The Basics of Non-Competition Provisions
Non-compete clauses are contracts with the purpose of prohibiting competition with former employees or contractors. They are typically worded to prohibit a contractor from working with a competitor in the same industry at the same location. They can be used to prohibit clients from getting a contractor or employee to provide the same services on a permanent basis to cut out the middle man. Non-competes can also prohibit a contractor from soliciting or doing business directly with customers of their previous employer once the contractor leaves their employment.
A non-compete clause may be part of an independent contractor agreement, employment agreement or shareholder agreement . A non-compete agreement with an employee is complementary to a non-solicitation agreement provided by fairly recent case law. Non-competition clauses may be viewed as injurious by the courts and most of the time the employment agreement will simply be void as unenforceable unless the clause is reasonable. In Ontario, for example, an employment agreement with a non-compete clause is automatically void as it is against public policy. It is important in any state or province to obtain legal counsel when drafting a non-compete clause or independent contractor agreement with a non-compete clause.
Non-competition Provisions for Independent Contractors
It is not uncommon for independent contractor agreements to contain non-compete clauses similar to those found in employment agreements. However, there are significant differences in the law relevant to non-compete clauses contained in independent contractor agreements as compared to those in employment agreements. While the objective of the two agreements is similar, the functions of the two relationships differ.
Independent contractors operate without the degree of administrative and managerial scrutiny employed by employers over their employees. The former do not need the same level of protection from so-called unfair competition as do the latter. Just as employees do not need as much protection from a company’s competitors that are based on the special services provided to that company, you do not need as much protection from a similar business that provides you with a job as an independent contractor. For the above reasons, your employer usually has more latitude a company entering into a similar relationship with an independent contractor.
Another major distinction between these two types of contracts is their duration. Your relationship as an independent contractor can begin and end at any time and a contract that was effective at one time may no longer be effective at another. On the other hand, an employee’s relationship with an employer is considered ongoing and does not usually end until terminated by one side or the other.
A judge may look at these differences and conclude that the same standard does not apply to an independent contractor agreement with a non-compete clause as it might an employment agreement. It is important for companies to review the forms they use for entering into relationships with independent contractors to make sure that non-compete clauses are appropriate, especially in view of the differences between independent contractors and employees.
Legally Binding Non-Competes
Understanding Non-Compete Clauses for Independent Contractors
The enforceability of a non-compete clause for an independent contractor or freelancer will vary from state to state. Some states and federal law tend to favor independent contractors more than employees when it comes to non-competes, while other states view both types of workers equally. Crucial factors that affect the legality of these clauses are the wording of the clause itself and state and federal laws on non-competes and independent contractors. The enforceability of a specific non-compete will also depend upon the context in which it arose. For example, if the independent contractor is later sued for breach of the non-compete, a judge will look closely at what legal rights may have been violated and how damaging the alleged breach was to the employer. While several factors must be taken into consideration, it helps to understand some of the most critical issues in determining the enforceability of a non-compete for an independent contractor. Independent contractors tend to be favored by the courts than employees. Courts thus have a liberal view regarding the validity and enforceability of a non-compete by an independent contractor. In most cases, the clauses are not favored by the courts. If there are circumstances to suggest that the clause is unreasonable, it will not likely be enforced. Apart from the reasonableness of the clause, the court will also take into account the circumstances under which the clause was signed. State law usually governs the independent contractor statutes. These include statutory requirements governing how they are paid, what deductions will be taken, and worker’s compensation. A few states impose additional requirements by statute, including: • Restrictions on how a contractor is paid. • Details about contract termination and compensation payment. • Other restrictions on employment-related issues. If the agreement is terminated, the independent contractor can start working for another company immediately. There are other laws that vary by state regarding the enforcement of non-compete clauses. Some states prohibit the enforcement of a non-compete for an independent contractor. Others will allow the enforcement based on whether the cirumstances were reasonable and the protection it gave to the business was necessary. One state will enforce a non-compete only after the customer was solicited and had a relationship with the contractor. Another state does not accommodate restraints on independent contractor. Most non-competes for independent contractors will not be enforced if they do not protect an actual legal right for the employer.
Pros and Cons of Non-Competition Provisions
In general, independent contractors can accept non-compete agreements under U.S. employment law; such agreements are often used by companies to protect their confidential information, their customer base, and their investment in training employees.
From the hiring party’s viewpoint, the advantages of including a non-compete clause in a contract include: A non-compete clause can benefit the independent contractor as well. When done correctly, the non-compete clause helps to ensure that the customer contact or trade secrets of the hiring party won’t end up with a competitor. In some cases, an independent contractor may leave a company and work for a competitor, only to attempt to entice existing customers of their former employer to become interested in their new employer’s services. An enforceable non-compete clause can prevent this from happening.
However, there are also disadvantages to using non-compete clauses in contracts. For instance, some independent contractors may refuse to sign a contract that includes a non-compete clause, in which case the hiring party may be unable to recruit the industry talent that they are seeking. Other independent contractors may demand more compensation to sign the contract so that doing business with these Contractors becomes more expensive for the hiring party. In some cases, independent contractors may refuse to sign a non-compete clause due to a belief that the hiring party will not enforce it.
How To Make a Non-Competition Provision Work for Your Contractor
The non-compete clause should include the following:
Purpose – The introductory sentence should state the purpose of the clause, namely, that in order to protect Company’s trade secrets and proprietary information, the Contractor enters into a covenant that restricts its activities in a specified manner.
Scope – The parties should agree on the extent of the restriction, which should be reasonable and specific. The scope should explicitly state the extent of the prohibition, i.e., the specific activity to be restricted, the prohibited time period and geographic area. A blank "Commonwealth of Pennsylvania" may be acceptable for a clause that relates to clients or existing employees.
Reasonable Time Period – Non-competes that extend more than two years have already been subject to a challenge in the Commonwealth Court. Do not go longer than two years; one year is even better. A period of time beginning six months after termination of a contractor or month-to-month basis is sufficient to protect against client solicitation. Many courts have found that interim periods of six months are reasonable but have found that periods of 16-18 months are unreasonable. See Jack in the Box, Inc. v. Schneider, supra., and Kingsbury v. Clear Channel Communications, 40 Pa. D. & C.4th 578, 2000. If a contractor leaves without notice or the contract is terminated by the company , a reasonable period of four to six months is sufficient. It is worth noting that this factored into the reasonableness determination in Schneider, above.
Geographic Area – A geographic scope should be limited to one that is necessary to protect the employer’s legitimate business interests, or "the limits of the area in which the employer has actually developed or engaged in business." Strock v. Public Utilities Commission of Ohio, 38 Ohio St.3d 95 (Ohio 1988). In some cases, the actual territory in which the employer conducts business will be very small, if any at all. If no real business territory exists at the time of the agreement, it is more defensible to limit the geographic area to two to three counties with the option to expand if the parties conduct business in other counties later on.
Miscellaneous Considerations
If the Company wishes to increase the chances that a court will uphold a non-compete, it should consider the following in drafting the paragraph concerning consideration: 1) a reference to the payment of a fixed sum of money in return for the contractor agreeing to limitations on its ability to compete; 2) requiring the contractor to disclose its trade secrets and/or proprietary information; and, 3) requiring the contractor to begin performing duties for a definite term of several months to one year and to train employees or educate customers in the contractor’s unique process or procedures. See George W. Helon, Jr. L.L.C. v. Martin, 2003 WL 23302171 (E.D. Pa. 2003).
Alternatives to Non-Competition Provisions
Many businesses may be surprised to learn that they have options that achieve their objectives while respecting the rights of independent contractors. We frequently recommend that business owners use confidentiality agreements to protect sensitive business information, rather than the overbroad non-compete clauses that are common in employee contracts. Some contractors may have customers that they have developed over the years or relationships with suppliers. In most cases, it is possible to prevent a contractor from raiding a company’s customer base by using a non-solicitation clause.
Case Studies and Real-World Examples
To better illustrate the nuances of non-compete clauses in independent contractor agreements, let’s examine a few real-world examples where these agreements have been successfully employed, as well as instances where they have created issues for companies and independent contractors.
A Case Study for the Employer
Consider a dental practice in new york. The practice routinely hires specialists on a contract basis, paying them on a fee-for-service basis while they are working with patients and sharing the office space and administrative staff. Some of these specialists later receive salaries and become owners, which is a common arrangement for successful practices that need specialists on a regular basis. After identifying one such specialist and offering a partnership, the practice a non-compete covenant was created and signed by all parties prior to the employment and the specialist began full-time work at the practice. As the old saying goes, "all good things must come to an end" and this is exactly what happened with the specialist, who had a falling-out with the office manager and later resigned, saying he could no longer work at the practice.
When the specialist began his search for new contracts, however, the practice gave him notice that it expected him to honor the non-compete covenant and not work for a competitor or open up his own competing practice within a 10-mile radius of the old practice for two full years. The specialist openly defied the non-compete, saying that he could not be held to its terms because he had never negotiated a non-compete agreement that he felt was fair. Naturally , the old practice did not see that as a legitimate excuse and filed a lawsuit to enforce the non-compete covenant.
A year later, the court agreed to narrow the geographical scope of the non-compete provision down to a 5-mile radius surrounding the dental practice, but refused to prevent the independent contractor from working for a competitor or opening a new practice. As for the original two-year time limit, the court held that it could be reduced to just one year. This outcome goes to show how important it is that both parties understand their roles and rights with these types of covenants.
A Case Study for the Independent Contractor
Not all the stories of independent contractors and non-compete covenants end this way, thankfully, as one sculptor based on the West Coast learned. The sculptor created works of art that she sold to numerous clients, including another local company. The local company later asked to display and sell her artwork, which she initially agreed to and then reneged on when she noticed that something was not right. Specifically, while the local company sold her artwork, it was using the artist’s pictures to promote the work done by someone else whom the sculptor suspected to be a competitor. When she confronted the company, she pointed to the fine print which said that the local company must get her approval before marketing her artwork; however, the local company was not interested in giving her a say over the marketing of her work. The local company sued the sculptor for breach of contract, but the sculptor won and the local company was eventually required to return her artwork, as well as pay her for her attorney’s fees and court costs.