What Is a Non-Compete Agreement?
A non-compete agreement is a contractual tool that employers use to restrict their workforce from engaging in or starting a competing business after an employment relationship has terminated. It is common in various industries, and can be found through all levels of employment. While any employer could use a non-compete restriction with employees who provide services to the business, more and more frequently, independent contractors are required to sign non-compete agreements as well . For example, many independent contractors in the fields of consulting, accounting and legal advice are being required to enter into non-compete agreements with their clients. As this trend continues, it is important for independent contractors, and for the businesses that work with them, to fully understand non-compete restrictions and their implications.
Legal Distinctions for Contractors
As noted previously, non-competes for independent contractors are not governed by the same set of rules as those for employees. For example, courts in many (but not all) states require a heightened level of consideration for independent contractors, which can be satisfied by additional benefits or post-term work assignments, rather than by continued employment. Independent contractors are less protected by some of the anti-competitive regulations that some states have passed in recent years. Non-competes for independent contractors are typically interpreted by the courts under the strict standards that apply to covenants not to compete for sales employees and key employees such as inventors or those with unique talents, skills, or specialized knowledge. Non-competes for contractors are also sometimes treated as if they were agreements for the sale of a business for purposes of determining whether they fit under the exception to the rule against restraints on trade for agreements "in connection with the sale of a business."
How Well Do Non-Competes Hold Up?
Given the role that independent contractors play in certain sectors, many industries rely heavily on them as a part of their workforce, including the technology, construction, and hauling industries, says Chris Lee of Shawe Rosenthal in Baltimore. Each industry has different arguments surrounding the use of non-compete agreements. Generally speaking, there are six main considerations with respect to the enforceability of covenants not to compete. These considerations are common across industries and can be used by defense attorneys and in-house counsel to help determine the enforceability and scope of these agreements.
First, the duration of the non-compete is an important consideration. Is the duration reasonable? If the owner of the covenant wants protection of twelve months or more, this can be a difficult threshold to pass. However, most courts will enforce protection of less than twelve months, and the enforceability of these agreements can vary from state to state. For example, if you are in the industry working as an independent contractor in the state of Virginia, you can expect to be covered under the non-compete for up to a year; whereas if you find yourself in California, a covenant not to compete is generally unenforceable under California law.
Second, the geographical scope can also affect the enforceability of the agreement. For example, if you live in the New England area and are asked not to work in New York, it is likely reasonable. However, if you live here in Baltimore and are then asked not to work in Virginia, and you drive trucks for a living, that same restriction is likely to be unenforceable, as you can’t operate a truck without crossing state lines. On the other hand, if you were being restricted to work only in the State of Maryland and you had a regional sales territory covering Baltimore and Washington DC, that is also likely to be unreasonable.
Third, the legitimate business interests of the employer or covenantee, and their relationship to protecting those business interests, will also be considered. For instance, are they lost sales, proprietary technical information, or part of a sellable goodwill? How significant is the potential impact on the loss and can the employer be satisfied by limiting the non-competition agreement to protect only those interests?
Fourth, the consideration offered to the covenantee must be commensurate with the restrictive covenants imposed. Under the rules of equity, if the value of the consideration is low, the restrictions on the covenants to compete must be proportionately less. As such, minor restrictions on competition between the parties might just be appropriate to alleviate the problems they might cause. On the other hand, if the parties agree to something major, then the courts generally expect the business relationship to be major as well.
Fifth, public policy can also play a role in the enforceability of a covenant not to compete. In other words, who benefits from the restriction and what is the social interest of the restriction? For example, in some cases, geographic restrictions may not be enforced depending on interstate mobility.
However, consult your attorney before any such departure is made, as you do not want to aggravate what may already be a difficult situation.
State Law Differences
The law governing non-compete agreements for independent contractors varies widely from state to state. In particular, a handful of states have express statutes invalidating non-competes with individuals who are not formally employees, but rather are independent contractors.
Of the states where independent contractor non-competes are likely still enforceable, there are, however, a few outliers. For instance, the Florida Supreme Court has held that a non-compete with an independent contractor is unenforceable under Florida’s non-compete statute if the non-compete was entered into before the contractor was admitted to the state’s bar and therefore could not be "a professional authorized by law to practice in this state." While the case did not consider a non-compete entered into after admission to the bar, the court noted a concern (shared by Florida practitioners) that allowing a non-compete entered into after bar admission "would frustrate the [non-compete] law and act as counterproductive to a settlement in which an individual in private practice agrees not to practice his or her specialty within a certain geographic area in exchange for the right to practice in another area."
Similar concerns constrain the scope of non-compete enforcement against independent contractors in Massachusetts and New York. Although the decisions interpreting the Massachusetts non-compete statute are inconsistent and appear to turn on individual facts (unless overturned by the Massachusetts Supreme Judicial Court), many former Massachusetts attorneys claim that they are unable to enforce non-competes with independent contractor attorneys. New York, too, has shown concerns that independent contractor non-competes may interfere with the practice of law. While not explicitly forbidden, New York courts have enjoined enforcement of non-competes involving only independent contractor employees (although non-competes involving full-time employees continue to be enforceable).
Advantages and Disadvantages for Contractors
From a contractor’s perspective there are some advantages and disadvantages in agreeing to a non-compete clause. Many contractors accept a non-compete clause even when they hate it. They do so for a variety of reasons. Some may figure that so long as they are a contractor they will have a new contract anyway. Others may think that to refuse to sign the non-compete would be bad taste or bad karma. In some industries where contractors are common but turnover high, another reason is that they can get a higher hourly rate paid to them Canada wide. Their target clients can be across Canada but their practical and legal restrictions can be limited to a geographical area. They may take the money and hope the non-compete is not enforced. The downside for an independent contractor agreeing to a non-compete is that they should be all too aware that a non-compete is meant to restrict their freedom to work and earn a living for a period of time. They are agreeing to pay a price (often as high as 20% of their gross income) no matter how short the non-compete is for. A 6 month non-compete at 20% is like paying a 2.5 year mortgage on a house you walked away from in 6 months. The cost is only not as high if payment is deferred. Consider a 6 month non-compete. At 20% it would be like paying 60% for the balance of the salary paid to the employee over the 6 months. This is a significant cost. If your purpose for being a contractor is that you can work in two cities through the year (for example , Vancouver in the winter and Calgary in the spring summer) then a non-compete clause that restricts you from competing in one of these cities until the fall of the following year may be of little value. However, your non-compete clause might still restrict how much you can earn or with whom you might work once your contract is over. If your goal is to run your own business and be your own boss, then have you created a timebomb in the form of a non-compete clause that you may be serving as a sub-contract for a year or more? Of course you can negotiate that any non-compete you agree to be limited to a shorter period or by geographical area. Sadly 20% of nothing is nothing and there are some employers and companies out there where no matter what you negotiate it will be meaningless. While you might think you can negotiate a lower percentage of your gross income, it does not always work that way. In some cases acceptance of 20% is a condition of employment. As a contractor you may not have the option of negotiating for a lower fee from client to client thereafter. Many will also fear that if they ask for a reduction in the fee, they will be terminated. These are but some of the reasons and issues that may make accepting a restrictive covenant a reality for some independent contractors.
Negotiating Non-Con Agreement Terms
Independent contractors should take special care to get appropriate protections and conditions written into their non-compete agreements. First, it is important to request that the agreement have a termination date; for example, "This Agreement, unless extended by mutual consent, shall terminate on January 31, 20XX." In many states, a covenant not to compete is reasonable for a two-year period after termination of the work relationship. It is also appropriate to request that the agreement cover only work directly for the company, and that carryover accounts and those gained from the general public after termination be excluded from the non-compete.
It is also worth making sure that the agreement provides that the client may not hire the contractor’s employees within a certain period of time. This limit should not be for more than one year. Independent contractors also should watch out for a very broad non-compete, which prevents them from working in a particular industry at all for a period of time. For example, a social media consultant should not be restricted from working for another social media consulting company for a period of time, especially if the consultant generates her own clients. Instead, a more reasonable approach would be to limit the consultant from working with any of the former company’s clients for one year after termination.
Case Studies and Legal Precedents
There are a number of widely cited cases that have actively shaped the understanding of non-compete agreements in relation to independent contractor status. As previously discussed in a case out of Tennessee, independent contractors are generally deemed employees if there is a sufficient amount of control. However, the outcomes of these cases largely rest on the specifics of the agreements between the parties. The following are a few examples of notable rulings. In 2014, the first case of its kind in Missouri, IBEW Local 1 v Transgenomic, Inc., the Court of Appeals upheld the trial court’s finding that Transgenomic could not enforce its non-competition provision against an employee’s spouse. The defendant was a scientific recruiter who made phone calls to applicants and worked from home. The defendants argued that due to her sole proprietorship she was an independent contractor. The Eastern District of the Court of Appeals disagreed finding that Transgenomic maintained a sufficient amount of control over the individual. The court stated the principal’s control must be significant in order to determine the existence of a master-servant relationship. In Michigan, the courts have found that the employer must prove that part of the consideration for the non-compete "had the effect of inducing reliance." The Michigan Federal District Court cited Brenner v. National School of Examiners as the leading case on the law in Michigan. In Brenner a director of one of the respondent’s bar review programs was terminated in 1983. Almost one years later, Brenner filed suit claiming the contract of non-competition was void for lack of consideration. The Michigan court ultimately found that the plaintiff had failed to demonstrate an adequate quid pro quo because the considerations recited in the contract were required by Michigan law and did not induce reliance. Consideration, the Michigan court noted, is a necessary ingredient for the validity of promises and has often been described as the price of a promise. In 2004, the Oklahoma Supreme Court denied an inventor’s claims for a restraining order against his employer on the grounds of the non-compete clause. This case is not only important in Oklahoma but influential in Ohio and Missouri. The Oklahoma Supreme Court held that the non-compete clause was void and unenforceable because the promises made for each party’s consideration (i.e. the contract) were inadequate. The Court stated that the promise of a work environment was a foregone conclusion. Also, since the respondent owned the patents, the Court found that did not constitute consideration for the petitioner’s services. In addition, the agreement made after the firing was a new agreement, and the two year clause was excessive for the duties performed by the plaintiff. These cases are indicative of the way courts view independent contractor non-compete agreements and the need for consideration in their enforcement.
Non-Compete Alternatives
With regards to enforcement of non-compete agreements against independent contractors, the law is not entirely settled and continues to develop along with the nature of modern work. There may well come a time in the future when non-competes do not make sense for independent contractors or there may be a time in which enforcement cannot be relied upon at all. For that reason, independent contractors and companies alike should consider alternatives to non-competes.
Confidentiality Agreements
It may be that a client has no access to the same customers as the contractor, even if the contractor has been privy to confidential information and brings along their relationships to new competitors. In that case, a confidentiality agreement may be more appropriate to protect trade secrets. Forcing a contractor to sign an overly broad confidentiality agreement may also interfere with the contractor’s ability to work if the contractor has to divulge all of their secrets to each customer.
Non-Solicitation Clauses
A non-solicitation clause may also be appropriate, particularly if a client has legitimate interests to protect but does not have a business similar enough to match what the contractor has been doing. Further , it is arguably a more limited alternative than a non-compete agreement. The contractor would still be able to perform work for any competitor, but is simply restricted from contacting the former clients or customers.
In addition to determining whether there is a legitimate interest to protect, a company should also consider the geographic scope of the protections. The scope of a territory should be limited to only those regions in which the client competes with the contractor. A company can then enforce the geographic restrictions against competing in those markets.
Employee Agreements
The law is much clearer regarding employee non-compete and non-solicit agreements. For employees, the agreement may be more likely to avoid scrutiny and be enforced to the extent with which it is intended to protect the business.
Companies can simply structure their relationship with an independent contractor as an employee to better protect the company’s information, unless the classification of employment is not appropriate. Unfortunately, the upside is that a company may then bear greater responsibility for the use of the company’s information.