Non-compete Partnership Agreement

March 30, 2022

Non-compete Partnership Agreement

A non-compete partnership agreement is provision or agreement that prohibits parties from engaging in certain business entities. Non-compete partnership agreements are common in partnership agreements, employment agreements, business agreements and franchise agreements where they prohibit parties from creating, establishing, operating or working for competing businesses. Further, non-compete agreements are mostly scrutinized by the courts and their implementation is mainly based on the relationship of the parties. They are also based the nature and language of the agreement that results to the non-compete and states the specific laws.

Some of the situations that require a non-compete agreement include:

  • Competitor
  • Shareholder
  • Partnership
  • Vendor relationship
  • At-will employment relationship

During the assessment of a non-compete partnership agreement, its implementation and the strategies begin with an evaluation of the contractual rights. Other aspects include factual situations that result in the agreement. To be enforceable, non-compete partnership agreements, should serve as legitimate purposes and reasonable aspects. In assessing the legitimacy of a business purpose and reasonableness of the non-compete partnership agreement, courts shall assess the relationship and agreement that gave rise to non-compete. For instance, non-compete results in employment relationships, partnership or shareholder relationship, or business relationship.

Reason for non-compete partnership agreement

There should be an evaluation of the reasons for signing a non-compete partnership agreement. Basically, non-compete partnership agreements and the threat of enforcement and litigation relates to either:

  • An employment relationship with an employment agreement that contains a “non-competition” covenant
  • A partnership relationship where, under the terms of a shareholder, partnership, or member operating agreement, the partners are subject to non-compete covenants;
  • A business buy/sell agreement where the selling party and its owners are subject to post-closing non-compete covenants; or
  • A franchise relationship where a franchisee is subject to non-compete covenants during the term of the franchise agreement and for a period of time following the termination or expiration of the franchise agreement.

In the majority of the states, non-compete partnership agreements are heavily scrutinized and their implementation varies depending how the non-compete was drafted and the particular circumstances. The section below presents a summary of typical non-compete relationships and the enforceability of non-compete agreements:

  1. Non-compete and employment relationships

In most states, non-compete partnership agreements and obligations created as a result of an “employer – employee” relationship face extreme scrutiny and assessment. Within this employer relationship, a distinction should be made between “contract employees” and “at-will” employees.

At-Will Employees – At-will employees in a non-compete partnership agreement are employees who possess no contractual rights to continued employment. That is, there is no agreement that prohibits the employer from terminating an “at-will” employee. In contrast to an at-will employee is a “contract employee” who is guaranteed employment for a specific period of time and where he or she cannot be terminated he or she breaches the employment agreement. Enforcing a non-compete agreement against an “at-will” employee is more difficult than enforcing against a “contract employee”. The reason is because the at-will employee has no contractual employment in a non-compete partnership agreement and guarantees and enforcing the non-compete may deprive him or her from earning a livelihood.

Contract Employees – For contract employee in a non-compete partnership agreement, unlike at-will employees, courts are more likely to enforce non-compete agreements. Of course, enforcement will also depend on issues of fairness and facts related to the contract employee’s termination, whether or not the contract employee will receive compensation during the non-compete period and the overall drafting of the actual non-compete agreement.

Partnership relationships

Such are of moderate enforceability. Unlike employment relationships, non-compete partnership agreements between business partners are more likely to be enforced and, many times, are supplemented by state law that creates a fiduciary duty and obligation between business partners. Non-compete obligations in non-compete partnership agreements between business partners are typically contained in the partnership, shareholder, or member operating agreements between the parties.

Business transfer and sales

The business transfer and sales have high enforceability when included in a non-compete partnership agreement. Many businesses buy/sell agreements – related to the transfer and sale of a business – include post-closing non-competition covenants and obligations in their non-compete partnership agreements. These obligations and covenants, although not guaranteed, are likely to be enforced by courts.

franchise agreements

Franchise agreements also have high enforceability in relation to non-compete partnership agreements. Non-compete restrictions are also necessary obligations to impose on a franchisee when dealing with a franchisor-franchisee relationship and such are included in the agreement. A franchisee will be given access to a franchisor’s confidential operations manual and systems and will be operating a franchised outlet under the franchisor’s brand name. As such it makes sense that during the term of the franchise agreement. That is, while the franchisee is still a franchisee and is operating the franchised outlet that the franchisee be prohibited from establishing or operating a competing business.

Similarly, to protect the franchisor’s intellectual property and the rights of other franchisees, it also makes sense that in the event of an expiration or termination of the franchise relationship that a franchisee, likewise be subject to a non-compete. Accordingly, non-compete partnership agreements are enforceable when dealing with franchisees and this is especially the case during the term of the franchise relationship. Upon expiration or termination of the franchise relationship, enforceability of a non-compete partnership agreement will depend on the language used to create the non-compete and whether or not the scope and time period of the non-compete appears to be fair and reasonable.

Further aspects of a non-compete partnership agreement

It is common to include non-compete and non-solicitation provisions in operating, shareholder or partnership agreements. When there is a dispute, these provisions contain limitations on the parties to the relationship in terms of what can and cannot be done in the way of competition if a member or shareholder departs the business.

This prevalence is consistent with a recent study by the Economic Policy Institute. Concluded in December 2019, the report found about 36 million private-sector American workers have signed non-compete partnership agreements. These agreements limit their ability to leave their jobs for new ones.

Enforceability of non-compete partnership agreements

Generally, New Jersey law disfavors non-compete partnership agreements. However, their enforcement can happen in the context of a shareholder agreement, LLC agreement, or partnership agreement. This is particularly true during the sale of a business. Especially when significant financial remuneration was exchanged for the restraints.

The strategy for enforcing such provisions varies depending on the facts and circumstances of each case. The same applies to avoid such provisions when representing a party leaving the business who wishes to compete. As a general rule, if you are the party seeking to enforce the agreement against a departing partner, member or shareholder, you cannot violate the underlying agreement yourself. There is an argument that once the shareholder, LLC or partnership repudiates the agreement, the obligations to perform by the departing shareholder end.

And, as in every case dealing with non-compete or non-solicitation agreements, enforceability depends on the restraints contained in the agreement. Both geographic and temporal limitations are important issues. Likewise, whether the business has a legitimate need to restrain a departing employee or is merely seeking to stifle competition.

New Jersey is a blue pencil state. This means that a Judge reviewing the agreement for enforceability can scale it back making it enforceable. It is important that there be no delay in seeking to enforce rights under such an agreement. Additionally, the employer/company must consistently enforce such rights against others with similar agreements.

Other factors

There are numerous physicians leaving a practice. For physicians, dentists and others in a similar situation, the analysis can be quite different. This is due to the public policy considerations involved (the patient’s right to a provider of her choice).

Finally, a shareholder, member, or partner who departs a business even without such restraints in a written clause of a contract must take care not to violate common law duties that may exist in favor of the company or partnership not to divert opportunities or damage the client base of the company or partnership. All of these factors must be considered carefully when planning to exit a company where you own shares, an interest, or are a partner.

Basics of a non-compete agreement

 

Other than protecting trade secrets and other intellectual property, a key strategy for preventing this situation is having all business partners sign non-compete agreements. A non-compete agreement is a restrictive covenant, meaning it is a contract between parties who all agree not to do something.

A non-compete agreement must be reasonable in scope to be considered legally enforceable. For instance, a non-compete agreement for any particular business should be limited to the territory where the business actually operates. It must include a reasonable time frame (one to three years after the business partner leaves is a rule of thumb). And, the subject matter of the non-compete agreement must directly relate to the original business. In other words, you could not prevent a former business from starting a restaurant if the business partnership was a financial services company.

 References

https://www.businsess-in-a-box.xom/non-compete

https://en-int.seekweb.com/search/nairobi

https://www.zapmeta.ws/web/results

https://www.pdfsimpli.com/

https://www.sec.gov

https://www.smallbizia.org

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