The Ins and Outs of Non-Compete Agreements
According to a March, 2016, U.S. Department of the Treasury report, nearly 30 million workers are covered by a non-compete agreement.[i] These workers run the gamut from CEOs to sandwich makers.[ii] It is important for firms and individuals to understand the importance of these clauses and to enter into agreements knowing what is expected and required of them if the employee were ever to leave. Further, when an employee does leave, the new (hiring) employer, the employee, and the former employer all have important factors to consider.
Much like a prenuptial agreement, employees and some employers find it uncomfortable discussing and negotiating non-competes on the front end. Some view it as an acknowledgement that the “marriage” will not work out. Some employers include this in a “take-it-or-leave-it” contract and eliminate any negotiation at all. All of this can lead to costly and complex litigation on the back-end. It is more important that parties to an employment agreement or an acquisition agreement seek advice of counsel to draft or review non-competes, and, later, to avoid running afoul of properly drafted non-competes either as the employee or the new employer.
Non-compete agreements are contractual agreements which state that an individual, under certain circumstances, will not operate in the same industry within geographical area and within a certain time period after their employment ends. The agreements typically arise in employment agreements or as a result of the sale of a business. Because covenants not to compete are agreements in partial restraint of trade, they may be critically examined and construed against the employer.[iii] The extent of this review and the enforceability of the particular portions of a non-compete agreement varies from state to state.
In reviewing a non-compete agreement, courts could consider such things as:
- The type and size of the business involved;
- The geographic limitations imposed by the non-compete agreement;
- The time frame of the non-compete agreement;
- The employee’s position within the company;
- The ability of the employee to earn a livelihood; and
- Public policy.[iv]
Further, in reviewing non-compete agreements, courts take various views on the ability of the court to revise a non-compete in light of an unreasonable provision. For example, if the court finds that a geographical restriction in a non-compete is unreasonable, courts disagree on whether they can strike the unreasonable restriction and provide a more reasonable one or otherwise save the non-compete agreement. Because these agreements can be construed against the employer and courts may not bail you out, firms need to pay particular attention to drafting these clauses with care and precision.
The Brokerage and Financial Services Industry
Perhaps no industry deals with non-compete agreements as often and under the same light as the brokerage and financial services industry. Brokerage firms rely on the personal goodwill of their brokers. Brokers build and develop their client lists over years and clients typically relate with the broker more than the firm. This type of personal goodwill is both very valuable to the firm and very susceptible to leaving. Firms recognize this as an opportunity and offer extraordinary recruitment bonuses, often in the form of a forgivable promissory note, to lure brokers (and their books of business) away from their current employer. Recognizing the risks as well, Firms structure forgivable notes in such a way as to incentivize the broker to remain with the Firm. A broker’s employment agreement and promissory note are both likely to have non-compete language in them.
The Brokerage industry recognized this web of non-compete agreements and has attempted to reduce the complexity associated with it. Attempting to “further the clients’ interests of privacy and freedom of choice in connection with the movement of their Registered Representative between firms,” a small group of brokerage firms created the Protocol for Broker Recruiting.[v] The Protocol for Broker Recruiting lays out the conditions and procedure for broker’s changing between signatory firms. It has become the primary document firms and brokers rely on in structuring firm changes.
The Broker Protocol allows brokers moving from one signatory firm to another signatory firm to take client names, addresses, phone numbers, email addresses, and account titles of the clients they serviced while at the firm. While the Protocol imposes certain burdens on the parties and excludes “raiding” cases, if complied with, neither the departing broker nor his or her new firm will be liable to the broker’s former firm for taking the information identified above. This does not replace the use of non-compete agreements in the industry. However, when complied with, the Broker Protocol does create substantial certainty around the movement of brokers within the industry.
Starting with just three signatories, The Broker Protocol currently has 1,521. Therefore, in many instances, both firms involved in a move will be signatory firms. However, non-competes will live on in the brokerage industry. They may still be effective restraints when brokers move to non-signatory firms, move to different lines of work, refuse to pay back forgivable promissory notes which contain non-compete clauses, attempt to take clients they did not service, etc. However, even for non-signatory firms, courts have warned that they will not be permitted to benefit from the Broker Protocol in recruiting brokers but strictly enforce non-competes when a broker attempts to leave.[vi] Courts and arbitration panels may consider enforcing the Broker Protocol against non-signatory firms; risking the enforceability of non-compete clauses.
Non-compete agreements are complicated subject matter and are often a difficult topic to discuss in the euphoria surrounding a new employment agreement or acquisition agreement. However, it is important for all parties to enter into these agreements with a proper understanding of what they prohibit and what they do not prohibit. In any industry, having a well-crafted non-compete agreement provides the comfort to allow business to invest in individuals or businesses and protects individuals from signing their economic freedom away.
The information within does not constitute legal advice. It is also not a substitute for legal or other professional advice. Users should consult their own legal counsel for advice regarding laws, regulations, and procedures.
[i] U.S. Dep’t of the Treasury, Non-compete Contracts: Economic Effects and Policy Implications, available at https://www.treasury.gov/resource-center/economic-policy/Documents/UST%20Non-competes%20Report.pdf
[ii] Clare O’Connor, Does Jimmy John’s Non-Compete Clause for Sandwich Makers Have Legs?, Forbes (October 15, 2014), http://www.forbes.com/sites/clareoconnor/2014/10/15/does-jimmy-johns-non-compete-clause-for-sandwich-makers-have-legal-legs/#56dd36a02740
[iii] Poole v. Incentives Unlimited, Inc., 345 S.C. 378, 381, 548 S.E.2d 207, 208-09 (2001).
[iv] For an example of a South Carolina court’s recitation, see, Faces Boutique v. Gibbs, 318 S.C. 39, 42, 455 S.E.2d 707, 708 (Ct. App. 1995).
[v] The Protocol for Broker Recruiting, http://www.thebrokerprotocol.com/ (2016).
[vi] i.e., Merrill Lynch, Peirce, Fenner, & Smith Inc. v. Callahan, 265 F.Supp. 2d 440, 444-45 (Dist. Vt. 2003) (“By seeking to halt such solicitation, Merrill Lynch seeks to enjoin the same behavior in which it engages as a matter of company policy.” Therefore, the doctrine of unclean hands prohibited imposing an injunction on a departing broker).