What Is a Non-Compete Agreement?
In its most simple sense, a non-compete agreement is a contract between an employer and an employee, or a contractor and a business. In its terms, the non-compete agreement states that the employee will not go to work for companies that compete with his or her employer, or similar competitors, for a specific period of time . This is a fairly standard clause in many employment agreements and a standard business practice of many business owners designed to protect themselves from unfair competition.
Arizona’s Approach to Non-Compete Agreements
Arizona, along with a couple of other states to be discussed below, takes a rather hard line against restrictive covenants. According to Arizona Revised Statute §23-493.01, which is part of Arizona’s "Freedom to Work" statute, a non-compete agreement is void if it has the effect of prohibiting an employee from seeking alternative employment. The legality of a covenant not to compete turns on whether its enforcement would impose an undue burden on the employee seeking to work in a certain area or industry – not whether the employer has a legitimate business interest that needs protecting. The potential for an undue burden is assessed according to the Detriment vs Benefit Test, whereby the legitimate interests of the employer are weighed against the harm to both the employee and the public at large when the restraint is enforced. An agreement will be deemed reasonable so long as it does not unreasonably restrict the ability of the employee to work in a specific field, or the public from benefiting from competition.
In 2016, there was some debate over the scope of the Freedom to Work statute. A controversial injunction issued by the Arizona Court of Appeals (Kimco Staffing Services v. Gonzalez) was criticized as an "overreach" that granted employees more protection than what was permitted under common law. While the statute appears less rigid in practice, Moritz v. Tres Blue, Inc. makes it clear that the freedom to work statute is the governing law. According to the court in Moritz, common law precedent is "inapposite" to assessing the nature of a non-compete agreement because the statute has a different purpose and a different scope. However, since the Kimco Staffing decision, the Arizona legislature has brought clarity to the issue by modifying the Freedom to Work statute to expressly state that it shall not "be construed to mean that an employer has an obligation to comply with any common law precedent that prohibits or restricts an employer from protecting the employer’s legitimate business interests."
The Enforceability of Non-Compete Agreements in Arizona
Non-compete agreements not supported by adequate consideration and less than 1 to 2 years of employment with an employer will almost assuredly be unenforceable in Arizona. All non-compete agreements may be rejected at the threshold if they are overbroad, however, in order to analyze the "reasonableness" of a non-compete agreement, parties take the risk of providing particularized reasons, or justifications, for what appears to be an overly restrictive agreement.
In general, to be enforceable, a post-employment covenant not to compete must be reasonable as to duration, geography and scope. In determining reasonableness, Arizona courts will probably apply a reasonableness standard taking into consideration the totality of the circumstances in each particular case. In analyzing the duration and geographical scope issues, Arizona courts will likely consider public policies principles. In May v. Acosta, 299 Ariz. 48, 51-52 (2019) the court stated: Reasonableness in the context of a covenant not to compete is a fact sensitive analysis under the totality of the circumstances from the parties’ perspective. Consistent with this, both Arizona and federal courts have applied a sliding scale to reasonableness, allowing the covenant to become more, or less, restrictive, depending on the situation. An overly broad covenant that reasonably serves the legitimate interest of an employer may still be enforceable, so long as it is narrowly tailored to its justifiable goal. It may also be the case that what was a reasonable restriction in one circumstance may become unreasonable in another.
Whether a covenant is "reasonable" or not and therefore enforceable is determined by the circumstances of each case (although some employment lawyers and many Arizona judges and juries will apply a reasonableness standard as set forth in the above quote, others seek to apply the sliding scale standard). A covenant’s duration, geographic scope, industry-wide scope, and industry innovation history are all factors that might be used by the Court to determine whether it is reasonable and therefore enforceable.
Common Provisions in Arizona Non-Compete Agreements
Although there are no template forms for non-compete agreements, the following are the most common provisions included in Arizona non-compete agreements:
- Duration. The length of a non-compete is often one of the most important factors to whether a court will enforce it. For this reason, the Courts in Arizona typically uphold a one year restriction on competition after termination from employment.
- Geographic scope. The concept of geographic restrictions in non-compete agreements is also fundamentally related to whether the restriction is reasonable. In Arizona, non-compete agreements generally are permissible if limited to the area in which the employer regularly provided its services or product.
- Business interests. The business interest protected by a non-compete must be sufficient to justify the restraint. In a case where some industry is generally free from competition, then a non-compete restriction could apply to the entire State of Arizona. If the employer’s business requires it to meet the customers of competitors across the State, an employer may be able to argue that a statewide restriction is necessary and appropriate. However, another company attempting to expand its business over long distances may be appropriately restricted from contacting only certain customers.
Tips for Drafting an Arizona Non-Compete
An effective Arizona non-compete agreement serves a legitimate business interest. They cannot be overly broad or unreasonable. A few best practices when drafting non-compete agreements in Arizona are:
A good non-compete agreement will not contain clauses that make it impossible to comply with Arizona law. For example, a company may include a provision in an agreement stating that a current employee’s agreement will be considered accepted and signed if the employee fails to return the agreement within 14 days. This is called a "deemed acceptance clause." If the employer does not have a written agreement at the time an employee begins working, it is advisable that the employer provide two options for the employee to sign the agreement. The first would be to authorize that the employment is conditioned upon acceptance of the agreement. The second would be for the employee to accept that the employment can be terminated if the employee does not sign the agreement. The second option is preferred.
A great deal of litigation ensues from employees who sign documents that they do not read. Courts often rule that it is a valid agreement as long as the employee was given notice of what they were signing , regardless of whether they read it or not. Because most companies require all employees to sign a non-compete, this could be a trap for unwary employers. By making sure employees have an opportunity to read agreements and contracts, employers are more likely to meet the "reasonableness" standard.
It is a best practice to define the terms used throughout the agreement. Both parties should acknowledge that they understand what the agreement means. The legislature has imposed a requirement for notice of non-compete agreements prior to the commencement of employment. To ensure compliance and security, employers should provide notice of all agreements with a copy of the written document to new employees.
How to Contest a Non-Compete in Arizona
To challenge a non-compete agreement in Arizona, an employee may file an action in the Superior Court in the county in which the company with whom the non-compete agreement is made has its principal place of business, or in the county in which the employee resides. The court may issue a preliminary injunction if there is a "likelihood of success" on the merits of the case, irreparable harm if the preliminary injunction is not granted and the preliminary injunction does not disserve the public interest. Employees often argue that non-compete agreements violate the statute of frauds because they are not supported by consideration; however, Arizona courts routinely find that continued employment is sufficient consideration.
Recent Developments in the Law
In 2016, the Court of Appeals addressed the enforceability of a non-compete agreement that prohibited an employee from working for a competitive business for one year in a 20-mile radius of the employer’s principal place of business or any branch office. That decision, Dethmers Mfg. Co. v. Peterson, concluded that a "non-compete agreement is only enforceable to the extent that it protects a legitimate interest of the [employer], is narrowly drawn to protect that interest, and does not impose undue hardship on the employee." The court confirmed that while non-compete agreements are disfavored in Arizona, they are not considered per se void. The court reasoned that the non-compete agreement had the potential to unreasonably restrict competition by forcing the employee to relocate outside of its state of residency in order to work for another employer after the termination of his employment.
More recently, in 2017, two new laws came into effect which further the trend restricting the reach of non-compete agreements. The first, A.R.S. §23-493.16(A), now prohibits an employer from contracting with an independent contractor for services if the agreement would prohibit the contractor from working for other businesses upon conclusion of the contract. The second, A.R.S. §32-2121(A), provides that "In an action or proceeding to enforce [a non-compete agreement entered into between an employer and an independent contractor], if the court determines that the agreement is overly broad, the court shall modify or limit the covenant so that the covenant is reasonable and enforceable."
Alternatives to Non-Compete Agreements
To the extent Arizona courts will enforce non-compete agreements, it is worth noting that there are several alternatives to the use of a non-compete agreement. In some cases, the better option might be use of a non-solicitation covenant, whereby a departing employee agrees for a certain time period of time and within a certain geographic area to avoid soliciting employees from the employer.
Another option is a confidentiality or trade secret agreement, whereby an employee or vendor agrees not to disclose confidential information and trade secrets. A confidentiality agreement is also an appropriate option for Internet or web based businesses , whereby the confidentiality agreement could even be incorporated into the terms of service that everyone must agree to before utilizing services from the organization. Whichever option(s) of these multiple choices an organization chooses, the best practice is to have any agreements prepared by experienced counsel for review and input. The limited circumstances under which Arizona courts will enforce a non-compete are exceedingly narrow, and many organizations are even now using non-competes in outright violation of the law.