Covenant Not to Compete More Complex Than It Seems

As seen in “Our Colorado News.” Written by John Kokish.

Many employers think that a covenant not to compete will solve their problems of employees who quit and set up competing businesses.  Unfortunately for those employers, it is not that simple.

  • In Colorado, the courts and the legislature frown upon covenants not to compete.  Pursuant to C.R.S. 8-2-113, covenants not to compete are presumptively void unless they meet certain exceptions.  Those exceptions are:
  • Any contract for the purchase and sale of a  business or the assets of a business;
  • Any contract for the protection of trade secrets;
  • Any contract providing for the recovery of the expense of educating and training an employee who has served as an employee for less than two years; or
  • Executive in management personnel and officers and employees who constitute professional staff to executive and management personnel.

Even if the covenant not to compete falls within one of the exceptions, it still must be “reasonable” in terms of geography and time.  Depending on the nature of the business, the courts normally will enforce a covenant not  to compete if it is for five years or less, but the radius depends on the nature of the business of the employer.  A radius reasonable for a retail business may be 10 to 20 miles, while the radius for a company that does business on a state or national scale may be 100 to 300 miles, or even the boundaries of the home state of the employer.

The reasoning behind the tough requirements  that the legislature and courts have imposed upon these covenants is that while it aids the party seeking to enforce it by preserving  its good will,  it can very well be a hardship to the party bound by it by preventing him or  her from making a living.

Therefore, the courts will often look for ways to avoid enforcement by examining what it takes to protect the goodwill of the party seeking to enforce it, and balancing this against the potential hardship to the employee.

Often an employee who leaves his position, either voluntarily or involuntarily, has experience and training in only one area and must seek employment in the area in which he is proficient.  This is why covenants relating to employees are strictly limited to executive personnel or upper management personnel and professional staff of executive and management personnel.  The courts have defined these terms narrowly.  In other words, hiring a salesman and giving him the title of sales manager, does not work.  One has to be at a much higher-level of management to be bound by these covenants.

Two cases decided by the Colorado Court of Appeals pretty much control the existing law in Colorado.

In Phoenix Electric City AL, Inc. v. Dowell, the court held that an employee who is not a manager at the time of the execution of a covenant not to compete but later became a manager was not bound by the covenant, since the time of execution controls the status pursuant to the statute.

In that case, the court also held that solicitation of customers is included in a covenant not to compete, and that if the covenant is void, so was the prohibition against soliciting customers.

However, solicitation of employees was not part of the covenant not to compete, and therefore, prohibition against soliciting of employees could be enforced against the party signing the covenant.

In another case, Reed Mill  & Lumber Company, Inc. v. Jensen, an employee of Reed Mill signed a covenant not to compete that provided when his position at Reed Mill was terminated, he would be bound not to compete with the company for three years.

Jensen, however, worked for six years before terminating his employment and then immediately began soliciting and competing with the company.  The company sued on the covenant that Jensen had signed.

The court held that the purpose of the covenant was to protect the company’s good will for three years, and that Jensen did more than that during the six years of his employment before he quit.  Therefore, the covenant which attempted to prevent him from competing for three years after his termination, in effect, was a nine year prohibition, since he executed the contract six years before he resigned.  The court held that nine years was an unreasonable time to be bound.

It is evident from both of the above cases that the Colorado courts look for ways to strike down  covenants not to compete when they prevent an individual from making a living.  The states differ in the enforcement of these covenants.  In Florida, the covenant not to compete is almost always strictly upheld.  On the other hand, in California, it is virtually impossible to enforce a covenant not to compete.  Colorado takes a middle ground, but leans toward prohibiting enforcement if it prevents an employee from making a living and, in the case of a business, prevents a new business from flourishing.

Therefore, attorneys for employers and sellers of businesses need to be very careful crafting the language of a covenant not to compete.