Can You Enforce The Unenforceable? Three Ways Courts Can Respond To Overlybroad Noncompete Clauses
Covenants not to compete are one tool used by employers and buyers of a business to protect valuable business assets. To learn the basics on covenants not to compete, read our noncompete article from February. It is important to keep in mind that the drafting of noncompetes, whether in the employment context or in connection with the sale of a business, is not a “one-size fits all” process. If you are drafting, seeking to enforce or trying to contest a covenant to not compete, you need to know more than whether the covenant is enforceable as written. You also need to understand how the law governing enforcement of the noncompete may or may not allow a court to respond if faced with an overlybroad noncompete.
There are three general approaches:
- The court refuses to enforce the noncompete. This is often called the “red pencil” rule and is the minority rule. A handful of states (including Nebraska [1]) follow this approach.
- The court strikes out the portion(s) of the covenant that are unreasonable and enforces the “edited” covenant. This is called the “blue pencil” rule. Note, here the court will not write into the clause new or modified terms, but will enforce the remaining portion of the “edited” clause.
- The court rewrites the noncompete covenant to be consistent with the parties’ intent and the law of the state. This is referred to as “reformation.” This is the approach taken by a majority of states (including Iowa).
To illustrate how each of these rules work, imagine that we have a covenant not to compete ancillary to the sale of a business for two years within Nebraska, Iowa and Kansas. The business has customers and operations in Nebraska and Iowa, but the business never operated in Kansas and has no ties to Kansas. If the court considers two years to be a reasonable duration, and that a geographic scope covering the states of Nebraska and Iowa is reasonable, how will the court respond to the inclusion of Kansas in the covenant?
- “Red Pencil” States: If the inclusion of Kansas makes the scope of the covenant overly broad, the entire covenant would be unenforceable, and the court would refuse to enforce the noncompete. This means that the seller would no longer be bound by the noncompete covenant and would be free to compete with the buyer. The buyer would be deprived of the full benefit of the bargain that the buyer (likely) paid for as part of the purchase price.
- “Blue Pencil” States: If Kansas was deemed to be overlybroad, the court would strike out the reference to Kansas and would enforce the covenant as modified (i.e., for two years within the states of Nebraska and Iowa).
- “Reformation” States: Let’s say the business never operated in Kansas but did conduct business in Missouri. The court in a “reformation” state could modify the covenant to delete Kansas and insert Missouri in its place; thus, the covenant not to compete would be enforced for two years in Nebraska, Iowa and Missouri.
To add further complexity, “blue pencil” and “reformation” states differ on whether the court must modify, or whether it may choose to modify or refuse to enforce, an overlybroad noncompete. Given the important role that these covenants play in protecting legitimate business interests, it is crucial to engage experienced counsel when drafting and making choice of law decisions in connection with an employment agreement or the purchase of a business.
COVID-19 and the resulting layoffs have spurred an increase in litigation by employees challenging the enforceability of noncompete agreements with their former employers. Now is a great time to review and evaluate the enforceability of restrictive covenants that may be present in your employee onboarding materials. And if you are considering buying a business or are in the process of negotiating a letter of intent, pay close attention to the terms of a noncompete. Failure to have a carefully drafted covenant not to compete can have a devastating impact on your business.
[1] Note that there is only one scenario in which a Nebraska court will modify and enforce an overlybroad noncompete. The Nebraska Franchise Practices Act requires courts to modify an overlybroad noncompete within a franchise agreement. Nebraska courts will not modify (and will refuse to enforce) an overlybroad covenant in the sale of a business or employment context.
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