Covenants not to compete, or noncompete agreements, can play a key role in helping a business entity protect its confidential information, prevent unfair competition and the raiding of its workforce. A poorly drafted agreement, however, can leave the business exposed to claims that the covenants are not enforceable, which in turn can lead to unnecessary litigation. Below are a number of common components that make up a well-drafted non-competition agreement.
Define the Parties
The parties should always be identified as one of the first terms in the agreement. The drafting attorney should make sure that all corporate entities which have an interest in the protections afforded by the agreement are included. This is especially important where there are parent, subsidiary or affiliated companies.
Use of Recitals
The introductory section of the agreement should focus on the protective purposes and justifications for the restrictions in the agreement. This serves to bolster the notion that prevention of unfair competition is the key purpose of the agreement. It is important to be aware, however, that in many states, such recitals are distinguished from the body of the agreement.
Describe the Job Duties
The agreement should identify the particular position that the employee is going to be employed in. This helps to establish that the agreement is ancillary to a contract of employment and part of a particular employment position. It is not necessary to identify the specific job title (since that may change over time), but rather the nature of the position so that it is clear why a restrictive covenant is needed.
If the noncompete agreement is executed in conjunction with an offer of employment, most states, including Delaware, will find sufficient consideration in the offer of employment itself. Both the offer letter and the noncompete agreement should state that the offer of employment is conditioned on the execution of the noncompete agreement and that the employee would not be employed, but for the employee’s willingness to comply with the noncompete terms. For current employees, the issue of consideration can be more complicated, since some states require additional consideration other than the right to keep one’s job.
The wording of the contract should make clear the distinction between the termination of the parties’ obligations under the agreement, and a termination of the employment relationship. Typically, an employer will want to ensure that restrictive covenants such as nondisclosure, nonsolicitation, and noncompete obligations run for a period of time following the termination of employment.
Scope of Restrictions
This is probably the most important part of the agreement and requires careful drafting. Restrictions may include limitations on the employee’s ability to work or compete, solicit employees or clients, and what information can be disclosed. To obtain enforcement of restrictions on a former employee’s ability to work, most courts generally engage in a balancing test to determine whether the restrictions are reasonable and equitable. Therefore, it is imperative that the drafter considers the nature of the business and the type of employee when determining what constitutes reasonable limitations. In addition, the duration and any geographic limitations must be considered as part of the analysis. Finally, consideration should be given to the venue and choice of law (see below) when drafting the restrictions to ensure they will be enforced.
A tolling provision generally extends the time limitation of the restriction for the length of time in which the employee has found to have been in breach. When an employee breaches a covenant not to compete, generally the period of breach runs concurrently with the period of restriction in the agreement. Often, the period of restriction can be as short as six months or a year, and it can take that long, or longer, for a lawsuit to result in a ruling. Therefore, without a tolling provision, the employer can lose the benefit of its bargain because the time period may have expired by the time the lawsuit goes to trial.
Remedies for Breach
There are various remedies which can be provided for breach, including injunctive relief, claw-back provisions, stop-payment provisions, and balloon payment or condition precedent.
Injunctive relief is the most common enforcement mechanism for post-employment restrictions. Most states, including Delaware, require some showing of irreparable harm in order to obtain injunctive relief, but the standards vary from state to state. It is advisable to include a provision stipulating that irreparable harm will result from the breach of the restrictive covenant.
The drafting attorney also should consider a one-sided provision allowing for the recovery of attorneys’ fees for a breach of a noncompete agreement. This provision can help deter a former employee’s breach of the agreement and create helpful leverage in settling a dispute. These types of clauses have been upheld in many jurisdictions, including Delaware. However, it is important to be aware of the applicable state law on this issue before including a one-sided attorneys’ fee recovery provision.
Choice of Law
Choice of law provisions are essential for noncompete agreements, because variations in state law can have significant impact on the enforceability of the agreement. Some states’ laws are more favorable than others to an employer seeking to enforce a noncompete. Moreover, the applicable law is not always easy to determine in noncompete cases. Depending on the particular state’s conflict of laws rules and facts of each case, law governing a contract could be at the place of performance, or at the place the contract is entered into. Determining the place of performance, for example, for a sales person who works out of her home, but who markets to a global territory, is not a simple task. Similarly, in the modern digital age, the place the contract is “entered into” can be less than self-evident. Therefore, a choice of law provision is critical to ascertaining the enforceability and limiting defense costs if the agreement is later challenged.
A choice of law provision will generally be enforced, as long as there is some material connection between the selected law and the parties and purpose of the contract. If the parties agree to a Delaware choice of law provision in their contract, Delaware law will presume a material relationship exists, as long as the parties are subject to the jurisdiction of Delaware’s court, and may be served with legal process. A recent case from the Delaware Court of Chancery, however, noted exceptions to this rule in a case involving an employee living in California.
Choice of Venue
A choice of venue or forum selection clause establishes the site of any lawsuit regarding the agreement. The inclusion of such a clause is recommended for several reasons. First, there is a natural deference of courts to follow their own state’s laws. Therefore, if the agreement includes a choice of (presumably favorable) law, then it is advisable to have the lawsuit in the court most likely to apply that law. Second, the inclusion of such a clause can also increase leverage of the party seeking to enforce it by reducing or increasing the cost of litigation for one party or another, based on travel distance. Most states will enforce forum selection clauses unless there are highly extraordinary circumstances that would make enforcement unreasonable or unfair.
The standard closing contract clauses, including survival, modification/waiver, integration, etc., are generally recommended for noncompete agreements. However, there are some traps for the unwary, of which the drafter should be aware. For example, integration clauses can be problematic if the agreement is one where other agreements (e.g., separation agreements) are meant to survive. A standard integration clause could arguably void all other agreements entirely. Where separate and important agreements exist (e.g., invention assignments, confidentiality obligations), the best practice is to carve these agreements out as an exception to the integration clause.
For more tips on drafting, see my earlier post on non-solicitation agreements.