Noncompete Clauses in Employment and Commercial Contracts

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Non-competes are an important tool to help protect the legitimate business interests of a company, and it is worth the time and effort to do it right. To ensure the best chance of surviving regulatory and judicial scrutiny, review the latest regulations on non-competes and their enforceability, and sample clauses to use in employment or commercial contracts.

What is a non-compete clause or agreement?

A non-compete agreement, or covenant not to compete, is a form of contract where one party promises to not engage in or to refrain from a specified action. Typically, non-compete agreements arise between an employee and employer or a purchaser and seller of a business. The agreement typically provides that the employee (or seller of a business) will not enter into the field of work, or a similar field, to that of the employer (or purchaser) for a certain length of time. Non-compete agreements are almost always in writing, and can be in a separate agreement or part of a more general employment contract.

The purpose of non-compete agreements is to limit a party’s ability to engage in unfair competitive activities. These activities might include starting a competing business, working for a competitor, or exploiting the other party’s confidential business information to gain a competitive advantage. Competitive activities can also include solicitation of customers or employees from a business.

Most courts recognize the need for employers to protect themselves from unfair competition. When employees leave their employer, they often possess confidential knowledge that could be used to unfairly benefit a competing business. On the other hand, courts also weigh the need to promote the free flow of commerce and the employee’s need to earn a living and practice in a given profession.

Are non-compete clauses enforceable?

When drafting a non-compete provision, you must review applicable state and local laws to ensure that the provision meets the requirements and does not exceed the legal limitations.

Enforceability of non-competes varies widely by jurisdiction. While most jurisdictions will enforce non-compete agreements if they are reasonable in scope and not overly broad, there is a trend towards more conservative enforcement of non-compete agreements. Several states, including California and Oklahoma, bar non-competes. Others, including Washington, Oregon, and Illinois, ban them for low-wage or hourly workers.

Because non-compete agreements are contracts, all the requirements for contract formation must be present, including sufficient consideration. Additionally, before enforcing a covenant not to compete, most courts generally engage in a balancing test to determine whether the restrictions are reasonable and equitable. Courts often look at the duration, geographic restriction, and type of employee to determine whether to enforce all or part of the agreement.

[Download our 50-state survey on non-compete clauses to see how states govern non-competes and their enforceability.]

Is the FTC trying to ban non-compete clauses?

On July 9, 2021, President Biden signed an executive order intended to promote competition in the American economy that, in part, “encourage[s]” the Federal Trade Commission to “exercise the FTC’s statutory rulemaking authority under the Federal Trade Commission Act to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”

On Jan. 19, 2023, the FTC published its proposed rule on non-compete agreements in the Federal Register. On Jan. 5, 2023, the FTC announced its plans to propose a rule (RIN: 3084-AB74) barring employers from entering into or enforcing non-compete clauses with employees or independent contractors and requiring companies to nullify any existing ones. The ban would exempt agreements between buyers and sellers of a business entity who have an ownership interest.

The FTC, under Chair Lina Khan, argues that non-competes reduce worker mobility, leading to reduced wages for all workers, not just those with non-competes in their contracts. It calculates that a ban could add almost $300 billion a year to nationwide wages.

For more information on the FTC’s rulemaking, see the agency’s fact sheet.

Sample non-compete clause for employment contracts

This unilateral non-compete clause may be used in an employment agreement with a management employee. It prohibits the employee from competing with the employer during the term of employment and for a period of 12 months post termination. Non-compete agreements are governed by state law, which should be consulted for issues of validity and enforceability.

Sample language

[Section #] Noncompetition. Employee shall not, during Employee’s employment with Employer and for a period of [twelve (12) months] following the termination of Employee’s employment, whether such termination is voluntary or involuntary and regardless of the reason for the termination, [in any geographic region for which Employee had direct or indirect responsibility on behalf of Employer,] perform duties or services for a Direct Competitor, whether as an employee, consultant, principal, advisor, board member, or any other capacity, that are substantially similar to the duties or services Employee performed for Employer at any time during the last [twelve (12) months] of Employee’s employment with Employer, or that require Employee to use, disclose, or otherwise take advantage of any Proprietary Information obtained in the course of Employee’s employment with Employer. For purposes of this section, a Direct Competitor means any entity that offers or plans to offer products or services that are materially competitive with any of the products or services being manufactured, offered, marketed, or are being actively developed by Employer as of the date Employee’s employment with Employer ends.

[Download our 50-state survey on non-compete clauses to see how states govern non-competes and their enforceability.]

Sample non-compete clause for commercial contracts

This sample clause may be added to a confidentiality or commercial services agreement to prevent a party’s goodwill or confidential information from being used to compete with or otherwise disadvantage that party during the term of the agreement and/or for a period after the agreement terminates. In general, non-compete agreements that are limited in scope and duration and ancillary to an otherwise legitimate business purpose will generally be valid and enforceable.

Sample language

[Section #] Restriction on Use; Noncompetition. Recipient/Service Provider shall not use any [Confidential Information of the Disclosing Party/Client] [information about the business or operations of Disclosing Party/Client learned during the course of the engagement] to compete with the Disclosing Party/Client in the business of [Describe] [or in connection with services for any other client of Service Provider].

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