Non-Compete Employment Agreements in Colorado
The purpose of non-compete employment agreements is to restrict employees from working for a competing employer or starting a competing business after their employment ends. Because non-compete agreements discourage competition, they are disfavored in the eyes of the law and are narrowly construed by courts faced with interpreting them. Further, in Colorado, non-compete agreements in Colorado are generally unenforceable unless they meet specific requirements. This article discusses those requirements as well as general considerations for non-compete agreements in Colorado.
Colorado Law Governing Non-Compete Agreements
In Colorado, the enforceability of non-compete agreements has been codified at Colorado Revised Statutes (“C.R.S.”) § 8-2-113(2). The default under the statute is that non-compete agreements are generally void unless the agreement fits into a specific, exempt category. In particular, the statute provides:
Any covenant not to compete which restricts the right of any person to receive compensation for performance of skilled or unskilled labor for any employer shall be void, but this subsection . . . shall not apply to:
(a) Any contract for the purchase and sale of a business or the assets of a business;
(b) Any contract for the protection of trade secrets;
(c) Any contractual provision providing for recovery of the expense of educating and training an employee who has served an employer for a period of less than two years;
(d) Executive and management personnel and officers and employees who constitute professional staff to executive and management personnel.
Accordingly, because the third category pertains to payment for education and training, and does not relate to a prohibition on employment; in order for non-compete agreements in Colorado to be enforceable they must fall into one of three categories:
– Agreements for the sale of a businesses or its assets;
– Agreements to protection a business’s trade secrets; and
– Agreements that apply to executive and management personnel, and their professional staff.
Notably, most non-compete agreements in Colorado arise in the context of employment, that is, agreements pertaining to executive and management personnel, and their professional staff; and agreements designed to protect trade secrets by restricting an employee who knows a business’s trade secrets from working for a competitor. However, while these types of agreement are the most common, non-compete agreements applicable to the sale of a business also frequently arise.
Importantly, even if an agreement does fall into one of the above categories, that does not automatically mean that the agreement is enforceable. Instead, Colorado courts have adopted additional requirements that the non-compete agreement must meet in order to be enforceable.
More specifically, in order to be enforceable, the agreement’s restrictions must also be reasonable in duration and geographic scope. Along these lines, in order to be reasonable, a non-compete agreement must not be broader than necessary to protect the promisee’s interests, and it must not impose a hardship on the promisor. Notably, non-compete agreements for terms of up to five years and within distances of 100 miles are commonly upheld. See Reed Mill & Lumber Co., Inc. v. Jensen, 165 P.3d 733 (Colo. App. 2006).
Whether a particular non-compete agreement fits into one of the three statutory exemptions for enforceable agreements, and whether the agreement is reasonable are fact specific inquiries determined on a case by case basis. Colorado case law regarding the enforceability of non-compete agreements for each of the three exemption categories will be discussed next.
Business Sale Exemption for Non-Compete Agreements in Colorado
Importantly, the business sale exemption in Colorado applies to both the sale of ownership interest in a business, such as sales of stock, as well as asset acquisitions from the business. For non-compete agreements in this category, Colorado courts have recognized that the buyer of the business has a vested interest in protecting the goodwill of the business in addition to the business’s capital and assets. That is, a buyer purchasing a company has a certain interest in the continued and repeated public patronage of the business, otherwise known as the goodwill of the company.
The purpose for allowing non-compete agreements in this context is simple: if a buyer of a company were unable to protect his purchase of the company’s goodwill, the sellers of the company could simply start a new company and take their old customers with them effectively rendering the buyer’s purchase useless. Non-compete agreements can prevent this from happening as the sellers would be prevented from working in a competing industry or developing a competing business for at least some period of time, thereby allowing the buyer to capitalize on her purchase. See King v. PA Consulting Group, Inc., 485 F.3d 577 (10th Cir. 2007) (discussing one purpose of non-compete agreements is to prevent “brain drain” of the company).
Accordingly, because the policy for allowing non-compete agreements in the sale of a business focuses on goodwill, the reasonableness of a non-compete agreement and, thus, its enforceability, depends on whether the restraint on competition provides fair protection to the buyer’s purchase of that goodwill. Where a restraint is too broad or too cumbersome, it will be found unenforceable. See Reed Mill & Lumber Co., Inc. v. Jansen, 165 P.3d 733 (Colo. App. 2006) (finding a non-compete unenforceable where its application to an employee-shareholder six years after the company was purchased was found to be unreasonable in time).
Additionally, where a non-agreement has been entered into pertaining to the sale of a business, if the business ceases to exist at a later date the non-compete agreement will cease to be enforceable as well. That is, the buyer of a business cannot continue to enforce a non-compete agreement against the seller of the business once the purchased business ceases to exist. See Gibson v. Eberle, 762 P.2d 777 (Colo. App. 1988).
Overall, although non-compete agreements are generally construed narrowly in Colorado, agreements arising under the business sale exemption are given a more liberal construction compared to other non-compete agreement categories. However, they are still construed narrowly and still must be reasonable in both duration and geographic territory in order to be enforceable. See The Law of Trade Secrecy and Covenants Not to Compete in Colorado-Part II, 30 Colo.Law 5 (2010).
Trade Secret Exemption for Non-Compete Agreements in Colorado
The second major category that enforceable non-compete agreements can fall into is agreement to protect trade secrets. In the trade secret context, in order to be enforceable, the non-compete agreement must be necessary to protect against the disclosure of the trade secret. Importantly, non-compete agreements in the trade secret exemption are construed more narrowly than non-compete agreements for business sales.
More specifically, in determining whether a trade secret non-compete agreement is enforceable Colorado courts have adopted a two-step analysis. First, the presiding court must look at the facts of the situation to determine whether a restrictive agreement is justified at all. Second, the trial court must examine the specific terms of the non-compete restriction to determine the reasonableness of its effect. Only where a non-compete agreement is justified and reasonable will it be enforceable. See Saturn Systems, Inc. v. Militare, 252 P.3d 516 (Colo. App. 2011).
While the reasonableness inquiry is factually dependent on the specific circumstances of each case, generally the narrower and limited in time the non-compete agreement is the more likely it will be enforceable. Examples of Colorado cases pertaining to the trade secret exemption include Cocona, Inc. v. Singtex Industrial Co., Civil Action No. 14-cv-01593-MJW (D. Colo. Oct. 9, 2014), where a non-compete agreement was deemed enforceable where the agreement was limited to six months and was specifically limited to prohibiting the defendant from using the plaintiff’s trade secrets in its manufacturing process; Continental Credit Corporation v. Dragovich, Civil Action No. 13-cv-01349-WYD-MJW (D. Colo. July 1, 2013), where the court refused to enforce a non-compete agreement in a motion for a preliminary injunction because the plaintiff had not sufficiently demonstrated a strong enough connection between the non-compete agreement and the existence of a trade secret; and Saturn Systems, Inc. v. Militare, 252 P.3d 516 (Colo. App. 2011), where the court upheld the enforceability of a non-compete agreement where the agreement was limited to one year and specifically prohibited the defendant from disclosing client lists or soliciting clients on his own behalf or on behalf of another entity.
Accordingly, in drafting a non-compete agreement in the trade secret context, the employer should ensure that the restrictions are focused on the protection of the trade secret, as opposed to generally prohibiting an employee from working for competitors, and are not of indefinite or overly broad scope in duration and territory.
Executives, Management, and Professional Staff Exemption for Non-Compete Agreements in Colorado
The third category that enforceable non-compete agreements may fall into is agreements limiting the ability of executives, management, and their professional to work for competitors. Similar to other non-compete agreement categories, whether an individual qualifies as an executive, management, or professional staff, and whether the agreement is reasonable are questions of fact that must be determined by the trial court. See Porter Industries, Inc. v. Higgins, 680 P.2d 1339, 1342 (Colo. App. 1984).
Specific factors courts look at in determining if an employee is an executive or manager are whether that employee is in charge of a significant portion of the plaintiff’s business. Put in other words, Colorado courts have indicated that in order to be part of the executive and management group, an employee must have significant responsibility for the business and act in a supervisory capacity. See Alexander & Alexander, Inc. v. Hall and Co., Civil Action No. 88-A-1621 (D. Colo. 1990).
Examples of Colorado cases applying the executive and management exemption include DISH Network Corp. v. Altomari, 224 P.3d 362 (Colo. App. 2009), where an individual was found to qualify as management where, although he was not a CEO, he was the head of a division, was involved in decision making processes, and was at the top of the company’s compensation scheme; Atmel Corp. v. Vitesse Semiconductor Corp., 30 P.3d 789 (Colo. App. 2001), where an employee was found not be management where he was a technical liaison, did not supervise anyone, and had three levels of management above him; and Porter Industries, Inc. v Higgins, 680 P.2d 1339 (Colo. App. 1984), where a salesman was not found to be management where he negotiated and sold contracts but was not in charge of existing contracts and did not act in an unsupervised capacity.
Additionally, for the professional staff portion of the exemption, Colorado courts have interpreted the statute to require some amount of a professional degree or training in order to qualify as professional staff under management or an executive. Further, in order to qualify, the individual must work closely enough with an executive or manager as to serve as a key member in the manager’s or executive’s implementation of management or executive functions. Examples of employees that would qualify as professional staff include nurses, dental hygienists, and therapists while employees merely administering management decisions, such as salespeople and purely administrative staff, would not. See Phoenix Capital, Inc. v. Dowell, 176 P.3d 835 (Colo. App. 2007).
Other Considerations for Non-Compete Agreements in Colorado
Other important considerations for non-compete agreements in Colorado include the application of non-compete agreements to independent contractors, the scope of what “non-competition” encompasses, and contractual defenses to non-compete agreements. These considerations will be discussed sequentially.
First, for independent contractors, Colorado courts have determined that non-compete agreements apply equally to independent contractors as well as employees. That is, whether a person was employed as an employee or as an independent contract is irrelevant to whether a non-compete agreement can be enforced. However, one important exception is that independent contractors may not be considered professional staff for purposes of the executives and management exemption discussed above. See Colorado Supply Co. v. Stewart, 797 P.2d 1303 (Colo. App. 1990).
Secondly, with regard to what “non-competition” encompasses, Colorado courts have interpreted what qualifies as “competition” relatively broadly. More specifically, courts have found that non-compete agreements include prohibiting the bound party from assisting others to develop a competing business, even if the bound party is not actually receiving any compensation from it. Additionally, courts will interpret a person who has not signed the non-compete agreement to be bound by it where that person is assisting a person who has signed the non-compete agreement to violate it, for example, where the bound party is using a proxy to get around the agreement. See Nat’l Propane Corp. v. Miller, 18 P.3d 782 (Colo. App. 2000); Gold Messenger, Inc. v. McGuay, 937 P.2d 907 (Colo. App. 1997).
Lastly, because non-compete agreements are contracts, the same defenses that would render a contract void or unenforceable in a breach of contract claim apply to non-compete agreements as well. That is, a defense to enforcement of a contract would also apply to enforcement of a non-compete agreement. Examples of defenses applicable to contracts include duress, undue influence, and failure of consideration. See The Law of Trade Secrecy and Covenants Not to Compete in Colorado – Part II, 30 Colo.Law. 5 (2001).
Remedies for Breach of Non-Compete Agreements
Importantly, C.R.S. § 8-2-113(2), the statute governing non-compete agreement in Colorado, does not include specific language covering remedies for breach of non-compete agreements. Accordingly, normal damages principles apply to non-compete agreements meaning the plaintiff, if she prevails, may recover lost net profits that are the proximate result of the breach of the agreement.
© 2017 J.D. Porter, LLC. Author: Jordan Porter. Denver, Colorado.