Effective Non-Competition Agreements for Expanding Businesses
By: Inku Nam
Expansions in your workforce and market territory can increase the likelihood that your business will encounter jurisdictional issues that can affect your non-competition agreements. This includes companies that have undergone a merger with a competitive business, geographical growth of its market territory, or distribution of its local workforce. A growing business should carefully scrutinize overly broad non-competition provisions in order to draft an agreement that is durable enough to survive such changes. This article will discuss some issues that can potentially affect your non-competition agreements along with some suggestions to consider in navigating the growth of your company.
1. Not All Non-Compete Provisions Survive Mergers
A larger workforce and expanded territories can arise as a direct result of a merger between two business competitors. In this situation, a non-competition agreement's survivability can hinge on whether a business merger occurs as an asset sale or a stock sale. With an asset sale of a business, the new business owner acquires the assets of a former company, which does not include the non-compete restrictions that were entered into prior to the sale. Where there is a 100% stock sale of the business to another, the prior non-competition agreements survive the acquisition, so as to maintain the provisions that were contemplated under the former corporate structure. Therefore, it is generally recommended to review all post-acquisition non-competition agreements in order to determine which agreements are now void. Indeed, a review prior to closing can save a lot of time. As for a stock sale, the non-compete provisions may have survived in their entirety, allowing for the possibility of simply amending the surviving agreements as necessary in order to ensure compliance with any new jurisdictional conflicts.
2. As You Expand, Adjust to the Market's Taste for Non-Compete Restrictions
A court’s taste for non-competition agreements can vary between jurisdictions, so restrictive provisions should contemplate mergers and expansions into new geographical territories. For instance, the courts in California disfavor employee work restrictions and generally find non-competition agreements unenforceable. This means that a California company that never had a non-competition agreement may be able to consider drafting one in anticipation of acquiring its competitor in Florida, where non-competition provisions are generally honored. In the alternative, your non-compete provisions that were drafted in Florida may be negated as your market territory expands into California. State laws vary greatly. For example, some legally non-compliant non-compete agreements in Colorado may result in criminal penalties. Therefore, it is generally recommended that durable and clear choice of law provisions be drafted into non-competition agreements with future growth in mind, while keeping in mind that some courts in some states may simply use their own laws for employees located in that state. Provisions that provide precise and reasonable restrictions should be considered in anticipation of being voided before a court's scrutiny. In addition to narrowly tailoring restrictive provisions, businesses can explore clauses that provide alternative restrictions in anticipation of jurisdictions that may challenge or seek to void broad non-compete provisions.
3. Negotiate Non-Compete Provisions Along With the Employee Benefits Package
It is generally recommended that a business evaluate non-competition agreements that follow direct acquisitions of a competitors’ employees. However, it is also important to create appropriate non-compete provisions that fit the role of the employee as business grows. These provisions should be revisited as the employee grows within the company and gains more contact with crucial market assets, such as when a sales executive gains new client insights and contacts after a merger. Another example is an expansion of market territory that requires a highly compensated sales person to engage a new client pool, different geographical territory, and possible relocation out of state. These employees may have to conduct some, or all, of their work in a new jurisdiction that may not honor an existing non-competition agreement. Also, a geographical restriction that was reasonable in one territory may become void if the provision is sought to be enforced in a territory with a higher geographical density of competitors. Therefore, it is recommended that businesses tailor non-competition agreements to the particular employee’s position and for future promotions within the company.
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