Meet Desmond, owner of an insurance brokerage that sells commercial and personal lines. His top-performing agent is Megan, ever since Graham—Desmond’s former No. 1—departed for a cross-town competitor.
When Graham left Desmond’s brokerage, he took with him a large client base and wealth of contact information developed over time—a crushing blow to Desmond’s business. To ensure this will not happen again, Desmond presents Megan and his other agents with a non-compete agreement, restricting them from competing with his brokerage after the termination of their employment. Megan and her colleagues are required to sign within 10 days—or else.
This scenario is not uncommon—companies like Desmond’s need to protect their legitimate business interests. This is especially important for insurance brokerages, given their dependence on not only products, but also the cultivation of relationships to develop and maintain business. But are Non-Compete Agreements—also known as “restrictive covenants”—such as these an appropriate vehicle for protecting those interests?
The answer: Perhaps—as long as they’re drafted properly.
Most courts frown upon non-compete agreements; some states, like California, deem them unenforceable. Yet to the extent they are permitted, courts insist that restrictive covenants meet three strict legal standards:
1) Legitimate business interest. A non-compete agreement must protect the “legitimate business interest” of the company compelling its execution. Such interests typically include confidential customer data, marketing and pricing strategies, new product development plans, and trade secrets—assuming the company took reasonable steps to secure this information. Note that customer lists alone are not generally protectable. That said, companies do have a legitimate business interest in preserving customer goodwill and relationships developed by investing time and money.
2) Reasonableness. To be enforceable, restrictive covenants must also be reasonable in terms of the time limit of the restriction and the geographic limitations imposed. But what is considered reasonable? Court rulings suggest an acceptable time limit could range from three months to several years, and restrictions that cover a former employee’s previous geographic territory may be permissible. For example, a nationwide restriction on competition would be reasonable if the employee’s territory was national, but unreasonable if they worked in a particular region or locale.
As a rule, reasonableness depends on many factors, such as the former employee’s responsibilities, access to confidential information, , role in developing that information or using it in performing services, and territory for performing them. And even if a non-compete is deemed unreasonable, many courts are allowed to rewrite or “blue pencil” an overbroad provision to render it enforceable.
3) Consideration. A company must provide something of value in exchange for an employee’s promise to refrain from competing with it. For years, requiring an incumbent employee to sign a non-compete agreement to remain employed was deemed permissible and supported by consideration. But in several jurisdictions, including New York, many employers must offer additional compensation or a promotion in order to secure a valid and enforceable restrictive covenant. For new employees, employment itself may be sufficient consideration for the promise not to compete.
Some companies are moving away from non-compete agreements in favor of non-solicitation agreements, which permit former employees to work for a competitor but restrict their access to prior customers or clients. Although the courts also frown upon such provisions, they look more favorably on them because, unlike non-compete agreements, they do not prevent individuals from finding work in a chosen field.
No doubt about it, Desmond took a hit when Graham brought his talents—and Desmond’s customers—to a competing firm. In retrospect, Desmond may have been able to protect his legitimate business interests with a properly crafted restrictive covenant. The lesson is invaluable: In the ultra-competitive brokerage industry, a non-compete or non-solicitation agreement can go a long way toward safeguarding company revenue.
Christopher D'Angelo is a partner at Michelman & Robinson, LLP, a national law firm with offices in Los Angeles, Orange County, California, San Francisco, Chicago and New York City.