Non-Compete Pacts: An All-or-Nothing Bet (Joseph F. Kolb Commentary)

You operate a small business. You’ve spent three years developing a business process that gives you a competitive edge. You’re considering hiring a new employee or bringing in an equity partner. But you’re afraid that your new hire will stick around just long enough to learn the business, then quit and open his own shop down the block.

How do you protect your business from an employee or partner who may be eager to profit from your hard work?

Non-compete agreements or "covenants not to compete" may be an answer. They’re one way to limit what employees or partners can do with certain information, specialized training or processes they learn on the job. But be aware. Not all non-compete agreements are enforceable. Care must be taken to draft them in a way that complies with the requirements of Arkansas law or they could be wholly unenforceable. Here’s an overview of what you need to know.

As a concept, we Americans value the free-market notion of competition. It should be no surprise that non-compete agreements have generally been disfavored by our courts. Early on, judges recognized that public policy favors competition and will not allow someone to simply buy off potential rivals.

As a result, courts originally presumed non-compete agreements to be invalid and uniformly declared them unenforceable. Their position softened over time, however.  Now Arkansas courts hold that the presumption that a non-compete is an impermissible restraint on trade can be overcome if you show that the agreement is "reasonable."
How do you determine what’s reasonable? It depends on the facts of your case. But courts have articulated at least four clear requirements.  

First, for a non-compete to be reasonable, you must have a legitimate business interest to protect. That interest must be more than just a desire to prevent competition. It’s OK for an employee to use at her new job the general experience she gained while working for you. If, however, you’ve entrusted her with something more than just general experience, you have a right to protect it. For instance, if you’ve given her access to your trade secrets or specialized training, you have a legitimate business interest to protect.

Second, the business activity you’re trying to restrain must be in direct competition with your business. If you use a non-compete to restrict an employee from engaging in a complementary business, it will be held unreasonable and unenforceable. For example, if you’re a wholesale pencil manufacturer, you can’t restrict your former partner from starting a business selling pencils at retail.

Third, the duration of a non-compete must be reasonable in relation to the business interest you’re trying to protect. Let’s say your goal is to prohibit a former employee from using your customer list. The key question will be, when will that list lose the greatest part of its value in terms of giving you a competitive advantage? The duration of your non-compete should correspond to that period.

Fourth, the geographic scope of your agreement must also bear some rational relationship to the business interest you’re trying to protect. If your company does business exclusively in Arkansas, a non-compete that prohibits a competing business in Missouri will be deemed unreasonable.

So here are the take-aways. To be enforceable, a non-compete must:
w Relate to a legitimate business interest, something more than just a general desire to limit competition;

• Restrict only business activities in direct competition with yours;
• Be reasonable in duration; and
• Be reasonable in geographic scope.

Here’s the catch: Non-competes are all-or-nothing bets. If a court finds, for example, that the duration of your agreement is unreasonable, it will declare the non-compete wholly unenforceable. So it’s essential that you get it right the first time.

(Joseph F. Kolb is a member of the Business & Corporate Law Practice Group at the Barber Law Firm of Little Rock.)