More and more states are enacting laws severely restricting or altogether banning non-compete agreements. During his campaign, President Biden even proposed to eliminate all non-compete agreements, “except the very few that are absolutely necessary to protect a narrowly defined category of trade secrets,” and an outright ban on all no-poaching agreements. So, are covenants not to compete still enforceable? The answer to this question varies depending upon individual state laws and whether the covenant was entered into ancillary to an employment relationship or the sale of a business. In Nebraska, the answer is yes for properly drafted agreements.
Just last month, the mayor of Washington, D.C. signed into law the “Ban on Non-Compete Agreements Amendment Act of 2020”, which bans agreements that would restrict a D.C. employee’s employment simultaneous with, and after the end of, their current employment. This “ban” is part of a larger trend of states making it more difficult to implement and enforce employment-related covenants not to compete. The D.C. law exempts noncompete agreements entered into in connection with the sale of a business, which is consistent with the approach taken by other states in distinguishing between restrictive covenants in connection with employment versus a sale of a business.
Covenants not to compete, also known as noncompetition agreements or noncompete clauses, are contractual provisions where the parties agree to not compete with each other for a specified time period in a particular geographic location or with respect to certain customers. These covenants are particularly common in two scenarios – the sale of a business and employment relationships. Generally speaking, covenants not to compete ancillary to the sale of a business are easier to enforce than covenants contained in an employment agreement. State law varies on the enforceability of these covenants (in both the sale of a business context and employment context), which is why it is crucial to engage counsel when you are negotiating or seeking to enforce a noncompete.
As a matter of public policy, courts have historically looked upon covenants not to compete with disfavor, and handful of states ban, or nearly ban, the enforcement of noncompete agreements altogether in employment relationships. Over time, courts have recognized that covenants not to compete in connection with employment can be legitimate if they serve a business interest other than the restriction of free trade, such as preventing unfair competition through the misappropriation of business assets.
Nebraska does not have a statute that governs noncompetition agreements ancillary to employment relationships generally. Accordingly, the common law of Nebraska courts governs these agreements. Nebraska courts have adopted a strict view of such agreements and have concluded that a post-employment restriction on an employee must be no greater than reasonably necessary to protect an employer’s legitimate interest (such as its goodwill, confidential information, or trade secrets). Traditional non-compete clauses with geographic restrictions are not allowed in post-employment restrictions on employees. Rather, Nebraska courts recognize only a narrow customer non-solicitation restriction, which must be properly limited to prevent solicitation of only those customers that the employee specifically did business with and had personal contact. It is critical that any covenant be properly drafted as Nebraska courts do not modify or “blue pencil” overbroad restrictions.
Sale of Business
As a general rule, a noncompete agreement executed in connection with the sale of a business is likely enforceable if it is reasonably limited in time, space and extent, and if it does not otherwise constitute an unreasonable restraint of trade or contravene public policy.
In Nebraska, covenants not to compete ancillary to the sale of a business will be enforced as long as the time and space limitations are found to be reasonable. Determining whether a restraint is reasonable depends largely upon the facts of each case and Nebraska courts have not implemented a concrete test to determine whether the restraints are reasonable. Typically, a geographic scope is reasonable if it covers only the area in which the business operates or has customers, and the duration of the covenant will generally be reasonable if it represents the “useful life” of the goodwill purchased by the buyer. So if a business has customers in all 50 states, a nationwide restriction may be reasonable, but if a business only has customers in Nebraska and Iowa, a Nebraska court would likely find a nationwide restraint overly broad. The covenant must be reasonable in both time and space to be enforceable, so it is crucial to evaluate the entirety of the restriction during transaction negotiations.
When reviewing and drafting noncompete clauses under Nebraska law, there are some general guidelines to follow:
- Must be reasonable: Covenants in connection with the sale of a business should be reasonable in time and space. Any employee covenant not to compete should have a reasonable time frame. Note, geographic restrictions are only allowed in connection with the sale of a business.
- Must be tied to competitive activities: A restriction cannot simply prevent any sort of future employment or future business operations – the restriction should be limited to products or services that are competitive with the business.
- Overly-broad restrictions will render the entire provision unenforceable: Nebraska is in the minority of states in that the courts will not revise an overly-broad covenant to make it enforceable. If one piece of the restriction is found unreasonable, the entire covenant will be unenforceable. Watch this space for our forthcoming blog post on the differing approaches that states take when faced with an unenforceable covenant not to compete (and the one exception in Nebraska to this no-modification rule).
When a Seller is Employed by the Buyer Post-Transaction
Often, the seller of a business will enter into an employment agreement with the buyer for post-closing employment. How does a court evaluate the enforceability of a noncompete in this context – will the covenant be evaluated using the more generous sale-of-a-business standard, or the more stringent employment standard? Once again, the answer varies by state.
Some states will analyze each covenant individually against its respective standard – so even if a particular covenant was part of a larger transaction which included the sale of the business, the noncompete in the employment agreement would be analyzed by rules governing employment contracts. Other states, including Nebraska, will interpret a non-compete contained in an employment agreement more favorably under the sale-of-a-business standard if the agreement was ultimately executed in connection with the sale of a business.
Depending on the jurisdiction, the sale of a business that is coupled with an employment arrangement between buyer and seller may be governed by the more stringent enforceability standards that are generally held applicable to employee covenants. This creates the risk that a seller who has been fully compensated for the goodwill of the business sold will be allowed to deprive the buyer of the full extent of its bargain.
Whether you are an employer, the seller, or buyer, it is critical to engage experienced legal counsel in connection with drafting and negotiating a covenant not to compete to avoid legal pitfalls and negotiate away the benefit of your transaction bargain. McGrath North has seasoned M&A and Labor and Employment attorneys skilled in these issues. If you have questions about this alert, or want practical review and guidance on your existing noncompete restraints, contact one of our attorneys below.