THE GENERAL RULE IS THAT NON-COMPETES ARE UNENFORCEABLE
I’ve received several questions over the last few weeks related to covenants not to compete. These clauses raise questions at companies, both for employers and employees. Employers wonder what they can require their employees to sign, and how to go about it. They may worry that employees with access to sensitive information might use it for their own or another company’s advantage if the employee departs. On the other side of the coin, employees want to understand the consequences of agreeing to non-competes. Rather than retaining flexibility to found their own competing business in the near future, employees are usually more concerned about whether signing a non-compete will impair their ability to find a similar job if the current one doesn’t work out. Both sides have equally valid concerns and, from a practical standpoint, want to keep the other side happy. Fortunately, in Colorado the answers are pretty clear. Under Colorado law the general rule is that non-competes are void and unenforceable. This is because public policy tilts against restricting an employee’s or contractor’s right to make a living by performing skilled or unskilled labor.
ENFORCEABLE NON-COMPETES: 4 EXCEPTIONS TO THE GENERAL RULE
As with most rules, the general rule that non-competes are unenforceable is subject to four relatively straight-forward exceptions. First, non-competes entered in connection with the sale of a business or of business assets are enforceable. Likewise, non-competes designed to protect trade secrets are enforceable. Third, if an employee has worked for a company less than two years and the company pays for them to obtain additional education, such as an MBA, the company may restrict the employee’s right to work for a competing business as a means of recovering its costs. Finally, non-competes are enforceable against executives and management level employees and also professional staff to executives and management level employees.
EVEN WHEN AN EXCEPTION APPLIES, NON-COMPETES MUST BE REASONABLY LIMITED
Over the years, in addressing and interpreting the underlying rule and its exceptions, Colorado courts impose a reasonableness restriction on covenants not to compete. To be enforceable, non-competes must be reasonably limited in time and geographic scope. For example, a non-competition clause in a stock purchase agreement, prohibiting the sellers from opening a competing business, is enforceable only if the restriction expires after a reasonable period of time and is reasonably limited as to where the sellers aren’t allowed to compete. Naturally, this rule leads one to ask what is “reasonable.” The answer depends on a question of fact; what is the non-compete intended to protect? When acquiring a business, the buyers wants to protect the goodwill of the acquired business as well as more tangible assets like customer lists. So, while a perpetual and worldwide prohibition against competition will always be void, the reasonableness of less broad non-competes depends on the nature of the business being sold. For example, depending on the nature of a business, a prohibition against opening a competing business for two years within a 5-mile radius of the store location or one restricting completion for two years within the entire state can each be enforceable, or unenforceable.
Non-Solicitation clauses provide an interesting twist on the rules. Colorado courts treat prohibitions on soliciting existing clients and customers of a business the same as non-competition agreements. Therefore, a non-solicitation agreement restricting an employee from actively soliciting a company’s present customers and clients after he or she quits or is terminated can be enforceable if one of the four exceptions applies, and if the scope of the restriction is reasonably limited. Customer lists and contact lists may or may not be trade secrets under Colorado’s trade secret law. If they are, then in addition to possible remedies under the trade secret law, employers may restrict a departing employee’s right to solicit customers and contacts on that list with a binding non-solicitation agreement. If a company doesn’t protect such lists as trade secrets, a non-solicitation agreement or provision may still be enforceable if another exception to the general rule against enforceability of non-competes exists. To date, non-solicitation agreements forbidding employees from soliciting their co-workers to leave a company haven’t been construed as covenants not to compete and therefore, aren’t subject to the requirements applicable to non-competes.
Having enforceable non-compete and/or non-solicitation agreements and policies is important in many industries and ideally, should be part of an over-all internal policy that is consistently applied. It is particularly important to include the concepts in any agreement to acquire a business and to be sure such agreements are enforceable. Summit 6 Legal is here to help your company navigate these issues and manage the conversation around them with your employees and can also help buyers or sellers be sure they are appropriately covered in purchase agreements for the sale of a business or business assets.
Happy Friday!
Dave