non-compete agreement due to its length or geographic scope. Instead, under Florida law, courts are required to "blue pencil" an impermissibly broad or lengthy non-compete agreement to make it reasonable within the limits of Fla. Stat. § 542.335. Also if the agreement is part of a general employment contract then there is the possibility of a prior breach by an employer. This may cause the non-compete clause of the contract to become unenforceable. However, recent case law from Florida's appellate courts has eroded the utility of the prior breach defense.
A new law bars high-tech companies, but only such companies, in Hawaii from requiring their employees to enter into "non-compete" and "non-solicit" agreements as a condition of employment. The new law, Act 158, went into effect on July 1, 2015.
Non-compete agreements will be enforced in Illinois if the agreement is ancillary to a valid relationship (employment, sale of a business, etc.) and (1) must be no greater in scope than is required to protect a legitimate business interest of the employer, (2) must not impose an undue hardship on the employee, and (3) cannot be injurious to the public. While reasonable geographic and temporal limitations on the non-compete agreement are not expressly required by governing law, they tend to be examined as a measure of whether the scope of the non-compete is greater than is required to protect a legitimate business interest of the employer.
Unlike other jurisdictions, which follow the general rule that consideration is only important as to whether it exists and not as to whether it is adequate, Illinois will inquire into the adequacy of consideration. The majority of courts will require at least two years of continued at-will employment to support a non-compete agreement (or any other type of restrictive covenant). However, in certain cases involving particularly sharp conduct by an employee, courts have required less.
While Illinois courts state the rule above, logically the analytical steps should be in reverse order--because inadequate consideration is fatal to the claim. Thus, under McInnis v. OAG Motorcycle Ventures, Inc. there are three requirements in order for a post employment restrictive covenant limiting a former employee's right to work for a competitor to be enforceable under Illinois law: (1) it must be ancillary to a valid contract; (2) it must be supported by adequate consideration; and (3) it must be reasonable, considering whether it: (a) is no greater than is required for the protection of a legitimate business interest of the employer, (b) does not impose undue hardship on the employee, and (c) is not injurious to the public. The McInnis decision interpreted the Fifield decision, above, to mandate two years' employment in order for consideration to be adequate.
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By 1837, Massachusetts had indisputably adopted the analysis established in Mitchel. In 1922, the Supreme Judicial Court eliminated any doubt that restrictive covenants in the employment context would be enforced when reasonable.
The basic proposition enunciated long ago continues to apply: "A covenant not to compete is enforceable only if it is necessary to protect a legitimate business interest, reasonably limited in time and space, and consonant with the public interest."
Reasonableness is the touchstone of the analysis and is highly fact-dependent. The context in which the CNC arises (such as employment relationship, contractual relationship) is a critical factor in the analysis. A CNC that is unreasonable because it is too broad, will be scaled back if it is in fact capable of being narrowed.
Even when a CNC is limited in duration, geographic reach, and scope, it will be enforced "only to the extent . . . necessary to protect the legitimate business interests of the employer." Recognized legitimate business interests are generally identified as the protection of trade secrets, confidential information, and goodwill.
An otherwise valid CNC must still, like other contracts, be supported by consideration. Accordingly, the Supreme Judicial Court has held that a CNC must be "ancillary . . . to an existing employment or contract of employment" or some other "permissible transaction . . . ." However, consideration can exist regardless of whether the CNC is entered into at the beginning of the employment relationship, during the term of employment, or even at the end of an employment relationship.
Under Texas law "a covenant not to compete is enforceable if it is ancillary to or part of an otherwise enforceable agreement at the time the agreement is made to the extent that it contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interest of the promisee." Specific rules apply to physicians, notably that a physician cannot be prohibited "from providing continuing care and treatment to a specific patient or patients during the course of an acute illness even after the contract or employment has been terminated."
However, Texas courts will not enforce a covenant not to compete if the court determines that such a covenant "is against public policy and therefore substantively unconscionable."
In Virginia, the enforceability of covenants not to compete is governed by common law principles. As restrictions on trade, CNCs are not favored by Virginia courts, which will enforce only narrowly drafted CNCs that do not offend public policy.
In Virginia, a plaintiff must prove by a preponderance of the evidence that the covenant is reasonable in the sense that it is: (1) no greater than necessary to protect its legitimate business interests, such as a trade secret; (2) not unduly harsh or oppressive in restricting the employee's ability to earn a living; and (3) not against public policy. Paramount Termite Control Co., Inc v. Rector, 380 S.E.2d 922, 924 (Va. 1989).
In Virginia, courts weigh the (1) function, (2) geographic scope and (3) duration of the CNC against the employer's legitimate business interests to determine their reasonableness. Additionally, CNCs are only reasonable if they prevent the employee from entering into direct competition with the employer and must not encompass any activity in which the employer is not engaged. Virginia courts will not generally attempt to revise or enforce a narrower restriction in a non-compete agreement. As a result, a drafting error or unenforceable restriction may render the entire agreement unenforceable in Virginia.
Second, to enforce the CNC, a plaintiff must show that it is not unduly harsh or oppressive in restricting the employee's ability to earn a living. In Virginia, a CNC is not unduly harsh or oppressive if balancing its function, geographic scope and duration the employee is not precluded from (1) working in a capacity not in competition with the employer within the restricted area or (2) providing similar services outside the restricted area.
Third, to enforce a CNC, a plaintiff must show the CNC is reasonable from the standpoint of a sound public policy. Virginia does not favor restrictions on employment and therefore CNCs are generally held against public policy unless they are narrowly drafted as enumerated above. In Virginia, a CNC does not violate public policy if the restrictions it imposes do not create a monopoly for the services offered by the employer or create a shortage of the skills provided by the employee.
According to Racine v. Bender, CNCs will be enforced by courts if they are validly formed and reasonable. There are exceptions, like in Labriola v. Pollard Group, Inc., where the Washington Supreme Court invalidated a CNC not supported by independent consideration by strictly enforcing the pre-existing duty rule.
While CNCs are one of the most common types of restrictive covenants, there are many others. Each serves a specific purpose and provides specific rights and remedies. The most common types of restrictive covenants are as follows:
The enforceability of these agreements depends on the law of the particular state. As a general rule, however, with the exception of invention assignment agreements, they are subject to the same analysis as other CNCs.
Microsoft and Google battled over a noncompete clause in 2005, when Google hired Kai-Fu Lee, an expert in speech recognition technology, even though he had signed a noncompete agreement at Microsoft. Google unsuccessfully worked to move the case from Washington to California, in hopes that the noncompete clause would be ruled invalid. The case was eventually settled outside of court.
In June 2006, Papermaster signed a non-compete agreement in which he agreed not to work for an IBM competitor for at least a year if he ever left IBM, according to court documents. He informed IBM of the Apple job offer last month. On October 20, IBM offered him a pay raise as well as the option to accept one year's salary if he promised not to go to a competitor, but Papermaster submitted his resignation the next day. On October 22, IBM filed suit.