Non-Compete Agreement Basics for Small Business Owners

Non-compete agreements (or Non-competition agreements) are used in contracts to prevent one party from directly competing with another party in the same industry or profession. You’ll typically see them in employment agreements to prevent employees from using a company resources or information to benefit competitors. Or worse, to harm their employer. Yikes. This past July, the Biden administration issued an executive order “to curtail the unfair use of Non-compete clauses that may limit work mobility” in order to promote competition in the economy. And it’s true, Non-compete agreements can affect a person’s ability to make a living, which makes prospective employees hesitant to sign them. That’s why it’s important for small business owners to understand the basics of Non-compete agreements so that they and their lawyers can create contracts that work for everyone.

Non-Compete Agreements must be reasonable

Michigan courts view Non-compete agreements as restraining or preventing commerce. As a policy matter, we want as few restraints on commerce as possible to promote economic growth and competition. To determine whether a Non-compete is enforceable or not, Michigan courts evaluate how reasonable the provision is in order to avoid unnecessary restraints on commerce. Reasonableness of Non-competes hinges on several factors that I’ll discuss below.

Protect Reasonable Competitive Interests

Employers can’t arbitrarily prevent an employee from working for a direct competitor just because they are in competition. A Non-compete agreement may be appropriate when the employee has access to information or resources that the employer has a reasonable competitive interest in protecting. This could include proprietary knowledge, trade secrets, customer lists, or financial information. Ever wonder what’s in the McDonald’s Big Mac sauce? So does Burger King. How about the algorithm that allows YouTube to curate your favorite cat videos? Vimeo might want to learn about that one, too. Non-competes are good tools to prevent this non-public information from disclosure in order to protect that competitive business interest.

Set Reasonable Geographic Limitations

Employers should set reasonable geographic limitations when using Non-competes. Let’s take the example of a Michigan business owner that only serves Michiganders. A court might find it unreasonable for the business owner to require their salespeople to sign Non-competes that cover a national territory. Whereas a global technology company might require a larger geographic scope in their Non-compete agreements to adequately protect their business interests. The bottom line is that geographic limitations should correspond to the realities of the business.

Create a Reasonable Time Period

Non-competes can’t last forever. People have to eat after all. The type of industry and business interest ultimately informs how reasonable the time period is for the Non-compete to be enforceable. Faster-paced industries generally have shorter time horizons and vice versa. It’s important to retain a lawyer with industry-specific experience to determine what time horizon is appropriate for your business.

Non-Compete Agreements must prevent irreparable harm

There are some things money can’t buy and legal damages in a Non-compete case is one of them. The business interest the employer wants to protect must be so valuable that the company would not be able to repair the damage if it were to be disclosed. The top secret formula for Coca Cola is a great example here. An employee disclosing the formula to a competitor could cause a copycat beverage to surface and seriously diminish Coca Cola’s competitive position in the market. If some individual or entity could pay a settlement to make those companies whole after improper disclosure, then the harm to the business is not irreparable.

Different Parties, Different Standards

It’s important to understand the type of parties involved when enforcing a Non-compete. In this article, I’ve primarily discussed Non-competes in employer-employee relationships. Businesses that contract with other businesses can also use Non-competes. However, those agreements are held to different standards than employment agreements. Thus, the intent and scope of the Non-compete must be tailored to the specific parties to the agreement.

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<em>About the Author</em>
About the Author

Joseph Shanley serves as the Principal Attorney and Consultant for Awen Innovations, LLC. Click the button below to learn more about Joe and how he could help you fulfill your business dreams.