Covenants not to compete: Overview, definition, and example
What are covenants not to compete?
A covenant not to compete (also called a non-compete agreement) is a contract clause that restricts one party—typically an employee, contractor, or business seller—from working for a competitor or starting a competing business for a certain period after leaving a company. These clauses are designed to protect businesses from unfair competition by preventing former employees or partners from using inside knowledge to gain a competitive advantage.
For example, a marketing firm may require employees to sign a covenant not to compete, preventing them from working for a direct competitor within the same city for one year after leaving the company.
Why are covenants not to compete important?
Covenants not to compete help businesses protect their confidential information, trade secrets, and customer relationships. Without such agreements, a former employee could immediately join a competitor and use knowledge gained from their previous job to give the competitor an advantage.
However, non-compete agreements must be reasonable in scope, duration, and geographic area to be legally enforceable. Many jurisdictions impose restrictions on non-competes to ensure they do not unfairly limit a person's ability to find new employment.
Understanding covenants not to compete through an example
Imagine a software company hires a developer who works on a proprietary project. When the developer leaves the company, they sign a covenant not to compete stating that they cannot work for a competitor or start a similar software company for two years within a 50-mile radius. This prevents the developer from immediately taking their insider knowledge to a competitor.
In another case, a dentist sells their practice to another dentist. As part of the sale agreement, the seller agrees to a covenant not to compete, meaning they cannot open a new dental office within a 10-mile radius for three years. This ensures that the buyer gets the full benefit of the acquired patient base without immediate competition from the former owner.
An example of a covenant not to compete clause
Here’s how a covenant not to compete clause might appear in a contract:
“For a period of [X] years following the termination of this Agreement, the Employee shall not engage, directly or indirectly, in any business that competes with the Company within a [specified geographic area]. The Employee acknowledges that this restriction is reasonable and necessary to protect the Company’s legitimate business interests.”
Conclusion
Covenants not to compete are valuable tools for protecting businesses from unfair competition, but they must be carefully drafted to remain enforceable. They should balance business protection with reasonable limitations on an individual’s ability to find new work. Businesses should ensure their non-compete clauses comply with local laws and are not overly restrictive.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.