A non-compete agreement (aka a non-compete) restricts an individual’s ability to engage in similar employment or activities that compete with their current or former employer. That is, if it’s enforceable. These agreements are prevalent in various industries, aiming to protect a company’s interests, such as trade secrets, client relationships, and investment in employee training. However, the use and enforceability of non-compete agreements are subject to ongoing debate due to their potential impact on employees and the labor market.
Advantages of a Non-Compete Agreement
Protection of Confidential Information
Non-competes are crucial in safeguarding a company’s sensitive information, such as trade secrets, proprietary methods, and client data. By restricting employees from joining competitors or starting similar ventures, companies ensure that their confidential information remains protected.
Investment Security
Companies often invest significantly in training and developing their employees. Non-competes help in protecting this investment by preventing employees from immediately joining a competitor where they can utilize the skills and knowledge gained, possibly to the detriment of their former employer.
Client Relationship Preservation
Employees often develop close relationships with clients. Non-compete agreements prevent employees from exploiting these relationships if they move to a competitor or start a similar business, thereby protecting the company’s client base.
Market Stability
These agreements can contribute to market stability by preventing rapid and potentially damaging shifts in competitive dynamics due to the movement of key personnel between companies.
Disadvantages of a Non-Compete Agreement
Restriction on Employee Mobility
Non-compete agreements can significantly hinder employee mobility. They limit individuals’ ability to seek better opportunities, which can lead to reduced income potential and career growth for the employee.
Potential for Abuse
Sometimes, companies may use non-compete agreements excessively or unreasonably, imposing undue restrictions on employees even when there is no legitimate business interest at risk.
Impact on Innovation
Restricting skilled professionals from moving freely in the industry can stifle innovation. New startups or companies that rely on experienced professionals may find it challenging to recruit talent due to these agreements.
Regional Economic Impact
In regions where non-compete agreements are heavily enforced, there can be a negative impact on the overall economic activity and entrepreneurship, as seen in cases where these agreements are less enforceable.
Enforceability of a Non-Compete Agreement in New Jersey
Non-competes are not always enforceable, even when prepared by counsel. Enforceability is a question of state law and varies significantly among states and across various industries. For example, non-competes are generally unenforceable in the legal profession. A law firm hiring an associate out of law school is unable to protect its interests with a non-compete. See NJ RPC 5.6. New Jersey has no general controlling statute governing non-competes.
Courts recognize that non-competes limit an individual’s ability to make a living and generally limit enforcement when doing so would restrict an employee beyond what is reasonably necessary to protect a legitimate business interest. In New Jersey, a non-compete that is not otherwise prohibited by a specific law, must be reasonable in scope and duration to be enforced. To determine if a non-compete is reasonable, New Jersey courts use a three-prong test:
First, is the restriction necessary to protect the employer’s legitimate interests?
Second, does the restriction cause undue hardship on the former employee?
Third, is the restriction against the public interest?
These criteria are fact sensitive, and the role of the courts is to weigh the various factors and decide the enforceability on a case-by-case basis. See Maw v. Advanced Clinical Communs., Inc., 179 N.J. 439 (2004) and Coskey’s Television & Radio Sales & Serv., Inc. v. Foti, 253 N.J. Super. 626 (App. Div. 1992).
Also, in the employment context, it’s the employer that has the burden of proving the reasonabless of the restrictions.
Legitimate Interest
When it comes to the first prong, it has been held that an employer has a legitimate interest in protecting customer relationships, trade secrets, and confidential business information. In the medical profession, for example, this extends to patient lists, referral sources, and methods of training.
[T]hree additional factors should be considered in determining whether the restrictive covenant is overbroad: its duration, the geographic limits, and the scope of activities prohibited. Each of those factors must be narrowly tailored to ensure the covenant is no broader than necessary to protect the employer’s interests. Karlin, supra, 77 N.J. at 423, 390 A.2d 1161. Although recognizing that “a longer restriction may be permissible in medical specialties where the number of contacts between the physician and patient are relatively infrequent,” the Karlin Court emphasized that “the covenant should not be enforced beyond the period needed for the employer (or any new associate he may have taken on) to demonstrate his effectiveness to the patients.” Ibid.
Cmty. Hosp. Grp., Inc. v. More, 183 N.J. 36, 44 (2005)
Undue Hardship
When determining whether a non-compete causes undue hardship, the following considerations come into play:
- The likelihood that the employee will find suitable work elsewhere in the employee’s field, and
- The overall burden on the employee
The second prong requires that the restrictive covenant impose no undue hardship on the employee. That inquiry requires the court to determine the likelihood of the employee finding other work in his or her field, and the burden the restriction places on the employee. See Karlin, supra, 77 N.J. at 423, 390 A.2d 1161. In applying this part of the test, the reason for the termination of the parties’ relationship is also relevant. If the employee terminates the relationship, the court is less likely to find undue hardship as the employee put himself or herself in the position of bringing the restriction into play. On the other hand, where the employer causes the parties to separate, “enforcement of the covenant may cause hardship on the employee which may fairly be characterized as ‘undue’ in that the employee has not, by his conduct, contributed to it.” Ibid.
Cmty. Hosp. Grp., Inc. v. More, 183 N.J. 36, 45 (2005)
Note however that a court is less likely to find undue hardship if the employee terminates the employment relationship because the employee’s actions caused the restriction to go into effect. See Cmty. Hosp. Grp., Inc. v. More, 183 N.J. 36 (2005).
Public Interest
New Jersey courts actively balance the public’s right to freely access professional advice against employers’ legitimate relationships with patients or clients. For instance, a court weighed a hospital’s interest in protecting its referral bases against the potential public harm caused by barring a neurosurgeon from working in an area facing a shortage of neurosurgeons. See Cmty. Hosp. Grp., Inc. v. More, 183 N.J. 36 (2005).
Furthermore, New Jersey courts really dislike restraints on trade to begin with, and for that reason, these restrictive covenants are narrowly construed.
Is a Non-Compete Right for You
Non-compete agreements serve an essential purpose in protecting a company’s interests but also pose challenges and limitations for employees and the broader industry. Their enforceability largely depends on a balance of interests and the reasonableness of the restrictions imposed. As the labor market and legal landscapes evolve, the debate over the use and fairness of non-compete agreements continues, reflecting the ongoing tension between protecting business interests and preserving employee freedom and market competition. For more information on how these agreements can be used in your business, contact us today.
