Non-Compete Agreements: An Effective Tool to Protect Legitimate Business Interests
Moss & Barnett Fall 2014 Firm Newsletter 10.01.14
Competition is everything in today’s world. Businesses compete for customers, the latest technology, publicity, and ideas. They also compete to attract and retain highly-skilled and knowledgeable employees and executives. Fortunately, there is something businesses can do to help ensure the loyalty of their trusted employees and top executives, or, at the very least, to prevent them from jumping ship and immediately setting up shop with a competitor.
A non-compete agreement – also known as a restrictive covenant – is a contract that restricts an employee’s ability to compete with or solicit the customers of its former employer for a specified period of time after the employment relationship ends. Such agreements protect the employer’s relationship with its customers, confidential information, and the business as a whole. Non-compete agreements are most common at the executive level and increasingly common at other levels of employment, depending on the skill of the employee, the amount of contact the employee has with the employer’s customers, and the information entrusted to the employee. Non-compete agreements regularly govern employees in technology, publishing, and sales industries and in any business where confidential information or customer relationships are at stake.
The law governing non-compete agreements varies from state to state. Such agreements may be enforceable in one state, but not in another. Although non-compete agreements are fairly common, Minnesota courts disfavor them, viewing them as restraints on trade and barriers to free competition in the marketplace. They are also disfavored because, by their very nature, they restrict the employee’s right to work and ability to earn a living. Despite this, Minnesota courts routinely enforce non-compete agreements as long as they are:
- For the protection of the employer’s legitimate business interests
- Supported by adequate consideration, and
- Reasonable in scope, duration, and geographic reach
The following is important information for both employers and employees regarding the enforceability of non-compete agreements under Minnesota law.
What Business Interests are Legitimate?
To be enforceable, a non-compete agreement must serve a legitimate business interest. Minnesota courts have recognized three such interests:
- Protection of an employer’s customer goodwill (i.e., the established business relationships between the employer and its customers)
- Protection of an employer’s confidential information and trade secrets, and
- Protection of the time and financial investment made to give an employee “specialized training”
Often, an employer will claim a combination of these interests at the enforcement stage. However, Minnesota courts see through attempts to enforce a non-compete agreement for the sole purpose of punishing the employee for ending the employment relationship. Thus, before requiring an employee to sign a non-compete agreement, the employer must be certain that one is actually necessary to protect legitimate business interests.
The “What” and “When” of Consideration
To be enforceable, non-compete agreements must be supported by adequate consideration. That means the employee must receive something of value in exchange for entering into the agreement. The adequacy of the consideration depends not only on what is received, but also on when the parties enter into the non-compete agreement.
If the non-compete agreement is signed ancillary to or as a condition of employment, prior to the employee’s first day of work, the employment itself constitutes adequate consideration. This does not mean, however, that the employer should wait until the employee’s first day of work to obtain the employee’s signature on the non-compete agreement. A non-compete agreement sprung on the employee on the first day of work lacks adequate consideration, and is therefore unenforceable because it takes unfair advantage of the employee.
Further, an employee’s mere prior knowledge that a non-compete agreement will be required is insufficient consideration if the employee had no opportunity to examine the language of the agreement. Thus, generally, the best practice is to make the non-compete agreement a condition of employment as part of the offer of employment and require the employee to accept the offer in writing before he or she commences employment.
Although this is generally the best practice, it is sometimes not an option. For example, when two companies merge, the new entity may face a situation where employees at one company are subject to non-compete agreements, while those at the other company are not. To create uniformity among all employees, the employees not formerly subject to non-compete agreements will be asked to sign them. When this occurs, additional, independent consideration, beyond the mere continuation of employment, is required for such agreements to be enforceable.
What constitutes adequate additional consideration? Adequate consideration can take many forms and may include one or more of the following:
- A raise or bonus
- A promotion or other professional advancement
- A share in ownership of the business
- Additional benefits, such as profit sharing or employer contributions to a 401(k) plan
- Access to confidential information or trade secrets
- An agreement to discontinue “at-will” employment in favor of “for cause only” termination
- Any other significant benefit
A court examining the adequacy of the consideration will evaluate whether the consideration is bargained for and, more importantly, whether the employee received a real and meaningful advantage or benefit in exchange for entering into the non-compete agreement.
Scope, Duration, and Geographic Reach
Minnesota courts will not enforce an unreasonable non-compete agreement, even if it protects a legitimate business interest and is supported by adequate consideration. To be enforceable, the agreement itself, in terms of scope, duration, and geographic reach, must be reasonable.
Enforceable non-compete agreements can be very broad in scope and may prohibit the former employee from working in the same industry as his or her former employer or for any competitor. Non-compete agreements may also be narrowly tailored. For example, they may limit the employee’s ability to solicit only certain customers of the employer or restrict the employee from working for certain competitors. Ultimately, whether the scope of the non-compete agreement is reasonably necessary depends on factors such as the nature and extent of the employer’s business, the nature and extent of the employee’s services for the employer, the specialized skill set of the employee, and other pertinent factors. Generally, the more specific the non-compete agreement, the more likely it is that a Minnesota court will enforce it.
Whether the duration of a particular non-compete agreement is reasonable depends on the circumstances. Minnesota courts weigh factors such as the length of time necessary to disassociate the employee from the employer in the minds of the employer’s customers and the length of time necessary for the employee’s replacement to obtain the requisite skills to do the job. As a general rule, non-compete agreements with a one-year restriction will be deemed reasonable. In some cases, non-compete agreements for up to two years in duration have been upheld. Durations of more than two years will likely face more judicial scrutiny.
A non-compete agreement must also be reasonable in geographic scope. This, too, depends on the extent and reach of the employer’s business. Generally, the geographic area to which the non-compete agreement applies should be no greater than the area in which the employer has done or reasonably expects to do business or has clients.
Finally, Minnesota follows the “blue pencil” rule, which permits a court to modify an unreasonable provision in a non-compete agreement to make it reasonable and enforceable. For example, a court may reduce the duration of such an agreement from two years to one year. Or it may restrict the geographic reach of the agreement. Minnesota courts are not required to use the blue pencil rule to modify an unreasonable non-compete agreement, however. They may simply refuse to enforce such agreements altogether.
In sum, Minnesota employers can successfully utilize non-compete agreements to protect their legitimate business interests, provided such agreements fairly balance the employee’s right to work and reasonable need to earn a living.