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Fairfax Circuit Court Strikes Down Noncompete as Overbroad - Part 2
April 28, 2014
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Money Sign Protected.jpgPart 1 of this post discussed a suit brought by Wings LLC to enforce a noncompete against two defector employees. The letter opinion said that the noncompete was unenforceable. In this post, I examine the role of noncompetition agreements and when other agreements may be better options in cases such as this one.

The Role of Noncompetes – Protecting the Investment

A closer look at this case also reveals a common misunderstanding about the purpose of noncompetes. Put simply, a noncompete is designed to protect a business from losing its investment. This can be seen most clearly in the context of a business sale. When one person buys a Pizza Hut franchise from its owner, the person also “purchases” the customer market that comes with it. If the former owner then opens a Little Caesar’s across the street, the purchaser’s investment is severely compromised in the form of lost customers and lost profits. A noncompete prohibiting the former owner from engaging in the same or similar business within the customer market for a sufficient period of time will help protect the purchaser from being undermined by immediate competition. And it prevents the seller from double-crossing the purchaser by profiting twice—once from the sale of the Pizza Hut and again from the profits made from Little Caesar’s.

Similarly, when an employer invests in an employee for purposes of maintaining its competitive edge, it does not want to lose that edge to a competitor after the employee leaves. Here, the noncompete is designed to prevent the former employee from using the employer’s investment for personal profit, either individually or on behalf of a competing business (for which the former employee likely will be handsomely rewarded). With a noncompete, the employer’s investment is protected from being leveraged by a competitor. The employee is permitted to take another job, but not for purposes of using the employer’s investment against it.

When Is a Non-Solicitation and Confidentiality Agreement a Better Option?

When the issue is mainly preserving an employer’s customer base, a noncompete is not always the best vehicle. This is because of the legal restrictions placed on noncompetes such as the requirement of a reasonable geographic range. Customers can be located all over the world but that is not always equivalent to the principle of protecting a business’s legitimate interest in its investment. For example, an employer with a customer base in Maryland and Virginia has no real interest in Ohio. If its employees move to Ohio and perform similar jobs, there should be no legal penalty against the employees. Thus, a noncompete prohibiting an employee from taking the same or similar job in Ohio almost certainly will be held unenforceable. Likewise, if an employer has customers in Ohio, but only occasionally conducts business with those customers, or the breadth of the customer base is very narrow, its interest in Ohio is too small to have a noncompete covering the entire state.

The better option in both cases is to execute a non-solicitation and confidentiality agreement. A non-solicitation and confidentiality agreement bridges the “investment” gap by preserving the employer’s customer market without succumbing to the legal limitations of a noncompete. Wings had a non-solicitation agreement but also relied on its noncompete agreement. The noncompete was overbroad, but stronger non-solicitation and confidentiality agreements would protect a company from losing its customers to a competitor, which was the real loss Wings seemed to have suffered. It would also protect against the improper use of Wings’ confidential business information that gave it a competitive edge in the market, preventing Capitol Leather LLC from using Wings’ former employees to undermine Wings’ business. A separate non-solicitation and confidentiality agreement would ensure that, even if a noncompete fails, the restrictions on pilfering customers and using an employer’s strategic information against it would remain intact. When drafted well, these agreements preserve fair competition even if former employees move to a competitor.

Using Restrictive Covenants Smartly

Although disfavored, noncompetes in Virginia are still enforceable. The key is to use restrictive covenants smartly. Employers should consider using noncompetes for protecting their business investments against unlawful competition, but consider relying more on non-solicitation and confidentiality agreements to protect their actual competitive position. Understanding when and how to use both can mean the difference between a triumphant victory in court over a costly loss.