Covenants not to compete, also known as noncompete clauses, have taken on greater significance in the Inland Northwest as the region builds on white-collar economic sectors, including medical care, finance, and technology. The proliferation of new business ventures in the area also demonstrates the need to protect novel or highly-specialized business interests.
In Washington state, covenants not to compete usually prohibit an employee from competing in the same field as their former employer for a set period of time and within a specific geographical area. Such covenants are typically applied to persons in professional and similar occupations, such as doctors, accountants, and insurance brokers.
While this article focuses on covenants not to compete in the employment context, such clauses also are used in the context of business ownership, such as between partners, shareholders, or franchisees. Indeed, covenants not to compete are more likely to be upheld by the courts when made reciprocal and attached to an equity stake in the business, as opposed to unilateral application to mere employees.
The purpose of a covenant not to compete is to protect the employer’s legitimate business interests. They may not be used solely to prohibit an employee from taking his or her skills elsewhere or to punish an employee who leaves the company. Legitimate business interests include protecting customer lists and client bases and maintaining confidentiality in the employer’s business model. Because covenants not to compete are meant to protect employers against the misuse of highly specialized or sensitive information, they typically don’t warrant application to unskilled or semiskilled workers.
Covenants not to compete are enforceable only to the extent that the restrictions imposed on the former employee are reasonable. This is a highly fact-specific and context-specific inquiry.
Generally speaking, courts are loath to uphold time restrictions of more than a few years. Acceptable time periods are often quite a bit shorter, depending on the circumstances.
Acceptable geographic restrictions are highly dependent on the circumstances. The geographic scope of a covenant not to compete can be quite extensive—perhaps even nationwide or international, when there is a need to protect the legitimate interests of a niche business with an extremely limited market. In most cases, however, the geographic restriction should be much more limited. Generally acceptable geographic restrictions may include limiting competition within a particular city or county, or within a few miles of the former employer’s place of business.
The degree to which a time-based restriction is reasonable may depend on the scope of the covenant’s geographical restriction, and vice versa. A covenant that attempts to cover an expansive geographical area will probably need to be shorter in duration than one which covers a smaller region.
Washington courts also will consider public policy in determining whether and to what extent covenants not to compete will be upheld. Some states have banned or severely curtailed the use of covenants not to compete on public policy grounds. In Washington, public policy concerns are balanced against the employer’s right to protect its business on a case-by-case basis.
Applicable public policy concerns include the restraint of trade that results from such covenants and the denial of public access to necessary services. Thus, in the case of vital and highly specialized services, covenants may need to be quite narrow in scope—especially in locations where the public has limited access to providers.
While covenants not to compete necessarily infringe on freedom of employment, the Washington Supreme Court has reasoned that they may still benefit employees when appropriately circumscribed. If covenants not to compete were disallowed, employers might be forced to severely restrict their employees’ contact with clients and access to sensitive business information.
Thus, covenants not to compete, like all contracts, represent a bargain of sorts—the employee is given access to clients and trade secrets in exchange for some protections to the employer.
Another area where Washington exhibits favor toward covenants not to compete is in judicial reformation of overly broad covenants. In some jurisdictions, an overly burdensome covenant will be held unenforceable. But in Washington, courts will enforce such a covenant to the extent that it’s reasonable.
Employers could consider a nonsolicitation agreement rather than a covenant not to compete. Those agreements require only that employees not solicit the specific clients of their former employer. They are more likely to withstand scrutiny than covenants not to compete, which typically prohibit all competition within a certain place and time. However, a former employer may never learn of the circumstances under which one of its clients went to a former employee, and proving breach of a nonsolicitation agreement can be difficult. Thus, covenants not to compete typically present a better option for an employer in situations where either agreement could apply.
Great care must be taken in drafting covenants not to compete. An attorney will need to evaluate such considerations as the type of business at issue, the characteristics of the area the business operates in, and the skills and duties of the particular type of employee. Overly broad covenants may subject your business to expensive litigation and the inclinations of a reviewing court.
Like all contracts, a covenant not to compete must be supported by adequate consideration. Essentially, this means that the employee must receive some benefit in exchange for agreeing not to compete. Having an employee sign a covenant not to compete at the time of employment will generally suffice, as the promise of employment can itself constitute sufficient consideration. But when a covenant not to compete is entered into after the employee has begun working, the agreement must be supported by new consideration. This could include such perks as a bonus, pay raise, or promotion.
Another area that requires care is in choosing whether to include and drafting an enforceable liquidated damages provision. Damages can be quite difficult to ascertain in the case of unlawful competition, thus making covenants not to compete especially qualified for liquidated damages. However, the amount of liquidated damages set in the contract must be reasonable; otherwise, a liquidated damages provision may constitute an impermissible penalty rather than an enforceable forecast of harm suffered from breach. An employer may also wish to include a provision awarding attorneys’ fees to the prevailing party in the event of litigation.
Other law may need to be consulted. The Uniform Trade Secrets Act may govern conduct even in the absence of a covenant not to compete. Other claims, such as tortious interference, may be implicated. Regional businesses may need to consult Idaho law, which applies different rules to covenants not to compete. Whether your business is drafting, subject to, or seeking to enforce a covenant not to compete, consultation with an attorney is important to protect your rights under the law.
Timothy J. Nault is an attorney in Spokane. He can be reached at email@example.com.
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