Chapter 19 - § 19.2 • NONCOMPETITION AGREEMENTS

• Jurisdiction: Colorado

§ 19.2 • NONCOMPETITION AGREEMENTS

§ 19.2.1—History Of Noncompetition Agreements

An understanding of the history of covenants not to compete will aid in understanding how a specific covenant will be viewed today. It is also an example of how the common law changed over time to take into account changing values and economic conditions. An interesting historical description was provided in the 1909 case of Freudenthal v. Espey, 102 P. 280 (Colo. 1909); see James R. Krendl & Cathy S. Krendl, "Noncompetition Covenants in Colorado: A Statutory Solution?," 52 Denver L.J. 499 (1975).

Historically, noncompetition agreements were found to be illegal restraints of trade. English courts held that contracts restricting one's exercise of a trade or profession were contrary to public policy and void. In the first reported case, the doctrine prohibiting restraints on employment was considered to be old and settled law. When the plaintiff attempted to enforce a covenant that his apprentice not exercise his trade of dyer's craft within the plaintiff's town for a period of six months, the agreement was considered to be so contrary to the law that the plaintiff was sworn at by Judge Hull and threatened with a fine, which apparently was the old English sanction for bringing frivolous claims. Freudenthal, 102 P. at 282.

As described by the Colorado Supreme Court in Freudenthal, changing times required the law to change as well.

Expanding commercialism, advancing science and arts, the desire and necessity for education, and the spirit of the age, however, eventually impressed the judicial mind with the necessity of remodeling the rule to meet the needs and requirements of men. It was recognized that both public interest and private welfare often render engagements not to carry on a trade or to act in a profession in a particular place for a limited time proper and even beneficial.

Id.

Freudenthal set forth the principles concerning the enforceability of noncompetition agreements in Colorado. Specifically, the court held that a reasonable restraint or restriction on competition would be enforceable. To be reasonable, a restriction must be necessary to protect the party in whose favor it is given, most often the employer, and not so broad as to interfere with the interest of the public. If the restriction was broader than necessary, it was deemed to be oppressive, unreasonable, and unenforceable. Therefore, the court concluded, a noncompetition agreement must be reasonable in purpose, and limited by geography and time.

The Freudenthal court found that a covenant not to practice medicine in Trinidad for five years was reasonable and necessary considering the fact that the plaintiff had trained a younger doctor and introduced him to his patients. The public policy was described as follows:

[W]e are not disposed by judicial decree to render it practically impossible for the unlearned to better their condition, and become skilled in a trade or experienced in a profession, by means of proper apprenticeships, as we would do, were we to declare this contract void. Few professional men would take assistants and intrust them with their business, impart to them their knowledge and skill, bring them in contact with their clients and patients, unless they be assured that the knowledge and skill imparted and the friendships and associations formed would not be used, when the services were ended, to appropriate the very business such assistants were employed to maintain and enlarge.

102 P. at 285. By 1913, the Colorado Supreme Court viewed restrictive covenants with great favor, especially when necessary to protect the purchaser of a business. Barrows v. McMurtry Mfg. Co., 131 P. 430 (Colo. 1913). It was stated that a covenant should be strictly enforced unless it clearly appears that the terms are so unreasonable as to deprive the vendor of valuable rights without any corresponding benefit to the purchaser. Id. at 438. In dicta that would be a harbinger of things to come, the court suggested that a court could partially enforce an unreasonable covenant by declaring it binding over only such territory and for such time as reasonably necessary for the protection of the purchaser. Id. Thereby, the court could, in effect, rewrite the restraint to make it reasonable and, therefore, enforceable.

Until C.R.S. § 8-2-113(2) was enacted in 1973, the Colorado courts generally found a way to enforce noncompetition agreements, even without time or geographic limitations. For example, in 1929, the Colorado Supreme Court approved an injunction that "perpetually" enjoined the seller of a bakery from competing with the buyer. Weber v. Nonpareil Baking Co., 274 P. 932 (Colo. 1929). In 1943, the Colorado Supreme Court upheld a restrictive covenant without any territorial limitation. Whittenberg v. Williams, 135 P.2d 228 (Colo. 1943). Because the trial court limited the covenant's effect to a specific area within the state, the supreme court found the restriction to be reasonable and enforceable.

In 1951, the Colorado Supreme Court held that an injunction enforcing a noncompetition agreement was enforceable in favor of the seller of a business even though the buyer was unable to prove injury as a result of the seller's competition. Quoting from C.J.S., the Colorado Supreme Court stated the following to support its decision upholding the injunction:

The rule is well settled that: "Where an established business has been sold with its good will and there is a valid covenant not to compete, a breach is regarded as the controlling factor and injunctive relief follows almost as a matter of course. In such cases, the damage is presumed to be irreparable, and the remedy at law is considered inadequate. It is not necessary that the buyer first prove special pecuniary damages or show an actual loss of customers who might in any event have discontinued their patronage. Injunctive relief may be given, even though only nominal damages are shown, or although no actual damage is shown."

Ditus v. Beahm, 232 P.2d 184, 185 (Colo. 1951).

In 1968, an employer sought injunctive relief based upon a promise that, for a period of two years, its former salesman would not engage in the institutional food, paper, and supply business; bakery supply business; and janitorial supply business. Although it was undisputed that the defendant's new employer was in competition with the plaintiff, there was no proof of threatened or actual irreparable damage to the plaintiffs.¹ Therefore, the supreme court affirmed the trial court's refusal to grant an injunction because "[t]he injury to Defendant Siders by enforcement of the agreement outweighs the benefit to Plaintiff Knoebel." Knoebel Merchantile Co. v. Siders, 439 P.2d 355, 358 (Colo. 1968).

Just one year after the decision in Knoebel, the Colorado Supreme Court conducted a review of the Colorado noncompete cases and determined that it was well settled in Colorado that restrictive covenants that were "reasonable" would be enforced, and that what is "reasonable" depends on the facts of each case. After reviewing 10 prior noncompete cases, the court stated:

We deem it significant that in 9 out of the 10 cases cited, the court upheld the enforceability of the non-competitive covenant. This substantial precedent evinces the court's unwillingness to search out legal excuses for a willful and deliberate violation of a reasonable covenant not to compete. We here declare renewed approval of this precedent.

Zeff, Farrington & Assocs., Inc. v. Farrington, 449 P.2d 813, 814 (Colo. 1969).

§ 19.2.2—Colorado Statute Restricting Noncompetition Agreements

In 1973, the Colorado General Assembly enacted a statute that deemed noncompete covenants to be void unless the restrictions fit within certain, enumerated exceptions. The statute, C.R.S. § 8-2-113(2), states as follows:

(2) 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 (2) 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.

C.R.S. § 8-2-113(2).

Following its enactment, the courts have held that C.R.S. § 8-2-113(2) expresses a strong public policy against covenants not to compete,² and that the exceptions set forth in the statute should be narrowly construed. Colorado Accounting Machs., Inc. v. Mergenthaler, 609 P.2d 1125, 1127 (Colo. App. 1980). The party seeking to enforce a restrictive covenant has the burden of proving that one of the exceptions applies. Porter Indus., Inc. v. Higgins, 680 P.2d 1339, 1341 (Colo. App. 1984). Further, the intent of the legislature was to preserve the rule that noncompetition agreements must be reasonable. Nat'l Graphics Co. v. Dilley, 681 P.2d 546, 547 (Colo. App. 1984).

The statute has been found to apply to covenants made by independent contractors as well as covenants made by employees. Colorado Supply Co. v. Stewart, 797 P.2d 1303, 1305 (Colo. App. 1990). A question sometimes arising in the cases, however, is the extent to which the statute applies to noncompetition clauses outside of the employment context. The answer is unclear. Two cases apply the statute to franchisor-franchisee relationships. See Keller Corp. v. Kelley, 187 P.3d 1133, 1138-40 (Colo. App. 2008) and DBA Enters., Inc. v. Findlay, 923 P.2d 298, 301-03 (Colo. App. 1996). But two courts that considered this issue in other contexts reached different results. Compare Nutting v. RAM Southwest, 106 F. Supp. 2d 1121, 1124-25 (D. Colo. 2000) (statute applies...