What Is a Non-Compete Agreement? Its Purpose and Requirements

What Is a Non-Compete Agreement?

A non-compete agreement is a legal agreement or clause in a contract specifying that an employee must not enter into competition with an employer after the employment period is over. These agreements also prohibit the employee from revealing proprietary information or secrets to any other parties during or after employment.

Many contracts specify a certain length of time when the employee is barred from working for a competitor after they end employment. Employers may require employees to sign non-compete agreements to keep their place in the market. Those required to sign these agreements may include employees, contractors, and consultants.

The validity and enforcement of a non-compete vary by jurisdiction and may require the former employer to keep paying the ex-employee a base salary during the non-compete period.

Understanding Non-Compete Agreements

Non-compete agreements are signed when the relationship between employer and employee begins. They give the employer control over specific actions of the employee—even after that relationship ends.

These agreements have specific clauses stating that the employee will not work for a competitor after their employment is over, regardless of whether they are terminated or resign. Sometimes, employees are prevented from working for a competitor even if the new job wouldn't involve disclosing trade secrets.

Some contract terms may include the length of time the employee is bound to the non-compete agreement, the geographic location the employee may work in post-employment, or the market they may work in. These agreements may also be called a "covenant not to compete" or a "restrictive covenant."

Non-competes ensure the employee will not use information learned during employment to start a business and compete with the employer once work is over. It also ensures the employer keeps its place in the market.

Components of a Non-Compete Agreement

Non-compete agreements are generally not standardized, but many have similar restrictive elements. Some of the components you might see in a non-compete agreement are:

• Duration: Non-compete agreements cover specific time frames, such as six months or one year. Long-term agreements are prohibitively restrictive for employees because they can keep them from finding work after leaving an employer.
• Geography: Some agreements consider geographical location, prohibiting an ex-employee from working in specific areas for a set time.
• Scope: Non-compete agreements must specify the type of work or services that an ex-employee cannot provide. They should include information, techniques, procedures, and practices that are unique to the business or otherwise proprietary.
• Competitors: The competition must be defined in the agreement. The company doesn't need to list them all, but it should give a general idea of the industry and types of businesses the employee agrees to not work in.
• Damages: Employers define the damages they are entitled to if an employee breaches the agreement.

When and Why Are Non-Compete Agreements Used?

Businesses use non-compete agreements to protect their intellectual property, trade secrets, proprietary information, procedures used to produce their goods and services, or to maintain their competitive advantage.

If a contract were not in place regarding the disbursement of information to competitors, many businesses would lose their advantage. Ex-employees could legally use the information they obtained at one company to help a new employer gain an advantage. Additionally, an ex-employee might be able to start their own business using information acquired from another firm.

If this information is provided to competitors, a company might be forced out of the market and industry—this makes non-competes an essential part of the hiring process for many enterprises.

Industries That Use Non-Compete Agreements

Non-compete agreements are common in the media. For example, a television station might have legitimate concerns that a popular meteorologist may siphon viewers away if they began working for a rival station in the same area. This would be considered a reasonable cause to sign a non-compete agreement in most jurisdictions. Other industries where these agreements are typically found include:

• Financial services
• Corporate management
• Manufacturing
• Information technology

Legalities of Non-Compete Agreements

In the U.S., the legal status of non-compete agreements is a matter of state jurisdiction. States vary widely in their enforcement and recognition of non-compete agreements, and many state legislatures have updated legislation related to non-compete agreements.

Non-compete agreements cannot be enforced in North Dakota and Oklahoma. California does not recognize non-compete agreements, and an employer who binds an employee to one after employment is over can be sued. Hawaii banned non-competes for high-tech companies in 2015. In 2016, Utah changed legislation, limiting new non-compete agreements to only a year.

Most states adopt some sort of standard that a non-compete agreement must not be egregious in the length of time or geographic scope and shouldn't meaningfully restrict a worker's ability to find employment. However, jurisdictions differ widely in interpreting what terms of a non-compete agreement would be overly demanding.

Non-Compete vs. Non-Disclosure Agreements

Non-compete agreements are distinct from non-disclosure agreements (NDAs), which generally don't prevent an employee from working for a competitor.

Instead, NDAs prevent the employee from revealing information the employer considers proprietary or confidential, such as client lists, underlying technology, or information about products in development. 

Pros and Cons of Non-Compete Agreements

Pros Explained

• Protect trade secrets: These agreements can protect employers from employees leaving for a competitor and sharing proprietary information. That being stated, the agreements should be fair to both the employee signing the agreement and the employer who is issuing it.
• Inspire more innovations: Non-compete agreements can keep ideas and information from spreading, encouraging competitors to innovate to keep up with other businesses.
• Used for employee matchmaking: A non-compete agreement may be used to match employers with employees who plan on staying put in a job or prize being trusted with valuable information.
• Reduce worker turnover or exit: Non-competes can reduce employee turnover because they tend to restrict other employment options. Additionally, businesses with non-competes may need to provide training and education for their employees to continue innovating, benefiting their careers and market value.

Cons Explained

• Weaken employee bargaining power: Workers are prohibited from seeking a better paying position or bargaining for more pay or benefits when under a non-compete.
• Wait time for a new job can be significant: Non-compete wait periods may keep employees who decide to leave from finding meaningful employment in their fields of expertise. Employees who sign non-compete agreements may leave their industry entirely if it is too hard to find a new job after signing one.
• Few social benefits: Non-competes generally only benefit the company, not providing much in the way of social benefits for employees.
• Can restrict employees without trade secrets: The U.S. Department of the Treasury's Office of Economic Policy reported that less than half of workers under non-compete agreements have trade secrets. Unfortunately, this means that more than half of workers under non-compete agreements are unnecessarily restricted by these clauses, further hampering their ability to bargain.

The Bottom Line

Signing a non-compete agreement may not always be in your best interest, but it's usually in the best interest of your potential employer. It helps to talk to an employment attorney before you sign one for clarification on your state's laws and consider the possibility that you may have difficulty finding work in your field if you leave your position.

Not all states uphold non-compete agreements, but some do, making it worthwhile to know ahead of time how a non-compete agreement might play out if you leave your job or break your agreement.