What Constitutes a Non-Compete Agreement?
Non-compete agreements are a specific type of restrictive covenant often used in the employment context. The purpose of these agreements is to balance an a business or employer’s free and unrestricted right to conduct operations using employees with an employees right to be gainfully employed at whatever work the employee considers appropriate. Non-competition agreements are also referred to as covenants not to compete. Where restrictive covenants or non-competition agreements do not comply with Alabama law, and are later litigated , a court can choose to reform the restrictive covenant for compliance with Alabama law as long as the court deems it appropriate and the language of the covenant itself is susceptible to be read as so limited.
Alabama courts have limitations on their ability to reform a non-compete agreement and any such reformation must be classficable as "narrowing" of the covenant. The agreement must still serve the business interest of the employer being protected and the agreement must still have a reasonable length and duration in time. The reason for the peculiar limitations in Alabama on the reformation of non-compete covenants is the Alabama case of Specialty Healthcare Management Services Inc. v. S. Health Care of Alabama, 746 So. 2d 975 (Ala. Civ. App. 1999). In Specialty Healthcare, the court analyzed the enforceability of a non-compete agreement which was broader in its scope (time and geographic area) than was actually permitted by Alabama Compete Covenant law. Instead of limiting the agreement to comply with Alabama law, the court executed a reformation that narrowed the non-compete agreement within the bounds of Alabama Law while at the same time still providing sufficient protection to the employer.
Legal Basis for Non-Compete Agreements in Alabama
The legal framework for non-compete agreements in Alabama is defined by both statutes and the interpretation of those statutes by the courts. The general rule under Alabama law is that post-employment restrictive covenants are invalid unless found to be reasonable as determined by the court. Generally, the law in Alabama does not favor non-compete agreements. That said, there is an increasing acceptance by some judges and other members of the courts that certain restrictions and limitations contained in some non-compete agreements might be enforced in appropriate circumstances, particularly non-compete restrictions on high-level employees.
In Alabama, at the outset, a non-compete covenant must be based upon either the protection of trade secrets or the protection of a "legitimate business interest." This protectionist function requires that a non-compete clause in a contract be narrowly tailored to accomplish these two ends, or else the clause restricting competition will itself be deemed a restriction that unfairly prohibits competition. Potentially valid business interests that have been held to justify a non-compete restriction include the following:
In 1990, Alabama statutes were redrafted in the hope of making clear that covenants in business contracts that involve the protection of a group of items, both trade secrets and customer lists, can now be enforced in Alabama. This change overruled a number of cases in Alabama that refused to enforce restrictive covenants because they encompassed multiple forms of business interests, meaning that all of the interests must be bargained for, a situation that offered a potentially persuasive implication. In addition, because the language of Alabama’s statutory scheme does not require that the business interests be demonstrated as valid or plausible, an agreement for a non-compete covenant may be upheld and enforced without having met this threshold.
While pre-1990 Alabama law stated that the reasonableness of a non-compete covenant was a question of law for the court to decide, reaffirming earlier interpretations issued by the Alabama Supreme Court, the post-1990 cases show that a court’s decision on the reasonableness or unreasonableness of a non-compete is not necessarily determined via a textual analysis alone. In 1992, the Alabama high court held that whether a restriction is reasonable or unreasonable is a matter for fact, and not law, subject to appellate review only for erroneous no evidence arguments. As a result, the court will look to the evidence presented in support of a restriction, such as the nature of the business, its competition, and potential impact and not only rely on the text of a non-compete provision. However, the general practice among most courts in Alabama is that unreasonable non-compete agreements will not be reformed or modified, while public policy might also play a role in how the courts view the enforceability of a particular non-compete agreement.
Essential Components of Enforceable Non-Compete Agreements
In order for a non-compete agreement to be enforceable in Alabama, its terms must be reasonable. This determination of reasonableness will be made by the judge when the case goes to court. In making this decision, judges will consider three elements: (1) the duration of the non-compete; (2) the area that the individual will be restricted from doing business; and (3) the type of business interest protected.
In Alabama, the most common duration of a non-compete agreement is six months. However, other jurisdictions have been known to rule this period reasonable as well. Duration periods of 18 months or 24 months are also becoming more common in many industries. The area and geographic scope of a non-compete agreement, in contrast to the duration period, is not strictly regulated, but must still be limited in the context to which it applies. In most cases, the area must not be broader than the area where the employee was doing business while working for the employer. In the past, courts have required that non-compete agreements clearly outline the scope of the competing business that is prohibited and have shown a requirement of specificity in this regards.
Most common are the business interests that are protected by non-compete agreements. While the non-compete agreement can apply to any business interest the employer has an interest in protecting from competition, the burden of proof is on the employer. If the employer is not able to prove that its business interests are legitimate, the non-compete agreement may be void.
Recent Jurisprudence and Illustrations
While non-compete agreements are so ubiquitous that litigation over them has become somewhat of a cottage industry in Alabama, there remain questions and issues on which the law is evolving.
In Nunn v. Liberty National Life Insurance Co., 2017 WL 3140022 (N.D. Ala. 2017), a federal trial judge struck down a non-compete agreement for lack of consideration – that is, exchange of something of value between the parties. The former employer had previously terminated the employee under circumstances in which it would have been liable for severance payments. To resolve this potential liability, the parties entered into a mutual release of all claims. There was no mention of a non-compete, but the employee requested a letter confirming that he was not prohibited from competing or soliciting business away from the employer. The employer’s response letter contained the "standard language" then used by the company, which included a non-compete. The former employee signed the letter but then refused to have a new one prepared. After the new owner of the company purchased it, the employee sued because he was let go after supposedly refusing to sign the new version, which had an extended non-compete of six months. The court ruled that the new letter was indeed new consideration and that the first letter was not enforceable as a non-compete.
But the court went on to uphold the non-compete in the second letter because the company had then provided sales leads to the former employee and he had accepted them, allowing him to generate more commissions than he would have otherwise. Therefore, the court ruled, the second letter was valid obligation – one that was upheld by reference to that exchange of value.
Bank of America, NA v. Orange Park Holdings, 18 Cal. App. 5th 594, 2017 WL 3116769 (Cal. App. 2017)(recently accepted for review) deals with the enforceability of a non-solicitation agreement placed in an employment handbook, in the absence of a signed document. The provision was referenced to a separate document, the Mutual Confidential Relationship Agreement, but the employee denied that he or any other employee had signed the referenced document. The employer argued that under the rule that an employer bears the risk of ambiguity in any contract, the court should place the burden of proof to prove lack of agreement upon the employee. The California Court of Appeal rejected that "could have signed" argument, stating that "… the [former employee] does not have the burden of disproving the existence of integration of the Mutual Confidential Relationship Agreement…." In other words, the court held that the assessment of whether the employer failed to put the employee on notice of each provision of company policy resides not with the employee, but with the employer’s proof that it did so.
In Montgomery v. TXU Mining v. Shumate, 2006 WL 2827560 (Ala. Civ. App. 2006), the Alabama Court of Civil Appeals addressed the material breach doctrine with respect to a non-compete agreement. In that case, the employee argued that the employer had committed a substantial breach by changing the formula used to calculate commissions. The trial court agreed, held the employee could work for a competitor and refused to enforce the covenant not to compete. The appeals court, however, reversed, stating: (1) that an employer could use a formula not in the contract if the new formula was disclosed to the employee before he began working under that formula, and (2) that while it is true that an employment contract containing a covenant not to compete is enforceable only if both parties have performed their contractual obligations, a minor breach will not preclude relief, absent a showing that such breach would reduce the party seeking the remedy to an "idle spectator."
As is clear from these decisions, the issue of what constitutes a valid non-compete agreement in Alabama continues to evolve. In many cases the focus is shifting to the issue of whether the employee was given adequate notice of the terms and conditions of the agreement. The issue of what constitutes "adequate notice" is, too, evolving.
Employer Challenges and Considerations
Employers face a number of challenges when they create non-compete agreements in Alabama, and these challenges require careful consideration. For example, drafting an agreement that is both defensible and highly enforceable can be a real headache. Furthermore, if employers attempt to enforce an agreement that is not air-tight, there are a variety of negative consequences that may occur.
Notably, overly broad or otherwise unreasonable non-compete agreements have been struck down in many past cases because the courts have found them to be offensive to public policy. Even though Alabama courts may allow for a brief period of time before a former employee may go to work for a competitor, if an employer fails to show that the time restriction in its agreement is reasonable, the employer’s ability to enforce any aspect of the agreement may hang in the balance.
To ensure that an agreement is defensible and enforceable, employers should take several steps. First, because scope is one of the most difficult items to satisfy, this consideration should be taken into account first. Consider the places in which your competitors operate and ensure that all of these places are named specifically in your agreement, preferably as a list. For example, if your business has locations only in Mobile County, you should state, "For a period of one (1) year after the termination of employment, Employee agrees that Employee will not perform the same or similar work that Employee performed for the Company…in the counties of Mobile, Baldwin, Escambia, Clarke, Wilcox, Marengo and Monroe . " Make sure not to be too specific, as saying, "Employee shall not perform work in Mobile, AL" could be interpreted as allowing the former employee to work directly across the street in a location you can’t name — such as in Fairhope, Alabama.
Second, the length of time needs to be reasonable. Alabama courts have ruled that an agreement that prevents a former employee from working for a competitor for one year is reasonable, while also holding that restricting a former employee for a period of time that exceeds two years is not reasonable. To be safe, limit the time to one year, unless you have a very unique business that justifies a longer time.
Third, Tell employees up front that they are expected to sign a non-compete. Often, state and federal law requires that employees be educated about the terms of a non-compete before they can be expected to sign it. State law also requires that any agreement obligating a current employee to not work for a competitor must be supported by additional compensation — such as a promotion, raise or bonus.
Fourth, Make sure the non-compete is clear on its face about what your former employee will or will not be doing. Finally, if all else fails, prepare to fight to uphold the agreement. If you are unable to structure the non-compete as you envision, don’t draft one — prove that the agreement is valid by litigating its enforcement and risk having it struck down on appeal.
Employee Defenses and Entitlement
Employees subject to non-compete agreements have several rights under Alabama law. First and foremost, they have the right to understand the basic terms of the agreement before signing. While you are not obligated to ask questions about every part of the agreement you do not understand, you may do so. For all terms of the agreement that you do not understand, but do not wish to discuss (or believe no one would adequately explain), you have the right to ask yourself whether the term is ambiguous. In other words, is it not clear what the term means? If not, ask for clarification, correction, or rephrasing. The important point here is that you are not obligated to sign something even if you don’t understand it. It is better to ask questions and seek explanations than to blindly continue the process of signing without understanding.
If you discover after signing an agreement that it is overly broad with regard to the geographic scope of your restriction, the time frame for the restriction, and/or the prohibited activities, then you may have a case. As stated above, a 2010 Federal case of AHSCA, Inc., demonstrates how a court in Alabama will consider and rule upon whether an employer’s non-compete agreement is reasonable.
From a practical perspective, it is often a reasonable approach to simply follow the process for obtaining any necessary exit release and move on in your career. Not all business owners or employees are going to be so rash as to actually challenge the enforceability of an agreement. While I am not saying that you should ignore the restrictions of the agreement, I am saying that in some cases, an employer may have a business need to have you work within the region, for a certain length of time, and within a particular market that is too broad for that purpose. However, an employee would typically run the risk of being eligible for a lawsuit if he or she went to work for a competitor with the express knowledge of the restrictions of the non-compete agreement. Once a matter is before the court, whether the restrictions of the agreement are reasonable is a different question.
Alternatives to Non-Compete Clauses
In lieu of a non-competition agreement, many employers choose to use a non-disclosure agreement in conjunction with a non-solicitation provision. A non-disclosure agreement, also known as a confidentiality agreement, can be used to prevent a departing employee from disclosing or using the employer’s confidential and trade secret information for his or her own benefit or the benefit of a subsequent employer. So long as the non-disclosure covenant is reasonable, the agreement will generally be enforceable as to confidential information.
The non-solicitation provision can be used to prohibit the former employee from soliciting or interfering with the employer’s relationships with its customers or other employees. This type of clause is also generally enforceable in Alabama so long as it is reasonable as to time and scope of prohibited activity. For example, a clause prohibiting a departing employee from interfering with the relationships the former employee had with his or her employer’s customers may be very reasonable if it only requires that the former employee refrain from conducting business with the customers for a small period of time following departure.
Future Directions in Alabama Non-Compete Legislation
Looking ahead, the fate of non-compete agreements in Alabama will likely be influenced by a number of factors, including societal changes, federal legislation, and ongoing discussions in the state legislature over whether to ban or limit the use of non-compete agreements altogether. One potential area for reform could come through changes at the federal level. At the time of this writing, for instance, there are growing calls to the federal government to ban non-compete agreements entirely. Many cite studies that they claim show that non-compete agreements are associated with negative results for employees and society. However , the traditional findings on their economic efficiency stand in the face of such studies. As states increasingly consider more comprehensive regulation of employment law, the Alabama House of Representatives has already introduced at least one bill that would limit the scope of non-compete clauses. Companion legislation banning or limiting the use of non-competes and nondisclosure agreements altogether may be introduced in the 2019 Alabama Legislature. Such legislative efforts, however, may face opposition as the the legal environment surrounding non-compete, non-disclosure, and trade secret protection continues to evolve.