Covenants Not to Compete

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Covenants Not to Compete

Covenants Not to Compete in Michigan

Benefits and Pitfalls of Covenants Not to Compete

One of the most important tools used by businesses to protect themselves from a variety of evils is the covenant not to compete. A covenant not to compete is simply a contract, or a provision contained within a larger contract, stating that an employee or business owner promises not to compete against the company.  A typical covenant not to compete will say that the employee cannot compete at all against the company while the employment continues. It will also usually provide that, for a reasonable period of time after employment ends, the employee will not compete against the company within a certain radius or market.

Legality of Covenants Not to Compete in Michigan

In most states, including Michigan, covenants not to compete are legal under most circumstances, so long as they are reasonable in scope and duration.

Years ago, covenants not to compete were thought to be against public policy, except in one circumstance nearly everyone recognized as fair: where the party signing the covenant has just sold his business to somebody else and will destroy the value of what he has sold if he’s allowed to immediately go out and compete in the same territory. In recent years, the general trend, also adopted in Michigan is to allow covenants not to compete even where business is not being sold, provided that they are reasonable in all of the circumstances.

Courts are given the power to review covenants not to compete and not only strike them down if they are completely unreasonable, but to surgically strike certain provisions and preserve others so that the basic intent of the parties is preserved, with modifications.

The most common reason a covenant not to compete will be deemed illegal is because too long of a time period or too far of a distance are outlined. For example, a covenant not to compete signed by a dentist in a neighborhood dental practice will probably be enforced if it prohibits the dentist from competing within a 25-mile radius for three years. People may well be willing to travel 25 miles to stay with the dentist that they trust, but if the covenant says that the dentist cannot compete within 100 miles, the covenant is unlikely to survive.  Few people would travel 100 miles matter how much they liked their dentist; and a restriction that brought would be seen as punitive rather than protective. Likewise, once the dentist has been out of that market for three years, if the rest of the practice is not been successful in capturing the patients that the dentist left behind, there is little reason to protect them any longer. Thus a provision that prevents him from coming back for 10 years would probably not survive.

Factors Making a Covenant More or Less Enforceable

In addition to time and distance, courts will look at whether the business really needs protection and has provided any special value to the employee in exchange for the covenant. For example, a five-star restaurant that brings in a chef at a high salary, advertises him heavily and builds its menu around him will be heavily damaged if that chef leaves and competes close by. Assuming that the covenant is reasonable in time and distance, it is easy to see that covenant being enforced. However, a dishwasher at the same restaurant should not need to sign a covenant. Any effort to impose a covenant on a lower-level employee in whom the business is not making a major investment will be seen strictly as a way of trapping employees who ought to have the right to work anywhere.

Sometimes a business will invest knowledge and trade secrets in a salesperson or research engineer. A covenant not to compete makes sense there and will likely be enforceable, if reasonable.

A covenant may be successfully attacked even by an employee who signed it voluntarily if the covenant and the terms under which it can be enforced are too favorable to the employer. Consider, for example, a situation where a successful sales representative is lured away from her former employer to work for her new employer. She signs a covenant saying she can’t compete within three years and 50 miles after her employment ends, but she is then fired three days later without cause. This covenant is unlikely to be enforced because the first thought will be that the new company never wanted this salesperson in the first place, and simply wanted to keep her from working for the competition.

At Seikaly, Stewart & Bennett, we advise employees not to sign covenants that will allow the employer to enforce them if the employer discharges the employee without cause. When we are advising employers, we tell them that if they reserve the right to fire an employee without cause and want to enforce the covenant, they should establish a sliding scale of a timeframe in which the covenant may take effect. The important thing is to keep a court from having an excuse to strike down the entire covenant on the basis that it was simply unreasonable.

Protecting Trade Secrets When a Covenant Cannot be Enforced

Covenants not to compete should not be confused with covenants against use of trade secrets or customer lists. When an employee is entrusted with the company’s trade secrets and customer lists, courts will enforce restrictions on a permanent basis against employees using those lists or secrets. Where these agreements get into trouble is where the trade secret is not truly the company’s own secret but rather knowledge that anyone in the industry would have. In some cases, the employee was aware of most, if not all, of the knowledge contained within the “secret” before they were even hired by the company. Prohibiting the employee from using what they already knew just because the company used the same knowledge is not going to be upheld by a court. Many courts have held that if a company wants to protect trade secrets and customer lists, they had better have made genuine efforts to protect this information all along. If trade secret information is made available to people who have no need to know, or if customer lists are left on open computer systems, the courts are much less likely to take the employer’s claims seriously.

Conversely, departing employees who take trade secrets or customer lists that have been genuinely and properly protected run a significant risk of being charged civilly and possibly criminally, with misappropriation of the employer’s property.

 

If you are being asked to sign a covenant not to compete or are interested in drafting such a document, please contact the Michigan business attorneys at Seikaly, Stewart & Bennett for a no-obligation phone call or office appointment.  Call 866-671-8115 or fill out our contact form to arrange your consultation.

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