Employers do not want employees they have trained and provided with proprietary business information to leave and go to work for competitors. Buyers who purchase businesses do not want the sellers to start new, competing businesses. Thus, employment and sale-of-business agreements often contain noncompete covenants. Such covenants may or may not be enforceable, and the answer may depend on the state in which the agreement is executed and performed.
Some states are far more restrictive than others with regard to the enforceability of noncompete covenants, and this creates issues for interstate businesses. For example, which state’s law governs an agreement between an employee who lives in Florida but whose job mainly involves work in Georgia and Alabama and a company that is headquartered in New York but does business nationwide? The answer is often unclear and the subject of litigation.
States vary widely both in their willingness to enforce noncompete agreements and in their remedies if such an agreement is deemed unenforceable. California prohibits almost all noncompetes and is the state most favorable to employees. Oklahoma, North Dakota and Colorado are also deemed “employee friendly.” Michigan and New York, in contrast, are generally considered to be more “employer friendly.” Florida, like most states, provides generally that noncompete agreements may be enforced, as long as they are reasonable with regard to time and geographical area, and protect a legitimate business interest of the employer. However, different states and courts have differing interpretations of what is “reasonable” and “legitimate.” For example, the Florida Supreme Court has recently resolved a circuit court split and held that a home health services provider has a legitimate interest in requiring a noncompete covenant to prevent departing employees from diverting client referral sources (e.g., physicians and hospitals) to competitors, as in White v. Mederi Caretenders Visiting Services of Southeast Florida, __ So. 3d __ (Sept. 2017).
If a particular provision within a noncompete is deemed unenforceable, some states will deem the entire noncompete agreement unenforceable (red pencil), others will strike just the offending clause (blue pencil), and yet others will rewrite the noncompete entirely (purple pencil or reformation). For example, if the covenant prohibits the employee from working for a competitor anywhere in the United States, such an extensive geographical restriction will often be deemed unduly broad. A red pencil state would hold the entire noncompete unenforceable for this reason alone. A purple pencil state would reform the contract and limit the geographic restriction to a more reasonable, smaller area where the employer actually needs protection. What about a blue pencil state? The blue pencil doctrine only allows the court to cross out the invalid provision. North Carolina is a blue pencil state, and its supreme court has recently held that the doctrine must be applied strictly. Thus, because a provision prohibiting competition in North Carolina and South Carolina was deemed too broad, and since putting the blue pencil through this geographic limitation provision left the noncompete with no geographic limit at all, the agreement was completely invalid. Beverage Systems of the Carolinas v. Associated Beverage Repair, 784 S.E.2d 457 (N.C. 2016). Parties can prevent this result by drafting the covenant with severable “step-down” provisions that provide for increasingly lesser restraints of time or territory to ensure the survival of at least some degree of restraint on competition.
Employers and business buyers also attempt to protect themselves by including: a choice-of-law provision specifying that the laws of an employer-friendly state, including that state’s choice-of-law rules, will govern the agreement, and a choice of forum provision requiring litigation or arbitration in such a state. Such provisions are important but they do not always work, as the choice-of-law and forum-selection clauses may be deemed unenforceable as contrary to the state’s public policy. For example, in Cardoni v. Prosperity Bank, 805 F. 3d 573 (5th Cir. 2015), a Texas bank attempted to enforce noncompete agreements against employees of an Oklahoma branch who had left to work for a competitor. The agreements contained a Texas choice-of-law clause. Texas law is more “employer-friendly” on noncompetes than Oklahoma law is. The Fifth Circuit refused to enforce the Texas choice of law provision, because “Oklahoma has the more significant relationship with the parties as well as a greater interest in whether the covenants are enforced” and “the chosen Texas law would contravene a fundamental policy of Oklahoma.”
There does not appear to be a trend one way or the other with regard to noncompete agreements—some states are making them more difficult to enforce, while others are doing the opposite. And there are splits of authority within particular states. In light of the wide interstate variations and the potential minefields, employers and business buyers need to draft noncompete agreements and companion choice of law and choice of forum provisions with great care.