Are Non-Compete Provisions Still Enforceable? [Part 1]

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As a Hispanic business owner when it comes to non-compete provisions, it pays to know your stuff

Here’s a hypothetical: Jose manages a Hispanic business with expertise in  software development in New York—Pharma Software Solutions Inc. (“Pharma Software”) — providing Enterprise Resource Planning (“ERP”) software to the pharmaceutical industry. One of his highest-ranking employees, Carlos, is a software engineer. Over the last few months, the relationship between Jose and Carlos has become very rocky. Jose sought to increase Carlos’s responsibilities but did not meet Carlos’s demands for a pay raise.      

Additionally, Carlos and Jose were increasingly seeing things differently: Carlos was advocating for hiring more engineering staff and decreasing the number of complex client projects. Jose, on the other hand, didn’t want to hire new employees, believing that this would just hurt his bottom line, and that decreasing complex projects would undermine the company’s niche reputation in developing custom-made solutions.      

At some point, the friction between Carlos and Jose came to a head, prompting Carlos to resign.

In short order, Carlos joined another company, Software Health Solutions Inc. (“Software Health”), a California-based company. Software Health also sells ERP software, but to health management companies, not to pharmaceutical companies. 

Angry at Carlos for leaving, and concerned that Carlos would help Software Health compete with his old company  in the pharmaceutical space, Jose unearthed Carlos’s employment agreement with Pharma Software. The agreement had a section that read as follows: 

“For the term of this Agreement and for 24 months thereafter, the Employee will not engage, directly or indirectly, either as proprietor, stockholder, partner, officer, employee or otherwise, in a business which distributes enterprise resource planning software solutions comparable to those provided by the company.”

Jose’s legal expert, Saul, made the following points:

Non-compete provisions are governed by state law, so the first thing an employer should do is to find out how local state law views the validity and enforceability of non-compete provisions. States like California have come to view non-compete provisions as restraints on trade and, for the most part, unenforceable.

States like New York, on the other hand, do not completely reject non-compete provisions but restrict their use.

In a recent memo released by the New York State Attorneys General’s Office (February 2022), for a non-compete to be considered valid, it must (i) be necessary to protect the employer’s legitimate interest, (ii) must not impose an undue hardship on the employee, (iii) must not harm the public, and (iv) must be reasonable in terms of its geographic scope and term of application.

The New York State Attorney General’s memo clarifies that a court may compel an employee to comply with certain parts of a non-compete and not with others:

  1. Even though Carlos was employed in New York and his employment was governed by New York law, Saul took pause at the fact that Carlos was now employed by a California company in California. Would it be possible to enforce a New York non-compete in California? Saul urged Jose to confer with a California attorney to be sure but cautioned Jose that there was a good chance that a California court would not enforce such restriction based on its violating California’s public policy prohibiting restraints on trade.
  2. Additionally, Saul was not sure that, even under New York law, the restrictive covenant was enforceable or, at least, not completely enforceable. He pointed out, for example, that while Carlos had been exposed to Pharma Software Solutions’ proprietary technology, that Software Health was not in a competing business, providing a different type of ERP software for use in the health management industry, so that the restriction might not be considered necessary to protect the employer’s legitimate interest. Saul thought that a Court could credit the argument that while Software Health was not presently in the business, Carlos’s knowledge about Pharma Software’s products could empower Software Health to move into a more competitive line of business, but then considered that this risk was better addressed by the employment agreement’s Confidentiality/Non-Disclosure provision, which was more likely to be enforceable nationwide.
  3. On balance, Saul was skeptical that the non-compete restriction was enforceable under New York law and that, even if it were, a court would likely limit the restriction significantly because precluding Carlos from working for any company developing ERP software for a period of 2 years on a nationwide basis would likely be considered an undue burden on the employee. 

In sum, while Saul encouraged Jose to obtain an opinion regarding the enforceability of the non-compete in California, he was guarded in advising Jose that a lawsuit was feasible. Saul also pointed out that, in addition to the complexities that would be involved in litigating a case across state lines, on the federal level, there was a movement afoot to invalidate non-competes as a matter of federal law. In January 2023, the Federal Trade Commission opened for public comment a regulation that purported to ban employers from imposing non-competes on their workers. The upshot, advised Saul, was that there has been increasing momentum to make it difficult for employers to require their employees to abide by non-competes unless a very significant interest, like the protection of a trade secret, is at stake.

Only time will tell whether non-compete provisions will survive or become legal relics of a bygone age.       

Related Content:

Entrepreneurs: What is the Best Way of Obtaining the Legal Advice You Need?

How to Address the Costs of Legal Services for Your Business

When Is an Oral Contract a Legally Binding Agreement?

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