A noncompete agreement prevents someone who works for you from working for one of your competitors. You can create noncompete agreements with employees or independent contractors.
Employee vs. Independent Contractor
An employee is under contract to work for you as part of your company, which withholds taxes from the employee's wages. The way you treat an employee is governed by federal and state employment and labor laws. Independent contractors, on the other hand, are hired as outside workers—meaning they are not considered part of the company and therefore do not have tax withheld by you—who handle a project or projects for you.
There are few laws governing how your business can treat outside contractors, but be sure to check your own state laws to see if anything applies. As a test, the Internal Revenue Service (IRS) looks at whether the employer has the right to control what the worker does and how they do the job: if the employer has the right to control, then the worker is an employee, not an independent contractor.
Understanding Noncompete Agreements
A noncompete agreement is a binding contract that prevents an independent contractor from competing with the employer during the contract and a set period of time afterwards. The agreement means the contractor cannot work for a competitor or work independently in the same exact field.
For example, if Tomi takes on a project for United Marketing as an independent contractor creating logos for the agency's soda company client, United Marketing could ask her to sign a noncompete agreement stating she won't work for other marketing companies that handle competing soda companies or work directly with soda companies to create logos. Noncompetes are usually in effect for a set period of time and are not indefinite.
The Problem with Noncompetes
Noncompete agreements provide benefits to the employer and can be detrimental to the independent contractor. If Tomi is an expert in logos for beverages, signing a noncompete preventing her from creating logos for soda companies would limit her ability to support herself and use her skills in the marketplace. Because of this, noncompetes are sometimes of questionable legality. Each state has its own rules about what is fair and some states (California, North Dakota, and Oklahoma) don't allow them at all. In many other states, it can be very difficult to enforce noncompetes since they can so unfairly restrict an individual's ability to work in her field.
Alternatives to Noncompete Agreements
Because noncompetes can be of questionable validity when applied to independent contractors, there are other ways to legally protect your company. The following agreements can be useful:
- Nondisclosure agreement. Sometimes referred to as a confidentiality agreement, this legal document prevents an independent contractor from sharing proprietary information learned while working with the employer. Nondisclosure agreements ensure that the company's confidential information and/or trade secrets can't be shared.
- Nonsolicitation agreement. This type of agreement ensures that the company's clients can't be stolen by preventing the independent contractor from seeking work from the company's clients or customers. It can also prohibit the contractor from seeking to hire any company employees.
Noncompete agreements provide protection for the employer, but because they can so negatively impact an independent contractor's ability to work, they are approached with a lot of legal scrutiny by the courts. You can create a noncompete agreement, nondisclosure agreement, nonsolicitation agreement, or independent contractor agreement yourself, but it is best to have help from a legal expert, such as an attorney or online service provider.