What Is a Non-Compete Agreement?
Non-competition agreements restrict an individual’s ability to earn a livelihood in a territory or market following a separation from employment or business relationship. Businesses and employers typically use them to prevent a former colleague from competing in a manner that would threaten those parties’ businesses, create confusion with regard to products or services, or otherwise interfere with contractual relationships the business possesses with its customers and suppliers. For this reason, businesses and employers often term non-competition agreements "restrictive covenants" or "non-solicitation agreements," and focus their implementation on post-termination competition.
In Kentucky, courts have enforced non-competition agreements almost exclusively with respect to employees, although some Kentucky courts have invited expansion beyond the employment context. For example, in 2011, the Kentucky Court of Appeals, in Keyser v . Cua, 359 S.W.3d 326, 334 (Ky.App. 2011) stated: "a valid noncompetition agreement or covenant not to compete could be appropriate in any contract, as long as it is reasonable in temporal and geographic scope, and that it protects the legitimate business interests of the employer or service recipient."
However, Kentucky courts have never addressed the enforceability of a non-competition agreement by a business party against an owner of even a minority interest in a business, and thus enforcement by a business against another business is currently untested.
Non-competition agreements may also impact the rights of the spouses of persons working for the business. Spouses should be aware that in situations in which two or more people are working for a business, the contracts of services for some or all of them could impact the business and may enforce a non-competition agreement against one or more of them.
Non-Compete Agreements in Kentucky
Kentucky does not have an overarching statute that applies to non-compete agreements. However, its common law jurisprudence can be helpful to both employers and employee litigants in understanding what the law will look like if the non-compete ends up in a court setting.
As with any contract, the non-compete must be supported by adequate consideration. The general rule in Kentucky appears to be that the employer must give something in exchange for the employee’s promise not to compete after separation from employment. In the employer-favorable case of Purity Dairies v. Zander, 770 S.W.2d 219 (Ky. Ct. App. 1989), the Kentucky Court of Appeals specifically held that the employer must provide something in addition to employment, a raise, or a bonus to support the non-compete. In certain circumstances, merely continuing employment may rise to the level of adequate consideration. In Jewelry & Loan of Richmond, Inc. v. McCoy, 2008 LEXIS 151 (Ky. Ct. App. 2008), the employee had worked for the employer for six months before signing the covenant not to compete. The court found that adequate consideration was provided due to the new obligations of the employee under the non-compete. From this, it would appear that all prior consideration must be excluded in order to ascertain whether the additional consideration is adequate. Thus, if a non-compete is signed at the commencement of employment, continuing employment is sufficient consideration.
Another interesting point in Kentucky’s common law judiciary tradition is what is essentially a public policy exception to enforcement of a non-compete agreement. In Broadbent v. Old Republic Title Ins. Co., 2010 WL 3935696 (W.D. Ky. 2010), the court found the non-compete agreement unenforceable because the non-compete agreement could reduce competition in title insurance. This is an unusual ruling because most non-compete litigation does not deal with an industry issue. Further, the same Kentucky judicial district did not recognize similar arguments in Mallard Creek Holdings, LLC v. Jernigan, 2009 WL 483882 (E.D. Ky. 2009). (In both Broadbent and Mallard Creek, the courts were deciding whether Covenant Not to Compete Act, KRS 365.385, applies to right of first refusal agreements for the purchase of a business.) Therefore, unless the non-compete has a significant impact on an industry, it is unlikely the Kentucky courts will invalidate a non-compete due to public policy.
Kentucky has only recently joined the group of states that have adopted the Uniform Trade Secrets Act. Ky. Rev. Stat. Ann. § 365.880 et. seq. passed in 2008 and thus has not seen an abundance of litigation under the statute.
If you look at the cases as a whole in this area Kentucky courts have a tendency to favor the interests of non-competing employees.
Requirements to Enforce a No Compete in Kentucky
In Kentucky, courts evaluate the reasonableness of the restrictions imposed by non-compete agreements. The common law approach permits the court to enforce covenants that are reasonable in duration and scope. Kentucky courts consider three criteria in these analyses: "(i) whether the restraint is reasonably necessary for the protection of the employer; (ii) whether the covenant is no greater than necessary to secure the employer’s lawful business interest; and (iii) whether the degree of restraint is reasonable considering the hardships imposed upon both the employee and the employer." The Kentucky courts also have held that the duration of a non-compete agreement should depend on the "length of service of the employee as well as the nature of the employer’s business." Kentucky courts also take a flexible view of a geographical restriction depending on the type and nature of the business.
Cases Impacting Non-Competes in Kentucky
Kentucky courts have contributed to the legal landscape of non-compete agreements with several influential rulings. In the landmark case of Arnett v. Thompson, the Kentucky Supreme Court identified the necessary elements for a restrictive covenant to be enforceable while also recognizing that the geographic and temporal scope of the covenant must be reasonable to be considered valid and thereby enforceable. Another notable case is Central Adjustment Bureau v. Ingram. The court in this case outlined specific criteria for what constitutes a "legitimate business interest," which often is successfully used as the basis for non-compete enforcement. In support of this definition, the court stated, "A patient will frequently exercise the free choice, based either upon the personal relationship imbued through long association with a particular service, or in response to a negative performance appraisal of the new doctor to whom he has been referred." In the case of General Electric Co. v. Golodoff, the Kentucky Supreme Court narrowed its earlier view, expressed in Arnett v. Thompson, that restrictive covenants of indefinite duration are per se void. In Golodoff, the court held that such covenants may be enforceable if specifically reasonable as set forth by the agreement, and highlighted the potentially narrower public policy considerations at play, on a case-by-case basis.
Writing a Non-Compete for Kentuckians
Do not underestimate the importance of drafting a good non-compete. The key to getting a court to enforce a non-compete is to stay within the bounds of the law. It is important that the scope (both geographic and time) of your non-compete be reasonable enough on its face so that it does not "shock" the court. This means that if your business uses a certain geographic area and you have been using that for the years prior to the termination, then its unreasonable for you to ask the employee for a much larger area.
Further, the scope of the non-compete should be limited to the scope of the employee’s and former employer’s employment with each other. If the non-compete is related to some other scope of requested non-competition than the work the employee did while working for the company, then again, its unreasonable. Non-competes are to protect against unfair competition, meaning, that they are only enforceable if it prohibits the person from competing against their former employer in their same scope.
Be careful that the scope of the non-compete is reasonable. For example , if you are paying only minimum wage and ask an employee to be restricted in competition for a period of two or three years, that court most likely will not hold that non-compete as reasonable. Some courts have a minimum barometer of at least a two year restriction, but that depends on the types of industries and businesses at play. Further, if the court does decide that the non-compete is unreasonable, then it can rewrite your non-compete so that it is reasonable or rewrite your covenant to what is reasonable.
If the non-compete is too broad, even if it exceeds the length of time that is reasonable, then the court could strike it down entirely. Therefore, it is best to have more strict limitations on the time and/or geographic locations.
In summary: Limit the scope of what you are attempting to achieve by having a non-compete, keep the time period short enough to be reasonable, but not so short that it becomes meaningless.
Non-Compete Litigation and Controversy
Non-compete agreements are frequently the subject of challenges or disputes in Kentucky. The employer may decide that the non-compete agreement is not worth the trouble to enforce. The employee may believe that he has no non-competition responsibilities at all. There are several common scenarios where a dispute arises between a former employee and his former employer.
For example, an employee may work for an employer for several years before learning of the existence of a non-compete agreement. Perhaps his employment agreement did not purport to include a non-compete limitation, and the non-compete restriction surfaced only in a policy manual that is not even acknowledged by the employee. In this scenario, it is likely that a court will rule that there is no enforceable non-compete covenant at all, or at least reform it to omit any responsibility requiring the employee to comply with restrictions that he was not even aware of.
In a related situation, there may be a dispute regarding whether the non-competing restriction only applies to solicitations, or whether it is a true "non-compete" that prohibits the former employee from engaging in business activity that competes with his former employer. Often a court will impose limitations only on the solicitation of customers or contacts with which the former employee became acquainted during his employment.
Another common dispute occurs when the agreement is ambiguous about whether the non-compete limitation applies to limit activities in a business with which the former employer is competing, or whether the provision prohibits the former employee from working for an actual competitor. Several Kentucky cases hold that an employer must precisely identify its actual competitors before enforcing a non-compete restriction against its former employee.
There are also cases where the scope of the limitation is ambiguous, and it appears to be an acceptable business practice for both the former employee and former employer to engage in and to offer the same products and services within a few hundred miles of each other. It is likely that a court will invalidate that type of covenant as overly broad, and re-write it to limit the restriction to those areas that can be shown to be significant portions of the former employer’s actual market.
In many cases, the former employee has been properly warned that his employment was conditioned upon his signing a non-compete agreement, but refused to sign it – and continued in his job. This situation often arises where the former employee is a senior manager, and offered a lucrative package to sign the non-compete agreement. If offered sufficient compensation – and if the employer provided the requisite advance notice – the employee will be bound by the limitation, and the former employer may enforce it regardless of the "effectiveness" of the contracts doctrine.
Regardless of the specific situation, the provisions of KRS 342.650 violate public policy and are unenforceable. Accordingly, employers should avoid restricting their employees’ right to compete in any area in the limited residual list of activities listed in that statute.
Non-Compete Alternatives
For individuals and businesses concerned with the enforceability of non-compete agreements and their potential legal implications, there are viable alternatives that can accomplish many of the same purposes as an overly broad or unenforceable non-compete agreement.
Nondisclosure Agreement
In lieu of a non-compete agreement, an employer may use a nondisclosure agreement to protect its confidential, proprietary, trade secret or other types of business information and the use of such information by a former employee in a competing business may be prohibited . A nondisclosure agreement is often easier to enforce than a non-compete agreement, which is also generally easier to draft and less likely to be found overbroad or ambiguous.
Nonsolicitation Agreement
Similarly, a nonsolicitation agreement can be used in place of a non-compete agreement to prohibit an employee from contacting customers and employees of the former employer. A nonsolicitation agreement is not as broad in its coverage as a non-compete agreement, as it applies only to activity with respect to customers or employees and not competitors. These two alternative types of agreements are often used in combination to provide even greater protection for employers.