What Is a Non-Compete Agreement?
A Non-Compete Agreement is a contract in which one party agrees not to compete with another for a set period.
The basis for this agreement is a disclosure of confidential information for a stated purpose, where the misuse of that information by the information recipient would give rise to an unfair competitive advantage.
Non-Compete Agreements are often used to protect trade secrets, client relationships, and other sensitive business information after a working or commercial relationship ends.
Non-Compete Agreements go by several other names, including:
- Covenant not to compete
- Non-Disclosure Agreement
- Confidentiality Agreement
- Non-competition agreement
To hold up in court, a non-compete generally has to be reasonable in three respects: its duration, its geographic scope, and the activities it covers. Overly broad agreements — such as a lifetime ban on working in an entire industry — are often reduced or thrown out.
Courts must balance the information provider's rights under the non-compete with every individual's right to earn a living.
What does a Non-Compete Agreement restrict?
A Non-Compete Agreement typically limits four things:
- Activity or industry scope: The type of work or business the information recipient can't engage in
- Geographic area: The region where the restriction applies, such as a city or county
- Duration: How long the restriction lasts after the relationship ends
- Prohibited relationships: Contact with specific clients, customers, or employees
Here's a short example of a non-compete clause:
For a period of one (1) year following the end of employment, the Employee agrees not to work for, own, or operate any business that competes with the Employer within a 25-mile radius of the Employer's principal place of business.
The appropriate wording will depend on the context and the state where the agreement we be enforced.
When should you use a Non-Compete Agreement?
Non-Compete Agreements are most common in employment, business acquisitions, and inventions or intellectual property. What these contexts all have in common is a disclosure of confidential information that needs to be protected against misuse by a competing entity.
Employment or service relationships
Employers often use non-competes with workers who access trade secrets, pricing data, or key client relationships. A non-compete may be a standalone contract, or it may appear as a clause in an Employment Contract.
Before adding one, it helps to review key items to check in an employment contract so both sides understand what they're signing. The non-compete ensures that the employee or contractor can’t make use of that privileged information for the benefit of a competing entity.
Business purchase or sale
Non-competes are common in business sales, and they typically come into play at two stages of the transaction.
First, during due diligence. Before finalizing the price, the buyer needs to inspect financial records, customer lists, and other confidential business information.
To protect that information, the seller usually has the buyer sign a non-compete (often alongside a confidentiality agreement) so the buyer can't use what they've learned to benefit a competing business if the deal falls through.
Second, at closing. Once the sale goes ahead, the buyer needs assurance that the seller won't open a competing business nearby and trade off the goodwill of the business they just sold.
The Business Purchase Agreement typically includes a non-compete clause restricting the seller from competing within a defined market and time period.
Inventions and intellectual property
If you're sharing an invention with an investor, collaborator, or manufacturer — especially before filing a patent — a Non-Compete Agreement can help protect your intellectual property.
It restricts the recipient evaluating the invention from using what they learn to build a competing product or business or from disclosing that information to any third parties.
Make sure to check state restrictions before completing a Non-Compete Agreement. Consider consulting with a lawyer for further legal advice
Non-Compete Agreement vs. Non-Disclosure Agreement
Both agreements protect sensitive business information by creating obligations of confidentiality, so there is a high degree of overlap. In both cases, the shared information may only be used by the recipient for the stated purpose.
A Non-Disclosure Agreement prohibits one party from sharing or using specific confidential information for anything outside an agreed purpose. It may also include a non-compete clause.
A Non-Compete Agreement includes the confidentiality obligations of a non-disclosure agreement or Confidentiality Agreement, but also details and emphasizes the prohibition on competing with the business of the information provider.
Are Non-Compete Agreements enforceable?
Non-Compete clauses have been controversial in the United States because they run counter to the restraint of trade doctrine, which promotes free competition in the marketplace.
In April 2024 the Federal Trade Commission sought to ban non-compete clauses nationwide, arguing that non-compete clauses suppress wages, innovation and entrepreneurship and are ultimately bad for the economy.
However, by August 2024, the proposed ban on non-competes had been set aside by the federal court decision in Ryan LLC v. FTC, meaning that the question of enforceability depends on the state and the scope of the non-compete clause.
Factors courts weigh when reviewing a non-compete
Courts generally look at whether the agreement is reasonable and necessary. Common factors include:
- Scope and duration: Is the restriction limited to a reasonable time and geographic area?
- Industry norms: Are non-competes standard in this field?
- Consideration: Did the information recipient receive something valuable in exchange, such as a job offer, promotion, or payment?
- Specificity: Are the restricted activities clearly defined?
- Legitimate business interest: Does the information provider have a real interest to protect, such as trade secrets or client relationships?
If a non-compete is overly broad, some courts will scale it back to a reasonable level. Others will throw it out entirely.
It’s important to note that the focus must be on genuine competition with the disclosing business. A non-compete clause typically can’t be used to prevent an ordinary employee from going to work for a competitor. At the executive level however, such a restriction might be reasonable.
State-by-state enforceability
State rules vary widely. A few examples include:
- California: Non-competes for employees are void, with narrow exceptions for business sales.
- Minnesota: Bans most non-competes signed after July 1, 2023.
- Oklahoma and North Dakota: Prohibit most employee non-competes by statute.
- Most other states: Allow non-competes if they're reasonable in scope, duration, and geography.
Some states also require specific notice periods or extra consideration when a non-compete is added to an existing job.
What happens if you break a Non-Compete Agreement?
Breaking a Non-Compete Agreement can lead to several consequences, depending on the state and the terms of the contract:
- Injunction: A court order stopping you from continuing the competing activity
- Monetary damages: Payment for financial harm caused to the former employer or party
- Legal fees: Some agreements require the losing party to cover the other side's legal costs
- Reputational impact: A public lawsuit can affect future job prospects
Before pursuing court, some businesses send a Cease and Desist Letter asking the other party to stop the competing activity.
The outcome often hinges on whether the agreement is reasonable and whether the state enforces non-competes. In states like California, an employer would have a hard time collecting damages against a former employee.
Key components of a Non-Compete Agreement
A well-drafted Non-Compete Agreement usually includes the following:
