But Is It Reasonable? It Depends!: A Short Discussion on Covenants Not to Compete for Web-Based Employers

Photo by Marek Levák on Unsplash

Rachel Ford, Associate Member, University of Cincinnati Law Review

I. Introduction

Restaurants and medical facilities have something in common: they hold private information that they need to keep confidential. This information includes secret recipes at restaurants and client lists at medical facilities. Executives at these businesses may wonder how they will keep this information confidential, particularly if they have disgruntled former employees. A simple solution lies in contract law: a covenant not to compete. If employees agree to covenants not to compete, they agree not to work for their employers’ competitors – within reason. Courts have consistently held that covenants not to compete must be reasonable in both time and region.[1]

This standard was already difficult to apply before the internet was a factor.[2] Now, we practically live on the internet. We socialize, work, shop, interview, exercise, and relax on the internet. There are companies that are based entirely on the internet, such as Etsy, and there are companies that use the internet as their primary tool to conduct business, such as Uber. These companies, particularly big tech companies such as Amazon and Google, have trade secrets and client lists that must be protected. When companies are accessible in every corner of the United States, how can the region of a covenant not to compete be reasonable? In short, whether a covenant not to compete for a web-based company is deemed enforceable should depend on the nature of the job and should always adhere to reasonable length and duration. This is different for every web-based job, and for some a covenant not to compete should never be enforceable.

II. Background

Covenants not to compete, also known as noncompete agreements, are widespread throughout industries where employees are required to know precise, and oftentimes confidential, information.[3] Covenants not to compete are also prevalent in service industries, with the goal of the agreement being to prevent an employee from taking her employer’s clients.[4] Other justifications for covenants not to compete include the reduction of employee turnover and associated costs, the imposition of various costs on competitors, and the increase of employers’ negotiation leverage with employees.[5] These covenants are contracts between an employer and employee that prohibit an employee from working for her employer’s competitors, either during or post-termination.[6]

Courts generally disfavor covenants not to compete.[7] Judges cite to economic loss, such as restraining trade and prohibiting a person from using her skills to economically support herself, when striking down covenants not to compete.[8] Courts’ distaste for covenants not to compete makes sense; society is losing out on a person’s skills, expertise, knowledge, and talents during the noncompete period and within the noncompete region.[9] The least they could do is ensure that the covenants not to compete are reasonable and strike down any that unduly burden an employee and, more broadly, society at large.

Covenants not to compete are contracts, so they are generally adjudicated in state courts and regulated by state statutes.[10] Because of this, there are many different standards by which they could be evaluated, albeit the differences are typically minimal. Generally, covenants not to compete are evaluated on the basis of (1) the employer establishing a legitimate interest in protecting information that the employee has knowledge of and (2) the covenant not to compete being reasonable in duration, geographic region, and scope of prohibited employment.[11] These analyses can get varied and unpredictable, depending on the venue and the particular judge hearing the case, because they are fact-intensive.[12] Additionally, the standards by which covenants not to compete are evaluated are different depending on the nature of employment.[13] For example, some states severely limit the use of covenants not to compete among physicians, citing the utmost importance for an abundance of doctors for public health, access to medical services, a patient’s right to choose her doctor, and a patient’s right to have an ongoing relationship with her physician.[14]

Courts have several options when they face an unfair covenant not to compete. First, they can decline to enforce the entire noncompete agreement, taking it out of the contract completely.[15] However, instead of declining to enforce the entire noncompete agreement, some courts will use the “blue pencil” rule to modify the agreement, making it enforceable.[16] The blue pencil rule allows courts to change or erase terms of a covenant not to compete provided that the problematic terms are easily severable.[17] If the terms cannot be easily taken out of the agreement, the court will hold the entire agreement unenforceable.[18] However, some courts will modify the covenant not to compete even if the terms are not easily severable.[19] Clearly, an employee challenging a noncompete agreement or an employer drafting one must use due diligence when researching her jurisdiction’s (and even the presiding judge’s) governing law – or she runs the risk of mistaking another jurisdiction’s rule over her own.

III. Discussion

So, how does this apply to web-based companies? This article argues that, for some web-based companies, covenants not to compete are never reasonable but are perfectly reasonable for other web-based employers. The issue is not of the nature of the employer; it is the nature of the employee. Employers and judges must determine a reasonable region based on the employee’s job, field, location, and expertise. For this reason, some may argue that no tech employees should be subjected to covenants not to compete. They should be encouraged to create – no matter for what company’s benefit – and never be inhibited from innovating.

However, the restrictions must always remain reasonable to the job being performed. Recently, Amazon sued a former employee for breaching a covenant not to compete after the employee, a marketing vice president (VP), left Amazon’s cloud unit for Google’s.[20] The agreement barred the VP from working for any competitor for 18 months – no matter the competitor’s location.[21] Although this case has not yet been decided, this article argues that it would not be reasonable to subject this VP to unemployment in his field of expertise across the globe for any duration, no matter what information he possesses. A court may strike out the entire covenant, or it may modify it to become reasonable.[22]

Some courts refuse to enforce covenants not to compete when employers fail to restrict the noncompete region to a geographical area where the employee actually performed work.[23] This is a good compromise for some employers whose products are available online but require an employee to facilitate the sale, such as an insurance salesman. However, other courts refuse to limit covenants not to compete to regions where the employee solicited customers for the employer and hold reasonable any region where the employer did business.[24] These holdings are overbroad and hurt employees, but it is important to note that some courts are willing to extend the region of a covenant not to compete nationwide.

If an employee traveled throughout the country, leaving no reasonable restriction on geographic region, companies could utilize a nondisclosure agreement (NDA) – an agreement not to disclose confidential information.[25] NDAs are commonly used in states like California where covenants not to compete are outlawed.[26] However, NDAs are risky, particularly when the information sought to be protected lies between confidential information and the employee’s knowledge and skills.[27] Covenants not to compete provide employers with clear protection of their information; if an employee is not able to work for a competitor, there is little to no risk that she will intentionally or unintentionally share their confidential information.[28]

IV. Conclusion

Some experts argue that the end of covenants not to compete altogether should be near.[29] However, covenants not to compete are reasonable in some situations, particularly where the employee subjected to the covenant knows confidential information that may inadvertently come out, such as a secret recipe of the best pizza sauce in New York City. So long as the prohibited geographic region and duration is reasonable, covenants not to compete are welcome. With regard to web-based employers, it depends on the nature of the employee’s job. In some cases, no covenant not to compete is reasonable, but in others a limited duration, scope, and region can be reasonable. Ultimately, like most other legal issues, it is up to the courts and judges to decide what is and is not reasonable.

---

[1] See, e.g., Hansen v. Edwards, 83 Nev. 189, 191-92, 426 P.2d 792, 793 (1967) (holding a noncompete agreement as unreasonable when it is “greater than is required by for the protection of the person for whose benefit the restraint is imposed or imposes undue hardship upon the person restricted”); see also Raimonde v. Van Vlerah, 42 Ohio St.2d 21, 325 N.E.2d 544 (1975) (requiring an enforceable covenant not to compete to (1) protect the legitimate interests of the employer, (2) not impose undue hardships on the employee, and (3) not injure the public).

[2] See, e.g., Jamie Maggard & John Vering, Overreaching Covenants Not to Compete Under Attack from All Sides, American Bar Association (2018) (noting that the standard to deem a noncompete agreement as enforceable varies widely depending on the state law and judge, even though the same factors are generally used in determining a noncompete agreement’s reasonableness).

[3] Ann C. Hodges & Rafael Gely, Principles of Employment Law 166-67 (2d ed. 2018).

[4] Off. of Economic Policy, U.S. Dept. of Treasury, Non-compete Contracts: Economic Effects and Policy Implications (2016).

[5] Id.

[6] Ann C. Hodges & Rafael Gely, Principles of Employment Law 167 (2d ed. 2018).

[7] Id.

[8] Id.

[9] Id.

[10] See, e.g., Rimkus Consulting Grp., Inc. v. Cammarata, 255 FRD. 417, 438-39 (S.D. Tex 2008) (holding that all covenants not to compete are governed by the Covenants Not to Compete Act (see Tex.Bus. & Com.Code 15.50)); Marsh United States, Inc. v. Cook, 354 S.W.3d 764, 768 (Tex.2011) (emphasizing the holding in Rimkus Consulting Grp., Inc.).

[11] Ann C. Hodges & Rafael Gely, Principles of Employment Law 168 (2d ed. 2018).

[12] Jamie Maggard & John Vering, Overreaching Covenants Not to Compete Under Attack from All Sides, American Bar Association (2018).

[13] Id.

[14] See Murfreesboro Medical Clinic. P.A. v. Udom, 166 S.W.3d 674, 679-84 (Tenn. 2005) (deeming all covenants not to compete unenforceable against physicians except when (1) “the employer is a hospital or an affiliate of a hospital” or (2) “the employer is a ‘faculty practice plan’ associated with a medical school.” Notably, the two exceptions are those that are prescribed in the statute).

[15] Ann C. Hodges & Rafael Gely, Principles of Employment Law 174 (2d ed. 2018).

[16] Id.

[17] Id.

[18] Id.

[19] Id.

[20] Toru Yamanaka, Amazon is suing a cloud employee who left for Google, rekindling the debate over non-compete agreements, CNBC (2020), https://www.cnbc.com/2020/06/11/aws-case-against-worker-who-joined-google-reignites-non-compete-debate.html.

[21] Id.

[22] See Alexander & Alexander v. Wohlman, 19 Wash.App. 670, 686-87 (1978) (holding the geographic scope of a covenant not to compete unreasonable but allowing the rest to stand enforceable).

[23] See AMX Internatl., Inc. v. Battelle Energy Alliance, Ltd. Liab. Co., 744 F.Supp.2d 1087, 1095 (D.Idaho 2010) (providing that, under Idaho law, a covenant not to compete was enforceable simply because the employer who drafted it “failed to restrict the geographic area [of the noncompete agreement] to those areas where [its employees challenging the noncompete agreement] provided services or had a significant presence or influence”).

[24] See Accruent, LLC v. Short, W.D.Tex. No. 1:17-CV-858-RP, 2018 U.S. Dist. LEXIS 1441, at *12 (2018) (refusing to limit a noncompete to regions where a salesman worked with customers because the former employee could “take business from [the company] in any state or country where [it] did business”); see also Marquis Software Solutions, Inc. v. Robb, N.D.Tex. No. 3:20-CV-0372-B, 2020 U.S. Dist. LEXIS 33385, at *17 (2020) (holding reasonable a nationwide restriction on a former software company employee’s employment ban).

[25] Ann C. Hodges & Rafael Gely, Principles of Employment Law 167-68 (2d ed. 2018).

[26] See Confidentiality Agreements Can Be Unenforceable Covenants Not to Compete, Hirschfeld Kraemer (2020) (noting that California courts will hold NDAs unenforceable if they have “the practical effect of a covenant not to compete”).

[27] Id.

[28] Id.

[29] James Heskett, Should Non-Compete Clauses Be Abolished?, Harvard Business School (2019) (arguing, at the very least, that covenants not to compete should be severely rewritten, if not downright abolished, for low income workers).