A covenant not to compete is a contractual agreement that one party will not go into business in competition with the other party. Historically, covenants not to compete have been used in two main situations:
- Employment Contracts – Employers often have employees sign agreements stating that after leaving the company the employee will not go to work for the company’s direct competitors. This is done to protect trade secrets and business strategies.
- Sale of Business Contracts – When purchasing a business, the buyer will often have the seller agree not to form another business in competition with the buyer.
Agreements in both situations can be enforceable, however there are much stronger limits on restrictions in employment agreements. In both situations the limits must be reasonable.
The enforceability of a non-competition covenant in a franchise agreement will sometimes depend on whether the court views a franchise contract as a sale of business or an employment relationship. Most courts have found that it is closer to a sale of a business since no side has a significantly stronger bargaining position, and therefore allow more significant restrictions with covenants not to compete.
In other cases, the courts will only look to determine if the agreement is reasonable based on its terms and the interests of the parties. Also, some states have statutes that impact the enforceability of agreements not to compete.
The rules on covenants not to compete can be very complex and difficult to understand. It is important in writing a covenant to be sure that is is something a court will enforce. An experienced business attorney can help you determine the applicable law in your area and help in drafting an agreement or in reviewing an existing contract. A lawyer can also represent you in court if needed.