What is a Non-Compete?
A non-compete agreement is a contract that sets forth restrictions based on where an independent contractor may work in the future, and under certain defined conditions. The agreement typically defines the restricted territory where the independent contractor is prohibited from accepting work that competes with his or her source of income. It may also define how long the restrictions will be in place . A non-compete agreement may also restrict how the independent contractor can compete during the time period when the contractor is still performing services for the company. There are no broadly applicable laws to determine how and when a non-compete agreement is enforceable in California. There is no general statutory framework for non-compete agreements in California, but court rulings in the state have generally held that a non-compete agreement that is set forth in the context of a personnel transaction or an employment agreement is ineffective and unenforceable.
Do They Apply to Independent Contractors?
Non-competes are typically entered into with regular employees or office workers but there are situations in which these agreements can be used with independent contractors. However, the rules are different for contractors than for employees. Most notably, in order for a non-compete to be valid with an independent contractor, some courts require consideration beyond the compensation agreed upon in the first of the contracts. Because independent contractors are usually, under the law, treated as business owners, California courts will look for evidence that the independent contractor contributed some form of "capital investment or substantial entrepreneurial effort" in negotiating and performing the contract. The consideration could be any of a wide variety of things such as the independent contractor’s investment of time, use of a special piece of equipment or provision of a guaranteed market for the product. The consideration does not have to be something given by the employer to the employee; it could be something given by the contractor in exchange for the non-compete.
Regardless of whether a non-compete is made part of an independent contractor’s employment contract or not, it should be made part of the contractor agreement as well if the employer wants to limit the contractor’s ability to work for a competitor once his or her services are no longer needed.
Legal Issues with Non-Competes
CA, OH, MD and MI are states with unusually tough restrictions on the enforcement of "non-competes," or any other post-employment restrictions on future employment. In Ohio in order for an agreement to be enforceable the limitation must be ancillary to a separate reason for doing business with the independent contractor. As the terms of the Contract require the independent contractor to refrain from solicitation "for purposes of maintaining a competitive advantage" and there is no separate compensation or consideration provided for the limitation restriction, a court in Ohio would likely find this clause not legally enforceable.
Maryland requires the agreement to be supported by adequate consideration, find that no compensation or consideration was given that would support enforcement in this case. Michigan and California require a "reasonable" relationship between the restraint, such as a legitimate business interest, and the geographical scope of the restraint. The clause is probably not reasonable because the primary geographical location is so broad. The reasons for the restraint are "to protect its confidential information and legitimate business interests, including it’s customer relationships." Most courts would find that this scope is too broad for a vague confession of the need for an agreement.
The Ohio Supreme Court ruled in 2006 that agreements should be gauged according to certain criteria when analyzing them for reasonableness and, in general, a court will not enforce a non-compete clause without first agreeing with it. In Matching points v. Skyhawk Techs., 112 Ohio St. 3d 2009, Docket No. 06-0294, the Ohio Supreme Court outlined five points to consider when analyzing non-compete clauses. These points can be cross referenced with the State Statutes. The five things courts should consider include the following:
Ohio law says "an agreement limiting competition must be no greater than is required to protect the employer’s legitimate interests, [and] must not impose an undue hardship on the employee." Westfield Ins. Co. v. Galatis. The employment of an independent contractor is not considered a legitimate business interest to protect.
The Good and the Bad for Independent Contractors
As with all paid employment, non-compete agreements do carry some pros and cons for independent contractors.
From a business perspective, such agreements can have many advantages. By making an independent contractor sign a non-compete agreement, a business can be assured that the contractor will not divulge confidential information to competing businesses for a certain time frame following termination and that the contractor will not provide services to a competitor for a certain time period post-termination.
For independent contractors themselves, non-compete agreements can have disadvantages. For instance, if the independent contractor is not offered a different gig by their current employer for a period of time following termination, the contractor may end up being out of work and unable to find new work at another company due to the non-compete agreement that they have signed. Non-compete agreements can also limit a contractor’s earning potential: if they cannot provide service to competing businesses or clients, then their income may be significantly reduced.
Importantly, even if the parties have agreed to a non-compete agreement, California law does not recognize such agreements (with limited exceptions). Thus, if the independent contractor is based in California and subject to a non-compete agreement, that agreement may be unenforceable.
Negotiating a Non-Compete Agreement
Whether you are given a non-compete when you become a contractor, or one is imposed upon you later, there are several ways to negotiate better terms. For instance, if you are a high-level contractor – like a software engineer for a tech startup, or a sales rep for a manufacturing/wholesaling company – you may have more latitude to bargain for less restrictive terms. You could request a reduction on the scope of employees subject to non-compete agreements in any future employer contracts. You might also ask for the assignments pertinent to your area of expertise to not be part of the non-compete agreement down the line.
Another way to negotiate better terms is to make sure the agreement itself is as specific and clear as possible. One of the biggest problems independent contractors have with non-competes is ambiguity in their wording. Sometimes, an agreement will not actually state that the contractor cannot work for a direct competitor after their contract with the company ends. A former employer may try to skate around this potential problem by taking you to court over what might be verbal agreements instead of specifically stated written terms. It is up to the contractor to insist that their new contract be as iron-clad as possible .
There are several things to look for when negotiating the terms of a non-compete agreement – both before and after you have signed one. The first rule of thumb is to read the fine print. Contractors should already be in the habit of reading their contracts closely, but it is especially important with these types of agreements. Fine print can betray loopholes, like whether the party bound is an "employee" or an "independent contractor." Ask for clarification if there is any possible gray area in your non-compete agreement’s wording.
Second, search for the specific triggers that would bind you to the terms of your non-compete. Are you limited to a specific geographic area? Are all of your current and former employers included in the non-compete? If so, how long do you have to wait before you can work for one of them after signing your initial contract? Some states, such as California, do not enforce non-compete agreements if they unduly restrict the ability of workers to earn a living. However, many other states have similar laws, and "blue pencil" allows for the specified details of an agreement to be changed between the original parties should the law allow. So it is always a good idea to be aware of the terms and stay up to date with changes in these laws.
Real Legal Cases Concerning Non-Competes
Understanding Non-Compete Agreements for Independent Contractors
In most industries, such as the technology industry, non-competes are very common. Microsoft has had non-compete agreements for many years that also affects their contractors. Most technology companies in Silicon Valley will likely have contractors who have signed non-compete agreements. Yet, nine years ago, Microsoft was sued by a software developer for allegedly forbidding a customer from hiring him after he was fired from his Microsoft contract in 2011. Under the terms of his Microsoft contract, the software engineer was expressly forbidden from being hired or doing business with anyone who victimized him involving Microsoft’s own "contracting engineers." The lawsuit says the engineer left Microsoft to work for another company competitor, Source International, only after Microsoft stole the engineer’s ideas and Source International contacted his Microsoft customer. Benson’s lawsuit against Microsoft was filed in 2013 but sent into arbitration until this month when he won a $2.5 million arbitration award. The engineers’ lawsuit against Source including "tortious interference" became moot when he accepted Microsoft’s arbitration offer. Although he was fired from Microsoft for exposing the company’s controversial patent plans, former Microsoft engineer, Benson may have ended up losing out on his award if he had signed a non-compete because it could have prevented him from signing a contract with Source International. As an example of a large firm, Microsoft frequently includes both non-disclosure and non-compete clauses when it brings someone on as an employee because screening those relationships helps define what the employee is reasonable expected to keep private. They limit all employees from discussing information about Microsoft’s patents or information about its "contracting engineers." If a contractor does have a specialized skill or unique trade secret, it is usually contained in terms of a period in which the employee can be banned from competing for the same business to preserve the employer’s proprietary interests. But there are also many real-world examples of independent contractors who have been affected by non-compete agreements. A very recent case involved a woman and her newly launched marketing firm, Elysium Digital. The company was to be launched by a mother and daughter joint venture in the State of Colorado. The mother was working for a Colorado company called Aimee Arnold LLC when she decided to leave the company and start her own marketing firm except the company did not want to let her go without a fight. Since the mother had signed a non-compete agreement, she was forced to shut down the entire start-up even though her daughter was still living off the money from her own job. Advertising agencies and other companies will use the Texas Uniform Trade Secrets Act or the covenant not to compete, both of which are federals laws under the U.S. Commercial Code and those laws set very strict guidelines for independent contractors who plan to launch their own business. As a rule of thumb, companies will usually try to prevent their employees from creating competition in the industry or not creating anything similar to what their competitors are building. So, if an independent contractor is using information he or she learned directly via the services it provided to the client, enforcing trade secret violations could lead to enforcement if the company has proof that the contractor’s violation is one that might affect the business in the long run. Even so new independent contractors should not consider a non-compete agreement as an enemy because it is a legally binding contract that both parties need to follow and expect.
Alternatives to Non-Competes
A company may find a non-compete agreement with an independent contractor to be less than ideal because, among other things, the contractor performs services over which the company has less control and the contractor is free to compete with the company in the market where the contractor is currently providing services. That said, the company should still have available to it a variety of contractual instruments or strategies to protect its business if the independent contractor contemplates competing.
Option 1: No Non-Compete Agreement
Certainly, one option is simply to do away with a non-compete agreement altogether. If a company believes that, despite its efforts to invest in its client relationships and customer good will, the independent contractor nonetheless may be inclined to compete, the company should consider whether its current investment in its client relationship already has created sufficient customer good will that can be protected by other contractual and legal doctrines. A company might think it sufficient to rely on a standalone non-solicitation clause that would restrict the independent contractor from soliciting the company’s clients for so long as the independent contractor is performing services for the company. In that case, the investment in the client relationship will be preserved for as long as the independent contractor continues to perform services for the company. A non-solicitation agreement coupled with a very limited non-compete agreement (for example, a six-month non-compete covenant that restricts the independent contractor from working with the company’s clients for six months after it completes consulting work with the company) can provide a strong contractual framework to prevent competition from an independent contractor that will protect investments in client relationships and customer good will . This method should be applied with caution, however, depending on the industry.
Option 2: Non-Disclosure Agreement
A company also may use a non-disclosure agreement (NDA) to protect its confidential business information, including client lists. Most NDAs will restrict any use or further dissemination of information maintained by the company that is confidential, proprietary or a trade secret. While an NDA cannot prevent an independent contractor from competing with the company, and cannot require the independent contractor to return a client’s returning business, an NDA does protect any confidential information that the company possesses and therefore the NDA may assist the company if it believes its confidential information is important to preserving its client relationships.
Option 3: Limited Client-Specific Restrictions
If the company has invested significant resources to develop a particular relationship with a client, the company may opt for contractual provisions that place specific restrictions on the independent contractor if it determines an NDA is not sufficient to protect its investment. For example, the company can impose requirements that, as long as the independent contractor is performing services for the company, the independent contractor must advise the company if the client intends to cease doing business with it during the period the independent contractor provides services for the company, or a requirement that the independent contractor requires its employees and subcontractors working on a company engagement to notify the client that all correspondence, recommendations and reports are company property. Such contractual provisions can give the company an opportunity to address any issues the client may have with the independent contractor’s performance while the company is still involved in the relationship.