Noncompete Agreements . . .

are contracts that discourage employees from leaving their employer by preventing them from performing a similar job for a competitor. They are used to encourage key employees to remain with their company and to prevent them from competing with it after they leave. Most venture capitalists require noncompete agreements from top management as a condition to funding. Investors often combine stock vesting agreements and stock bonus plans with noncompete agreements to better insure management loyalty. Trade secrecy and confidentiality agreements are also commonly included in noncompete agreements.

To be enforceable, noncompete agreements need to be drafted carefully. Courts dislike noncompete agreements because they interfere with a person’s ability to earn a living. As a rule, courts will enforce them only when their provisions are carefully limited. The types of restrictions these agreements must contain to be enforceable vary from state to state. Some states’ courts will not enforce any employee noncompete agreement. Others will, but only if they are entered into in connection with the sale or financing of a company. All states require noncompete agreements to be tightly drawn in compliance with the particular requirements of local law.

Although the rules vary from state to state and different states apply similar rules with different emphasis, a few principles of noncompete agreements do have general applicability. All states require noncompete agreements to be in writing and supported by valuable consideration. Most require them to be restricted as to territory and time. That is, an employee cannot be prevented from competing everywhere forever.

Many states require that the competitive behavior that is restricted reflects only the activities the employee undertook for the company. Some states will not enforce a noncompete agreement that is signed after the employee joins the company unless the employee receives something significant from the company at the time. However, most states relax their rules when reviewing a noncompete agreement entered into between management and a company buyer or financier.

It is difficult to draft an enforceable noncompete agreement, especially one that is not entered into in connection with a company financing. Only an attorney who is knowledgeable about his state’s noncompete laws can insure that a noncompete agreement is drafted properly. When noncompete agreements are important, management should be sure to enlist the aid of a qualified attorney to either draft the agreement or consult with management as to the agreement’s scope and enforceability. See: Confidentiality Agreements, Golden Handcuffs, ISOs (Incentive Stock Options), Options, Think Capital, Vesting Schedules.