Six Factors to Consider When Drafting Non-Compete Agreements
In a recent decision, the Kentucky Court of Appeals reaffirmed that there are still no hard and fast rules for employers attempting to draft non-compete agreements for their employees. In Charles T. Creech Inc. v. Brown, No. 2011-CA-000629-MR (Aug. 17, 2012), the Court concluded that a determination regarding whether to enforce a non-compete agreement requires “case-specific flexibility.” Moreover, the Court stated that a “blue pencil” rule, whereby courts will reform or amend restrictions in non-compete agreements if they believe the initial restriction to be overly burdensome or broad, extends to all provisions of a noncompetition agreement. For employers attempting to draft enforceable non-compete agreements this leaves great uncertainty as to whether agreements will be upheld as drafted. However, the Court left us with some guidance in the form of six factors that should be considered in every case, giving companies and their lawyers some tools to use when drafting these agreements—and when litigating to enforce them.
Prior to this recent decision, the Kentucky appellate courts only gave vague descriptions of a “reasonableness/fairness” test used to determine whether a non-compete agreement should be enforced, and only offered sporadic suggestions of what may be “reasonable” and “fair.” For example, in 1982, the Kentucky Supreme Court wrote that “the fairness of the transaction and its freedom of any taint of oppression is always a matter of consideration in weighing the right of a party to the aid of the court [in enforcing noncompetition agreements.]” Previously, that Court stated that “reasonableness is to be determined generally by the nature of the business or profession and employment, and the scope of the restrictions with respect to their character, duration and territorial extent.” In Charles T. Creech Inc., for the first time a Kentucky appellate court listed collectively all of the factors that Kentucky courts should consider when evaluating non-compete agreements.
As the Court of Appeals’ decision repeatedly states, there are no universally applicable, dispositive rules that govern enforceability of a non-compete agreement. The reason is that the surrounding factual circumstances necessarily vary depending on the industry, the particular employer, the particular employee, and the geographic region. However, the decision sets forth six specific factors that always should be considered: (1) The nature of the industry; (2) The relevant characteristics of the employer; (3) The history of the employment relationship; (4) The interests the employer can reasonably expect to protect by execution of the noncompetition agreement; (5) The degree of hardship the agreement imposes upon the employee, in particular the extent to which it hampers the employee’s ability to earn a living; and (6) The effect the agreement has on the public. The decision also offers a series of questions the employer can think about in considering each of these factors:
- The nature of the industry: Is the industry in which the employer is engaged, and in which the employee desires to continue working, highly competitive? Is there a limited opportunity to participate in this industry? How many players are there in the market, and are their respective market shares relatively large or small? Is there a history of competitors trying to gain knowledge of one another’s data or methods to gain a competitive advantage? Is there a history of “poaching” competitors’ employees so as to eradicate competition? Does each employer develop its own competitive strategy, business model, or technology which determines how successful that particular competitor will be? Are all competitors succeeding primarily according to their own skills which are not kept confidential or secret, including their reliability, people skills, reputation, competitive prices, and good service? If the industry is highly competitive and has a history of employee “poaching,” the non-compete agreement is more likely to be upheld.
- The relevant characteristics of the employer: Who is the employer in the context of the industry and the geographical region? What is the scope of the employer’s operations, both in terms of geographic reach and number of customers serviced or products distributed? How many employees work for the employer? What roles do those employees play in the company, and to what type of information are they exposed? What is the employer’s industry status and what share of the market does it serve? The larger the area the employer requires to sustain its business, the larger a court will likely permit the geographical area of limitation to be. The more likely it is that an employee could use his or her position within the business to undermine the employer’s position with its clients, the more likely the covenant will be enforced.
- The history of the employment relationship: Was the employer’s insistence that the employee enter the covenant not to compete fair? When was the non-compete agreement signed relative to the onset and end of the employment relationship? Did the employee arrive on the job with all the skills needed to do the work required by the employer, or did the employer have to specially train and develop certain skills which would be of special value to the employer? The closer in time the covenant was entered to the time the employee was hired, and the more skills the employee learned from the employer, the more likely a non-compete agreement will be held fair and thus enforced.
- The interests the employer can reasonably expect to protect by execution of the noncompetition agreement: Would the employee’s subsequent hiring by a competitor of the employer essentially deprive the employer of its competitive position? Would it be no different than if the competitor had hired an employee from another competitor in the market? Would the employee’s departure, and subsequent employment by a competitor, necessarily cause the employer’s own innovation or distinctive approach to its business to be used against it? Is the agreement narrowly tailored to afford fair protection to the employer’s interests? The more likely it is that the former employee could aid another business in using the employer’s distinctive approach against the employer, and the more narrowly tailored the covenant is, the more likely it will be upheld.
- The degree of hardship the agreement imposes upon the employee, in particular the extent to which it hampers the employee’s ability to earn a living: What are the specific limitations of the agreement—what spatial, temporal, and employment restrictions are there on the employee’s ability to work, and what is their impact on the employee? How long has the employee worked in the industry, for the employer and for others? How likely is it that the employee will find gainful employment if he complies with the covenant’s restrictions? Will enforcing the covenant effectively compel the employee to part with his education and experience to find employment in a new sector? Are the restrictions on future employment so broad as to unduly burden the employee’s ability to find work? The more restrictive a covenant is, and the more the covenant prevents an employee from finding work that is suited to his skill set developed over time or through training/education, the less likely the covenant will be enforced.
- The effect the agreement has on the public: How, if at all, will enforcement of the covenant affect the public? Does the covenant restrict the public’s access to the types of goods or services offered by the employer? Are the consequences and extent of that restriction acceptable given the nature of the employer’s services and the community’s needs? The more the enforcement of the covenant would serve to restrict the public’s access to goods or services, and the more beneficial/necessary those goods and services are to the public, the less likely the covenant will be enforced.
While there are still no bright line rules on what is and is not permissible in terms of non-compete agreements—and according to the Court in Charles T. Creech, Inc., we are unlikely to see any in the near future—these six factors will at least give employers and their lawyers something to think about when drafting their non-compete agreements, and what arguments can be made in the courtroom if litigation arises to enforce a contract. However, while the general rule is that courts will not re-write contracts, employers attempting to draft non-compete agreements also should remain mindful that Kentucky courts are willing and able to use a “blue pencil” to re-write non-compete terms to conform to what it believes to be reasonable and fair.