What Is a Non-Compete?
Non-compete agreements are contracts between an employer and an employee that restrict the employee from engaging in competition with the employer for a stated period of time following the termination of employment. The existence of a non-compete will not necessarily mean that the employee is bound by its restrictions . If you have already signed a non-compete, the enforceability of that non-compete will largely turn on the facts and circumstances of your particular situation. As a general matter, non-compete agreements are disfavored by Arizona courts – but they are not rendered unenforceable simply because they are disfavored.
Legal Requirements for an Enforceable Non-Compete
The enforceability of non-compete agreements is governed by Arizona law, A.R.S. 44-1401 et seq. This law states that "[a] covenant not to compete is enforceable only to the extent it is reasonable." A well-drafted non-compete must meet the requirements of the statute. First, it must be "ancillary to" a lawful business purpose. A lawful business purpose is an objective such as protecting confidential information, trade secrets and customer relationships. A non-compete that is a condition of employment or sale of business is deemed ancillary to a lawful business purpose.
Second, the covenant not to compete must not impose a greater restraint than is necessary to protect a legitimate business interest. The court will consider the circumstances under which the agreement was made, the relationship of the employee and employer, and the contemporaneous exchange of consideration for the covenant.
Third, the covenant must be reasonable in terms of its temporal scope, geographic scope and mission restriction. The temporal scope must be no longer than is necessary to protect a competing business or former employer from the loss of its knowledge and business relationships. The geographic scope refers to the territory where the agreement states the employee cannot work. The mission restriction refers to whether the restraint sufficiently separates the employee from the employer.
To demonstrate a reasonable duration, geographic territory and mission restriction, the employer must prove by a preponderance of evidence that the covenant (1) is no greater than necessary to protect the employer’s goodwill or other business interest, (2) and is not against public policy. While Arizona courts ordinarily consider the totality of the circumstances to determine if a non-compete is reasonable as a matter of law, the burden is on the employer to prove the covenant’s reasonableness.
Often times, courts will reform overly broad non-competes but Arizona courts also have viewed covenants to be unreasonable as a matter of law. For example, the Arizona Court of Appeals found a one-year ban on working for a competitor to be unreasonably long. In another case, the court deemed a five-year restriction unenforceable.
When Can a Non-Compete Be Enforced?
Courts will enforce a reasonable non-compete agreement in Arizona, but how long is "reasonable"? That depends on a number of factors. Duration and geographic scope are important elements of non-compete agreements. A typical duration for a non-compete is 1-2 years, and from a geographic standpoint, the area is usually no more than a 100-mile radius from the employer’s place of business, but sometimes the scope of the restriction can be even smaller. For instance, if the employee only has knowledge of customers located in a small geographic area only 50 miles in radius from the employer’s principal place of business, then 50 miles might be reasonable.
In addition to duration and geographic scope, the nature of the business interests that the employee is exposed to by working for the employer is also an important factor, as it may warrant an increased duration and/or geographic scope. A more difficult question to answer, however, is what happens when an employee violates their non-compete with two sources of competition? An employee could simultaneously violate a non-compete prohibiting them from working in a similar field of business and also one that prohibits them from working for a specific competitor client (referred to as a "customer" non-compete or "client" non-compete). In either case, both forms of non-competes place some restrictions on the employee, such that each should be considered in the context of the other. In other words, it may not be enough that the violations be "concurrent" where the employee only performed services for a limited time for the second competitor. In a recent decision issued in September 2015 by the Arizona Court of Appeals, Division One, the Court stated that the two types of non-competes were independent; meaning that an employee could violate the customer non-compete agreement with one of the competitor customers without violating the competitor non-compete agreement, and therefore, the court refused to "stack" the two non-competes when determining what duration of time the employee’s violation should be prohibited. Accordingly, if an employee is subject to a customer non-compete prohibition and a competitor non-compete prohibition, each would be considered separately in terms of the duration for which the employee’s new employment violates both "at the same time."
Case Law Updates and Precedents
The recent case of Centuori v. Medical Protective Co. of Fort Wayne, No. 12-CV-01974-PHX-NVW (D. Ariz. 2012) addressed the enforceability of a noncompetition agreement in the context of whether the noncompetition agreement was made in connection with the sale of the employer’s business. A noncompetition agreement is made in connection with the sale of a business when it "is incidental to an otherwise enforceable agreement made in connection with the acquisition by the buyer of a business or intangible assets."
The plaintiff physician practiced orthopedic surgery in Tucson, Arizona. The defendant was a company that insured physicians. The plaintiff entered into a professional services agreement with the company to provide medical services at an imaging and surgery center in Tucson (the "PSA"). During the course of the PSA, the plaintiff agreed to a noncompetition agreement that prohibited him from providing orthopedic services in Tucson at any center that the defendant owned for two years after the termination of the PSA.
The plaintiff sued the company, arguing the noncompetition agreement was an unlawful restraint of trade under A.R.S. ยง 23-491 because it was not ancillary to the sale of the company and it did not protect a proprietary interest. The company moved for summary judgment on the issue. The court found for the company, holding that the noncompetition agreement was made in connection with the sale of the defendant’s intangible assets when the PSA was sold from one company to another. The court explained that the defendant was not required to sell the PSA to another entity. The company sold the PSA and the surgeon’s goodwill associated with the PSA because the company no longer operated the center. Although the court was unable to determine who or what entity owned the PSA before it was sold, there was a transfer of that business and the surgeon’s goodwill. Therefore, the consideration was sufficient to support the noncompetition agreement.
In Pyeatt v. Smith, 646 F. App’x 636 (9th Cir. 2016), the United States Court of Appeals for the Ninth Circuit affirmed a district court opinion holding that a doctor’s noncompetition agreement was enforceable. Pyeatt performed ophthalmologic surgery at his hospital in Flagstaff, Arizona. He was, however, contractually obligated to spend a certain number of days per month at a hospital in Cottonwood, Arizona, which is roughly 50 miles away from Flagstaff.
Pyeatt sued the hospital and his employer in state court, seeking a declaration that the noncompetition agreement was unenforceable. The case was removed to federal court, where Pyeatt moved for summary judgment. The district court denied Pyeatt’s motion and granted summary judgment to the defendants. Pyeatt then appealed.
On appeal, the Ninth Circuit held that the noncompetition agreement was not overbroad because it was geographically limited to Cottonwood, Arizona (50 miles from Pyeatt’s office in Flagstaff, Arizona). The appellate court concluded that the noncompetition agreement did not bar Pyeatt from working in the state of Arizona if he had moved his office from Flagstaff to Cottonwood. In addition, the appellate court noted that Pyeatt had no property interest in his patients at the time of signing the agreement. The court reaffirmed prior precedent that a noncompetition agreement does not require a seller to turn over to the buyer his existing patient base or a right to solicit them in the future.
The Pyeatt court made clear that such testamentary clauses must be tied to an employment or asset sale pursuant to A.R.S. section 23-492(3) and must comply with the reasonable time, geographic, and scope tests set forth in A.R.S. section 23-491. Further, in the context of sales of commercial hospitals, the agreement should be viewed in light of the business necessity for enforcing the employment agreement and not as an absolute restraint on free trade or the exercise of a profession.
How to Write a Non-Compete That Can Be Enforced
Given an employer’s interest in preserving its client relationships, confidential information, and trade secrets, whether a non-compete provision can be used to prevent former employees from bidding on an employer’s current work, doing any work for a former employer’s clients, or soliciting a former employer’s employees is often at the forefront. The parties are free to negotiate the terms of the non-compete provision as long as it is reasonable. A non-compete provision not intended to prevent the employee from competing for employment with their old employer’s clients , from using information gained during the course of their employment with the former employer, or solicit employees from their old employer is likely to be held unenforceable in violation of Arizona law.
To draft a compliant non-compete, the following key terms should be included: To summarize, to be enforceable in Arizona, a non-compete restriction must be reasonable as to both the scope of activity and territory, and must be supported by consideration. Because an overly broad covenant will not be enforced, a non-compete should be as narrow in scope as possible to cover only truly legitimate business interests of the employer.
Exceptions and Pitfalls
Although non-compete agreements can provide employers with meaningful protection, they are not a perfect solution. For example, mere confidentiality agreements are frequently held to be a sufficient means of protection, without the need for a non-compete agreement. Employers must understand that non-compete agreements are disfavored and there are many exceptions to keep the contract from being enforced. Courts will only enforce non-compete agreements in narrow circumstances. Some of these "excuses" to enforceability include the following:
- "Term of Years" Issues: A non-compete contract that is supposed to last a specified "term of years," such as a two-year period, is unenforceable if the two-year period has expired. A court will not simply enforce the contract for a reasonable amount of time. It is also worth noting that a multi-year contract is less likely to be enforced than that of a one-year term.
- Employer’s Diligence: An employer seeking to enforce the full terms of a non-compete contract will have a difficult time showing diligence if it did not act diligently when the contract was signed by trying to protect its employment with notices or the like.
- Public Policy: An employer’s legitimate interest may not justify an undue restraint on an employee’s ability to earn a living.
- No Legitimate Interest: A simple confidentiality clause, without any reasonable pre-requisites, is frequently found to be sufficient protection by the court.
- Service Industry: The service industry is especially prone to exceptions on public policy grounds.
- No Confidential Information: A non-compete contract signed by an employee was found not to be enforceable because it did not include customer information and the employer had no secret processes or customer lists or other confidential information.
If you are considering having your employees sign a non-compete, contact an employment attorney for legal advice.
Alternatives to Non-Compete Agreements
Fortunately, there are various options other than a non-compete agreement that an employer can employ to protect itself. Non-Disclosure Agreements: One way to protect trade secrets and other sensitive information is to have employees sign a comprehensive non-disclosure agreement. As long as the boundaries of the information kept secret are carefully drawn, a non-disclosure agreement can be enforced in Arizona. Trade Secret Protection: Arizona law provides broad protection for trade secrets , and courts will enjoin former employees from using such secrets. The law requires that a company make efforts to protect its sensitive information by treating it as confidential. Non-Solicitation Agreements: The Arizona Court of Appeals recently held that some types of non-solicitation agreements are enforceable in Arizona. If a non-solicitation agreement fits into the narrow exceptions recognized by the Court, and if it is reasonable in scope and duration, such an agreement may be enforced. For example, an agreement not to solicit former customers for a period of six months is likely enforceable, provided that the agreement does not unreasonably bind an employee to the former employer.