How to Draft an Enforceable Non-Competition Agreement
By Ned Sackman
Trends in the New Hampshire trial courts have signaled changes in the area of non-competition agreements. If employers do not pay attention to what is happening, they run the risk of rendering existing non-competition agreements useless.
A recent New Hampshire Superior Court order suggests that a court may infer that an employer has acted in bad faith by trying to enforce an overbroad non-competition agreement. As a result, the court may conclude that the entire agreement is unenforceable. Courts have traditionally dealt with overbroad non-competition agreements by reforming the agreements to what the law allows. Because employers have no way to test the enforceability of non-competition agreements without litigation, an employer may not find out that its agreements are unenforceable until it is too late.
The Superior Court case demonstrating this risk involved a financial advisor employed by a firm that was later acquired by a company based in Concord, New Hampshire in 2009. See Granite Investment Advisors, Inc. v. Timm, No. 2013-CV-00094, March 28, 2013. When the financial advisor initially was hired in 2008, he was offered a flat salary and was not required to sign a non-competition agreement. He continued to work under this arrangement for the Concord based firm. Five months after the acquisition, the Concord based firm presented him with a non-competition and non-solicitation agreement, and told him that he would continue to be paid on a salaried basis. The agreement provided that, for a period of two years following his separation of employment, the advisor: (1) could not solicit any client or prospective client of the firm; and (2) could not engage in a competing business within 75 miles of the Concord firm’s office. After the advisor signed the non-competition agreement, the firm changed his compensation arrangement from a salaried to a commission structure, which resulted in the advisor’s pay decreasing. Eventually, the advisor resigned and went to work for a competing financial firm in Massachusetts that was just inside the 75- mile radius in his non-competition agreement. His former firm sued the advisor in New Hampshire Superior Court to enforce the agreement and prevent the advisor from working for his new employer.
The Superior Court began its analysis of the Concord firm’s claim by recognizing that, while non-competition agreements are generally disfavored as a matter of public policy because they restrain free trade and markets, they are enforceable under New Hampshire law to the extent that their purpose is to protect a recognized legitimate employer interest. One such interest was the firm’s need to prevent the advisor from using information learned about the Concord firm’s clients to entice these clients to move business to his new employer. Although the non-solicitation provision in the advisor’s agreement protected this interest by prohibiting the advisor from soliciting current clients, it also precluded the advisor from soliciting any of the Concord firm’s prospective clients. The Superior Court concluded that the prohibition on prospective customers was unenforceable under established New Hampshire Supreme Court precedent.
The Superior Court then turned to the question of how much of the non-solicitation provision to enforce as it applied to existing clients. What the court did next is the most dangerous part for New Hampshire employers: While the court recognized that a court may reform, or “blue pencil,” an overbroad non-competition agreement by narrowing it to the extent of the law, the court also explained that an employer must show it acted in good faith before a court will do so. The court relied on the overbreadth of the agreement in considering whether the employer acted in good faith.
The judge decided that the employer had failed to establish good faith for two reasons. First, the non-solicitation provision drafted by the firm to cover prospective clients was overbroad under settled New Hampshire law. Thus, the firm should have known that it could not insist on this type of restriction, and the firm’s decision to go forward with such a provision despite the clear law to the contrary suggested the firm was acting in bad faith. The court inferred from the employer’s failure to know the law—or failure to update its agreements when the law changed—that it had acted in bad faith and declined to enforce the agreement altogether.
The Superior Court’s second reason for concluding the firm had acted in bad faith should give employers pause as well. The court was troubled by the fact that the firm presented the advisor with the agreement five months after he began his employment. In that context, the agreement became a requirement for keeping his job. The court observed that, where an employee is required to sign a non-competition agreement to retain a job he already has, the employee’s ability to bargain over the terms of the agreement is at its weakest because the employee will want to keep his or her job. This conclusion makes it difficult for employers to require existing employees to sign non-competition agreements because such action may be judged an act in bad faith.
Recent New Hampshire statutory law (which did not apply to this case because the events happened before the law went into effect) also reflects the concern about uneven bargaining power in the negotiation of non-competes. In 2012, the N. H. Legislature enacted N. H. RSA 275:70, which requires an employer to provide a copy of the agreement before or at the time an offer of employment is made, or at the time an offer of change in job classification occurs. The statute does not address whether a non-competition agreement presented to an employee during employment and when there is no prospective change in job classification (which the statute does not define) will be enforceable. Attorneys for employees have started claiming that the law demonstrates a legislative articulation of public policy against employers requiring employees to sign non-competition agreements after employment has begun.
There are two lessons for employers from these recent developments: First, do not overreach when drafting non-competition agreements. An employer’s default to draft broadly and assume the courts will sort it out is likely to backfire because insistence on overbroad provisions may lead a court to throw out the entire agreement. Second, employers need to consider the need for a non-competition agreement in advance of hiring so the agreement can be presented as part of the initial hiring package. Employers should review with counsel the need for a non-competition agreement in advance of hiring so that the agreement can be presented as part of the hiring package.
The law is unclear as to what an employer will be able to lawfully do to protect its legitimate business interests if its current non-competition agreements are overbroad. Prior to the enactment of RSA 275:70, employers could amend terms of the agreement and offer an employee consideration in exchange for his or her agreement to the revised terms. It is now less certain that such amendments are enforceable. Employers should consider other ways to protect confidential information and reduce the likelihood that an employee would leave to join a competitor. Such measures may include preventative steps to limit the number employees privy to confidential information, a change in the manner in which confidential information is protected, and incentives designed to retain employees, such as company loyalty programs.
Ned Sackman is a member of Bernstein Shur’s Business Law, Labor and Employment and Litigation practice groups. His practice focuses on intellectual property and complex commercial litigation, including representing companies in actions brought to either enforce or challenge non-competition agreements. Contact Ned at email@example.com or 603 665-8844.