Non-compete agreement. A checklist to read before you sign it

It is hard sometimes to restrain an ironic smile when you see non-compete provisions in your new software development agreement, isn`t it? Though typical NCA often smell like roses and seem to be harmless, there is still a chance that they entail some risks in the future.

So, how to know that particularly your agreement will not affect your business plans for the next, let`s say, five years?

“How to be sure that your favorite employee or a loyal business partner won`t have the courage to become your most dangerous competitors tomorrow?”

(Non)-compete?

A lot of professional contractors enter into agreements with their customers all the time, slightly laughing at the other party`s efforts to keep them by their side with exorbitant fines. On the other hand, entrepreneurs constantly worry about disclosing to their employees and contractors too much of the inside and are afraid to create a competitor with own hands. When the employer’s effort to protect its niche overcomes the employee`s fear of own freedom restriction, the parties are ready to negotiate signing a non-compete agreement (or a non-competing agreement, or NCA).

NCAs concern both employees and sole proprietors. Some of your friends and colleagues have signed the NCA at least once (seeming calm, but mentally crossing their fingers behind their backs) – however, in Ukraine these agreements do not work.

Ukraine vs. World

Unfortunately, a standard service or employment agreement often contain a copied one-size-fits-all provision.

“Employee (or Contractor) undertakes not to engage in similar to the Company’s activities, or to participate in similar to the Company’s projects, solely or with other persons, within __ months/years from the date of termination of this (employment) agreement.”

Ukrainian courts are suspicious of non-compete agreements, prohibiting employers and customers from depriving their vis-à-vis of rights to work and earn a living with their work (as stated in Constitution of Ukraine) or from worsening employer`s position (as this violates the Labor Code of Ukraine). Speaking of sole proprietors, Ukrainian law allows recovering unearned income from them. However, it will be hard to hold a non-public employee liable, as it is prohibited to place liability for unearned income on an employee under the Labor Code of Ukraine.

Ukraine isn`t lonely in placing NCA practice out of law. There is a number of American states and European countries where it is also prohibited. At the same time, in some countries, where NCAs are allowed, they are often barely alive under the numerous restrictions and additional requirements imposed by law and case law.

Now, employees and contractors are protected from the customers` chaotic actions. On the other hand – what about the freedom to contract? Is it just a declaration in reality?

Not really. In many countries, the freedom to enter into any contractual relationship not prohibited by law is extended to non-compete agreements as well. NCAs can be concluded in many countries around the world. However, the fact of physical presence of your office (or even an apartment where you work) in Ukraine may not save you from unpleasant consequences under NCA because (among other reasons) subordination of your contract to foreign law (which, e.g., recognizes NCAs) is likely to make particularly your NCA real and valid.

However, will the provision we suggested above be valid?

Under the hood: what is OK and what is not to write in NCA

Even if a state law allows NCAs, most of the time it grates you with a bonus of restrictions that prescribe depriving an employee or a contractor of the opportunity to earn a decent living and do their business. These requirements vary from state to state, and therefore it is important to pay attention to the law applicable to your NCA. Such agreement can be subject to one or several restrictions, so you need to take into account all the factors that may be relevant to it (even theoretically).

What are these potential restrictions?

Areas of activity

“Contractor undertakes not to engage in activities in the field of arcade mobile games design, in particular, to refrain from participating in developing and implementing of arcade mobile games or individual elements design, to provide advice in design and modify the design of arcade mobile games.”

Some jurisdictions require you to indicate which types of professional or business activities must be refrained from – and as detailed as possible. The main purpose is always to protect legitimate interests of an entrepreneur/employer or their special rights – right to confidential information, trade secrets, goodwill and business reputation, intellectual property, regular clients or databases with customer contacts. Sometimes employers are forced to specify only the particular professional industry, similar position or particular competitors, to which the employee is prohibited from moving. However, it is important that a non-compete agreement does not impose burden that is too heavy on its executor and does not deprive him/her of the opportunity to earn a living (which often causes reducing or depriving of useful skills). Agreements with provisions that are too broad are likely to be either restricted or invalidated by the court – and this refers to requirement of not entering into agreements for activities in which the customer or employer does not work.

It is especially important that NCA does not violate public order: if a non-compete agreement creates a monopoly position in the market, it is unlikely to escape its invalidity.

Duration of restriction

“This Non-Compete Agreement is effective from the moment of conclusion and continues for 10 years after termination of the Main Agreement.”

A common mistake drafting NCAs is to choose beautifully impressive (and scary, too) numbers. It is important that restriction period is reasonable and justified by the need to effectively protect employer`s interests. Many states limit the maximum duration of non-competition (from a few months to 2-3 years in exceptional cases) because market conditions, technology and clientage of the former employer change fast enough. Often, the duration depends on other factors, too, such as employee’s position or occupation, or duration of employment, and even their behavior (e.g., if an employee abuses their position, a court or law may reduce the required duration of permanent employment, and then NCA comes onto the field).

Sometimes there are requirements for the particular moment when a NCA comes into force. Here are some examples:

  • NCA comes into force from the moment of termination of an employment contract;
  • NCA comes into force from the moment of termination of an employment contract, with or without an advance notice;
  • a contract comes into force in case employee was dismissed for valid reasons after the probationary period, etc.

Territory

“Employee undertakes to withhold from competing with Employer throughout the world, including international or foreign space stations, the oceans, outer space, as well as from employment with interplanetary missions and embassies.’

States tend to limit the territory within which competition is prohibited. While some recognize the territory of the entire state, others allow only a radius of a few miles from the former employer’s headquarters. Sometimes parties are required to agree on a list of cities or regions (districts, counties, lands, etc.) to which NCA will apply. Moreover, NCA can be declared valid only in those regions where new employer will be considered a competitor to former employer by court – and this is not list of all possible options.

Assignment of NCA

“In the event of reorganization of the Employer, the rights under this Agreement shall pass to the Employer`s successor or successors without Employee`s notice nor consent.”

Seems to be all right at the first sight, but it isn`t. In some jurisdictions, the seller of the company is prohibited from assigning rights under NCAs to the buyer unless the employee specifically agrees.

Provisions on the law governing NCA and the place of its conclusion

“This Non-Competition Agreement was concluded in Brussels (Belgium) between a citizen of Ukraine and American Company Ltd. and is governed by the substantive law of the State of Montana, USA.“

Some state law may prohibit any restrictive measures that adversely affect trade in general (and a NCA is a restriction on trade, no matter how hard you try). At the same time, case law may not recognize these agreements as valid.

Alternatively, vice versa: precisely because NCA is governed by the law of another state, it is valid in a state where such agreements are prohibited. It is also possible that only those agreements concluded within the country will be recognized as concluded and will remain in force.

Сonsideration

“During the term of this Agreement, the Company undertakes to pay the Contractor a fixed amount of ____ USD per month.”

Sometimes no agreement is possible without the mutual exchange of values. Therefore, it is important that the executor receives a reward for his abstention from engaging in his professional activity. This can be a single payment right after terminating the cooperation, or bonuses to payments under the main contract, or a new position with a fee for additional liability, or salary increase, and so on. In some countries, the amount of such remuneration is up to the parties` decision, but other jurisdictions may make the agreement conditional on existence, adequacy and reasonableness of the remuneration amount. Sometimes law provides the right to assign the remuneration amount in collective agreements. A change in status or position can also matter – if the new NCA, in conjunction with the previous one, makes the situation too difficult for the counterparty, court may change or cancel it.

The right to terminate NCA

“The Parties have the right to terminate the Non-Competition Agreement unilaterally not earlier than 30 days after the notice of intent to terminate the Agreement.”

It depends only on the state law whether the parties have the opportunity to terminate NCA or not. Sometimes this right is granted to only one of parties in the form of an option (usually the employer or the customer). And sometimes law allows you to terminate the contract only by mutual consent, for a specific period or only until a certain event.

Liability for breach of agreement

“In the event of a breach of the non-compete agreement, the Employee undertakes to pay a fine of ______ USD and reimburse all Employer`s losses and unearned profits.”

The state determines at its own discretion whether the employee/contractor will only pay compensation, or will be forced to compensate only for the damages (or all together). It will be necessary to determine separately whether the employee will be exempted from the obligation to refrain from further competition. It may happen that, despite the payment of all fines, the Employee is forced to refrain from non-competition during the NCA).

A special case is liability of a new employer: either separately or in solidarity with the employee. The law may matter whether a new employer knew about an employee’s NCA, and when they became aware of such obligation, whether before hiring, during, or after employment.

Exit from a dead end

Employees of service companies often have close relationships with customers and other potential employees or business partners (especially if these employees work in sales or HR). Therefore, it is unlikely that a client doesn`t get used to “his” manager (who often has access to sensitive information) and doesn`t continue focusing more on his own expertise, rather than the employer`s.

If loss of customers with the dismissal of an employee is inevitable, the company may insure itself and not try preventing its former subordinate from continuing his career – in particular, by buying out the right to continue working with customers (or use the knowledge and skills that the employee obtained through access to confidential information of the former employer).

 

The company can choose any form that would be convenient:

  • the former employer links the amount of redemption to the number or value of projects that the employee implements in the new job,
  • fixed payments over a period of time, without restrictions on the type or cost of projects and services to be provided by the former employee,
  • offer a ransom to a former employee if the he/she violated NCA – a compromising decision instead of protracted litigation and professional relations destruction.

You can also enter into buyout agreements with the employee’s new employer. Moreover, in some countries there is a practice of turning a former employer to a new one if employee has violated NCA with a buyout provision. In this case, law and case law may offer the parties, for example, the following three ways:

  • payment of a fine provided for in NCA – either by the new employer or by the employee with subsequent one-time compensation from the new employer;
  • joint and several liability of the new employer and the employee against the payment of fines and compensation for losses and lost profits;
  • payment of a fine by the employee, but provided that the new employer increases his salary and gradually reimburses his expenses.

However, in many cases, the employee is forced to pay the fine himself – and without any compensation.

The provisions of the buyout may also take the form of an employee’s option: in the event of such a request, the former employer may not refuse to accept payment and insist on the performance of the agreement.

 

Readiness to enter into an agreement: ten, nine…

A non-compete agreement usually comes in handy when:

  • employment contracts are concluded;
  • the company is being bought or sold;
  • business agreements are concluded with suppliers, business partners and independent contractors.

The former employee or contractor may use the information they had access to while working with the company to compete with the (former) employer or partner. It is unlikely that every employer dreams of this, so eventually they have an idea of adding a NCA to their standard contracts.

However, before you call all the contractors with an offer to make another tiny deal, your lawyer will first suggest ten steps to take.

 

  1. Identify positions and partners that require an individual approach

A single template for a NCA for the entire company will not retain any employee or contractor, except for the very first one (for which this agreement was once written). Position, responsibilities, level of income, relations with the company customers, and even the number of activities in the company can affect the content and form of the agreement. They should also be reviewed from time to time, as legislation can change so much that an outdated NCA can only create problems. If NCA is provided for in a collective agreement, the law may require proofs that the employee was aware of such obligation (which is, in fact, a separate consent of the employee).

  1. Sign NCAs with talented employees

Talented professionals and junior partners often resign or leave the company to start their own business. And if your former employees had access to clients or trade secrets – the appearance of a threatening competitor in an office across the street can become your reality.

  1. Use additional tools to protect your market share

The NCA is not the only way. It is worth considering whether restricting competition (even potentially) alone is enough to prevent disclosure of confidential information and loss of regular customers and key employees? These risks are combined, so the tools must be complementary. It is better if NCA insures the company’s internal acts, non-disclosure agreements and contracts with counterparties, rather than being your only weapon.

  1. Sign a non-compete agreement separately from the main agreement…

… And also in writing. This may be due to both substantive and case law. Sometimes these NCAs are kept separately to ensure their confidentiality (both from other company`s other employees and third parties). Another requirement for concluding an agreement is the validity of the main contract to which NCA is attached – and this must also be taken into account when, for example, employee is being dismissed.

  1. Do not include non-competition provisions in all standard employment contracts

This can be justified both by efforts to maintain the reputation of a caring employer and by compliance with law – the chosen jurisdiction may have a lower limit on the employee’s earnings, under which NCAs are prohibited. In other countries, the starting point may not be income but position or responsibilities.

  1. Make sure, that your employee can enter into NCA

It may be that law either prohibits restrictions on professional freedom in a particular field, or significantly weakens the influence of NCAs – in the duration of the contract or in the possibility of terminating it. And vice versa – only IT professionals may enter into such agreements or extend them for several years, not several months. In addition, there are more traditional frameworks – for example, the age of the employee (usually 16-18 years, although in many countries adolescents may start working earlier).

  1. Get acquainted with court practice

Parties usually ask the court to make sure that NCA is valid and really binding. Judges are guided not only by law but also by their specific rights and limitations. For example, in certain jurisdictions, rules of the trial allow judges and the parties to modify the contract by discarding or amending certain provisions and leaving the rest in force. This approach is known in English-speaking countries as bluepenciling, while in other courts the agreement will often be invalidated even because of technical rather than substantive errors.

  1. 8. Leave the employee an opportunity to withdraw from NCA

If loss of confidential information or customers is only a matter of time after the employee is fired, why not mitigate the blow? The former employee may not mind reducing the term of the contract and redeeming some customers (those who could otherwise leave the company if the employee’s non-compete period has expired) from the former employer, or the right to use skills or knowledge gained through access to the former employer’s confidential information. Moreover, in some jurisdictions such opportunity is a must NCAs, and this is enshrined in law or case law.

  1. Consider whether you can protect yourself with a less burdensome contract

Sometimes a non-disclosure agreement (NDA) or a non-solicitation agreement in other countries can be seen as a more flexible approach to protecting business assets (such as customer bases): some state courts are known to The United States and Canada have often wondered whether it was possible to enter into a less onerous contract that would have had a similar effect, and if so, declare the NCA invalid.

  1. Do not forget about the responsibility under the law

Even if you can’t choose the law that would legitimize NCA, you can still defend yourself. The law usually leaves you the right to sue for breaches of confidentiality and intellectual property rights so that the company can recover at least damages caused. Depending on the jurisdiction, the court may also separately prosecute the other party for violating competition rules. But even in this case, companies still tend to reinsure their risks, and they are not satisfied with the level of protection provided only by law.

Instead of conclusions

In any NCA, its goal will always be paramount. If the goal is keeping a particular employee – he/she will most likely have the fear of losing skills and bonuses every time he/she thinks about dismissal. If the goal is to protect business assets, then a tailor-made NCA, along with a moderate and prudent policy of access to trade secrets, will affirm the seriousness of the company’s intentions to act decisively when a need arises.

A non-compete agreement is always based on mutual respect between the parties and their willingness to keep their promises. That is why a properly made agreement is a method to protect yourself, but also to maintain the loyalty of the former employee or contractor in the event that his knowledge or talents will be vital for the further development of the business, even if it is unlikely. Responsible planning and preparation for NCA will reassure both parties of mutual respect and can significantly strengthen professional relations.

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