What is a Non-compete Agreement?

Non-compete agreement
Non-compete agreement. Paul Giamou/Getty Images

Non-compete agreements are becoming more common in U.S. hiring agreements. In fact, as reported in 2015 by The Verge, Amazon requires temporary employees to sign a non-compete agreement in which they agree that "they will not work at any company where they "directly or indirectly" support any good or service that competes with those they helped support at Amazon." 

So what are non-compete agreements anyway? And are they legal? 

Non-compete agreements are commonly misunderstood agreements and are often unenforceable.

Let's look at the non-compete agreement and see what it's intended to do in business situations. 

Non-compete agreements are a specific form of restrictive covenant (that is, an agreement which restricts someone or keeps someone from doing something). They are sometimes called "covenants not to compete." 

This type of agreement may not be a separate document, but might be a clause or section in a larger agreement. For example, you might find a non-compete clause in an employment agreement. 

What is a non-compete agreement

A non-compete agreement, like it sounds, is an agreement by someone not to compete with someone else. Non-compete agreements come in two varieties (with an example for each): 

  • An agreement by an employee not to compete with an employer or former employer by setting up a competing business. One common example in this case is a technical employee who has knowledge of a specific area of a company and who uses that knowledge to form a competing business. 
  • An agreement by someone selling a business not to compete with the buyer of that business. In this case, Seller A is selling a professional practice (let's say a dentist) to Buyer B. Buyer B wants to prevent Seller A from setting up a competing business down the street and taking all of the patients, leaving Buyer B without a patient base. 

    Non-compete agreements vs. non-solicitation agreements vs.non-disclosure agreements

    Non-compete agreements are often confused with two other types of agreements typically found in employment contracts. Some contracts contain all three types of  agreements.  

    Non-solicitation agreements: In contrast to a non-compete, a non-solicitation agreement is an attempt to prevent a former employee, partner, or owner from soliciting customers and employees of the former company.

    Non-disclosure agreements: Non-disclosure agreements prevent an employee or an independent contractor or anyone having access to confidential information from disclosing that information to others. 

    Note that non-solicitation agreements and non-disclosure agreements may be required of anyone working for a business in a contract situation or other relationship, not just employees. 

    Read more about non-compete agreements vs. non-disclosure agreements and non-solicitation agreements. 

    Why Non-compete agreements are required 

    In an employment agreement, a non-compete is included to prevent the employee from leaving the company and stealing customers for his or her new business. In this case, an employee should not be able to take customers away from the primary business.

     

    A non-compete in a business sale is designed to prevent the former owner from opening up a competing business down the street and taking the business customers.

    A non-compete clause is often included in a partnership agreement for the same reason - to keep a former partner from opening a competing business. In the case of the dental practice, for example, Buyer B doesn't want Seller A, an experienced dentist with a large practice, from setting up a competing practice down the street and stealing all of Buyer B's patients. 

    Restrictions in a non-compete agreement

    A non-compete agreement imposes restrictions of three types:

    • Time    A non-compete restricts someone from opening a competing within a certain time period.
    • Distance   A non-compete also restricts someone from opening a competing business within a certain distance from the original business.
    • Type of Business
      Non-competes also restrict businesses from similar types from competing with former businesses.

     Enforcing non-compete agreements

    Non-compete agreements are difficult to enforce, because they may unduly restrict someone from legitimately going into business. Reasonableness is decided by a court of law (or mediation/arbitration) and according to the laws of a specific state.Some states, like California, do not allow non-compete agreements, while other states are more lenient. It is difficult to predict the result of a dispute relating to a non-compete agreement.

    If you are presented with a non-compete agreement to sign, you should check with your attorney before signing.