In a previous post (Noncompete Agreements – A Hurdle to Employment and Innovation?), we discussed research that suggested noncompete agreements hinder innovation.
Expanding on why innovation is hindered, in any context in which a noncompete agreement is entered into e.g., an employment relationship, a founder whose start-up is being acquired, or an owner selling his or her business, such an agreement will universally restrict an individual from competing against the other party in a particular geographic area and market.
Geographical restrictions under a noncompete agreement, however, may become an even more significant impediment to innovation than originally contemplated by either party to the agreement for two reasons: Noncompete agreements are always broadly drafted to begin with and after entering into such agreements companies frequently expand business operations (think of acquisitions, joint ventures, or obtaining new customers) or enter into new business markets.
For example, a typical noncompete agreement will provide some description of the business and geographical area in which the individual may not compete. Consider the following example:
Employee shall not directly or indirectly engage in any geographical area where the Company is doing business or is making preparations to do business in any line of business that is similar to or competitive with that conducted by the Company …
The problem for those creating innovation, i.e., employees, entrepreneurs, founders, etc., is that the day the individual signs the noncompete agreement, the geographical and business restrictions may be relatively limited. But as time passes, those restrictions may significantly expand as the company grows.
Assume for example that the noncompete restriction only applies to Michigan where the company is located and doing business. But after entering into the noncompete restriction that Michigan company acquires a California company. Or it enters into a joint venture with a Chinese company. And what if a Texas based customer is landed? Or consider what happens if the company is in the business of “X” when the noncompete agreement is entered into but later expands into “Y” and “Z” business? Now the noncompete restrictions arguably expand to reflect these changed circumstances in terms of geography and lines of business.
Expanding Business Under Noncompete Agreement Should be Shared Concern for Individuals and Companies
A court addressing a dispute under a noncompete agreement will generally require that geographic limitations be tailored so that the scope of the agreement is no greater than is reasonably necessary to protect the legitimate business interests of the party seeking to enforce the noncompete agreement. Both companies and individuals need to be mindful of this issue, but for different reasons.
For companies who use noncompete agreements to protect their competitive business interests, nailing down the geographical scope of a noncompete agreement is a critical element for making sure it will be enforced. This is because, Michigan courts have refused to enforce and otherwise modify an overly broad noncompete agreement that lacked a geographic scope and blocked a former employee from performing “any services” for clients. A Complete Home Care Agency, Inc v Gutierrez, (2004).
So from the company’s perspective, it is critical to balance the need for having a noncompete agreement that is specific enough to withstand the Monday-morning quarterbacking of a judge tasked with determining what is “reasonable” but broad enough to account for business growth from the time the noncompete agreement is signed.
Conversely, an immediate red-flag for any entrepreneur or employee entering into a noncompete agreement is what happens if/when the company expands its operations, lines of business, or customer base. The tradeoff of restricting your options for future employment or starting a business may make sense if you are taking a position with a company only doing business in Southeast Michigan in one area of business. But the same may not be true if those restrictions now expand outside of Michigan or the original market.
For more information about noncompete restrictions and agreements, as well as strategies for drafting and enforcing noncompete agreements, contact Jason M. Shinn. Since 2001, Mr. Shinn’s legal practice has focused on drafting noncompete agreements and litigating noncompete disputes involving business and individuals.