Nevadas Treatment of Covenants Not to Compete

Posted by: on Wed, Sep 05, 2012

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Covenants not to compete, sometimes called non-compete clauses, are “contractual provisions where the parties agree not to compete with each other for a certain time period in a particular geographic location.” 2 Mark A. Rothstein, Employment Law, Sec. 8.1 (3rd Ed. 2004). Treatment of covenants not to compete is purely a state issue. Most states have statutes on the subject and many of those statutes have been amended through the years to account for changing economic trends. State statues regarding covenants not to compete generally fall into one of three categories: (1) statutes generally prohibiting any restraint of trade (Arizona, California, Iowa, Indiana, Minnesota and North Dakota); (2) statutes specifically addressing covenants not to compete in employment contracts (Colorado, Georgia, Michigan, Montana, and South Dakota); and (3) statutes addressing covenants not to compete but only with respect to specific professions (Delaware, Colorado has two types, and Louisiana).

Does Nevada enforce non-compete clauses?

In Hanson v. Edwards, 426 P.2d 792 (1967), the Supreme Court of Nevada held that an agreement on the part of an employee (a podiatrist) not to compete with his former employer after termination of the employment (within 100 miles of Reno) is in restraint of trade, and “will not be enforced in accordance with its terms unless the same are reasonable.” There was no time limit in the covenant. The test laid down by the court is whether the restrictions impose upon the employee “any greater restraint than is reasonably necessary to protect the business and goodwill of the employer. A restraint of trade is unreasonable, in the absence of statutory authorization or dominant social or economic justification, if it is greater than is required for the protection of the person for whose benefit the restraint is imposed or imposes undue hardship upon the person restricted.” The court noted that the two critical issues are time and territory (geography). In other words, the length “of time which the restraint is to last and the territory that is included are important factors to be considered in determining the reasonableness of the agreement.” The court applied the reasonableness standard to geographical reach, duration and scope. The court allowed the restrictive covenant for one year (the time limit was supplied by the court since the clause was silent on time), but only within the city limits of Reno.

Guidelines for Territory Restrictions

The Nevada Supreme Court in Camco Inc. v. Baker, 936 P.2d 829 (Nev. 1997) was again faced with a case involving a non-compete clause contained in an employment agreement. The Supreme Court first held that the post-hire employment agreement was supported by sufficient consideration, even though the lower court had held that there was insufficient consideration. The court explained that continued employment in an at-will state like Nevada, is sufficient consideration for post-hire noncompetition covenants since a noncompetition provision is no more than a modification of the original employment contract, and a contrary holding might put the employer in the difficult position of having to fire an at-will employee and then rehire that same employee with the restrictive covenant in place. The court explained that there is no inflexible formula or rule for deciding the question of reasonableness of time or territory in such clauses. However, because the loss of a person’s livelihood is a very serious matter, the court explained that post-employment anti-competitive covenants are scrutinized by the courts with much greater care than those contained in a sale of a business contract. The court then held that the clause in the Camco decision was unreasonable since it covered too broad of an area (any area targeted for future expansion) and thus imposed a far greater restraint on trade than was absolutely necessary to protect the employer’s interests. The Court then laid down a key principle to follow in these types of cases as follows:

“We adopt the view that to be reasonable, the territorial restrictions should be limited to the territory in which the former employer had established customer contacts and goodwill.”

Other decisions throughout the United States have also held that the failure of a covenant to contain any geographical restrictions can render the covenant overly broad and therefore unenforceable.

Guidelines for Time Restrictions in Nevada

In Jones v. Deeder, 913 P.2d 1272 (1996), the Supreme Court of Nevada reviewed a restrictive covenant prohibiting a former employee from competing with his former employer within a 100 mile radius for five (5) years. The court concluded that the five-year restriction was unreasonable because it placed too great a hardship on the employee and was not reasonably necessary to protect the former employer’s interests. The Nevada Supreme Court has found the following time limitations to be reasonable:

(1) A two year restriction against an orthopedic surgeon from practicing medicine within a five-mile radius by the former employer medical client. Ellis v. McDaniel, 596 P.2d 222 (Nev. 1979).

(2) A restriction against a podiatrist from practicing in one particular city. There was no time limit in the agreement so the court supplied a one-year limit. This type of procedure, where the court amends or supplies its own reasonable restrictions, is sometimes called a blue pencil or blue-line rule. This allows the court to modify non-compete clauses in certain situations. Hansen v. Edwards, 426 P.2d 792 (Nev. 1967).

Is the non-compete agreement assignable when corporate assets are sold?

In 2004, the Nevada Supreme Court in Traffic Control v. United Rentals, 87 P.3d 1054 (Nev. 2004), held that in the absence of a separate agreement negotiated at arm’s length supported by separate consideration, which explicitly permits assignments of the non-compete agreement to asset purchaser entities, an employee noncompetition clause is not assignable (absent the employee’s express consent) when a successor corporation acquires the assets of the employer entity.

Is the non-compete clause valid after a corporate merger?

In 2009, the Nevada Supreme Court held that the rule stated in Traffic Control did not apply where two corporations are merged. HD Supply Facilities Maint., Ltd. v. Bymoen, 210 P.3d 183 (Nev. 2009). Here the court held that covenants not to compete are enforceable by a successor corporation that acquires non-competition agreements as part of a statutory merger. The court explained that while a contractual asset-purchase agreement creates a new entity and thus a new employer, a statutory merger merely unites two corporations into a single entity. The court declined to accept Bymoen’s argument advocating the adoption of a Vermont Supreme Court case which held to the contrary.

Can a new employer be sued for hiring an employee who is subject to a non-compete?

An important factor for employers to consider when making a new hire is whether the prospective new employee is bound by any prior non-compete agreement signed with his or her prior employer. This issue was addressed in the case of Las Vegas Novelty v. Hernandez, 787 P.2d 772 (1990).

The Nevada Supreme Court explained that even though the new employer was not an actual party to the covenant not to compete, the new employer may nonetheless be enjoined if he had actual knowledge of the prior covenant and breaches the covenant in active concert with the restricted employee. The rationale is that to allow a third-party employer to knowingly aid and abet violations of a covenant not to compete would entirely emasculate the covenant. This decision was also based upon Nevada Rule of Civil Procedure 65(d) which states that an injunction or restraining order is binding upon not only the person against whom it is issued but also “upon those persons in active concert or participation with him who receive actual notice of the order by personal service or otherwise.” The warning message is clear. Employers must verify with prospective employees they are interviewing whether they have executed any agreements that might contain restrictive covenants such as a noncompetition clause. Otherwise the new employer may be named as a defendant in an expensive lawsuit trying to determine whether the clause was reasonable, which as described above has many variables and is determined on a case by case basis.

Which State Law Should Apply?

While a corporation generally selects a state to incorporate in that has favorable incorporation laws, sometimes former employees will incorporate their new competing business in a state which disfavors non-competition agreements in an attempt to circumvent a validly executed non-compete agreement. This is what occurred in Ferrofluidics Corporation v. Advanced Vacuum, 968 F.2d 1463 (1st Cir. 1992). However, the First Circuit rejected the ex-employee’s attempt to apply California law by incorporating his competing business in California. The parties had executed their original agreement in Massachusetts. California disfavors non-compete clauses, but the court refused to allow the employee to choose California’s favorable state law in order to prevail on his claim.

Covenants Not to Compete to Protect Trade Secrets

Covenants not to compete are often used to protect trade secrets. The concept is the need to prevent unfair competition and invasion of privacy while promoting innovation, progress and efficiency. Protecting an employer’s trade secrets is often deemed reasonable when it involves the employer’s own “detailed confidential processes which are kept secret from customers and competitors.” See Jeremy P. Cattani et al., Employment Contracts, (2008). In protecting trade secrets, many courts consider the following or similar factors:

1) The extent to which people outside the business know the information;

2) The extent to which employees and others involved in the business know the information;

3) The extent of measures the employer took to prevent dissemination of the information;

4) The information’s value to the employer and/or competitors;

5) The amount of money or effort the employer expended in developing the information; and

6) The ease or difficulty with which others could acquire or duplicate the information.

See Cattani, supra, quoting Novelty Bias Binding Co., V. Shevrin, 342 Mass. 714, 715 (Mass. 1961).

By Mark Albright

About the Authors: The law firm of Albright, Stoddard, Warnick & Albright is an A-V Rated Nevada-based full-service law firm having attorneys licensed in Nevada, California and Utah. Our firm’s practice includes a strong emphasis on commercial litigation, including employment law litigation matters, such as non-compete agreements.

Note: This article, and any other information you obtain at this website, is not offered as legal advice, nor should it be relied upon as such, nor is it a solicitation for legal services. Only a licensed attorney can advise you with respect to your specific legal needs. We welcome your contacting our firm to discuss such representation. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.

About the Authors: The law firm of Albright, Stoddard, Warnick & Albright is an A-V Rated Nevada-based full-service law firm having attorneys licensed in Nevada, California and Utah. Our firm’s practice includes a strong emphasis on personal injury accidents. Call us at 702-384-7111.

Note: This article, and any other information you obtain at this website, is not offered as legal advice, nor should it be relied upon as such, nor is it a solicitation for legal services. Only a licensed attorney can advise you with respect to your specific legal needs. We welcome your contacting our firm to discuss such representation. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.