Chapter 34 - § 34.1 • THE LAW OF RESTRICTIVE EMPLOYMENT AGREEMENTS IN COLORADO

• Jurisdiction: Colorado

§ 34.1 • THE LAW OF RESTRICTIVE EMPLOYMENT AGREEMENTS IN COLORADO

In analyzing or drafting any restrictive covenant in an employment agreement, it is best to approach the task keeping this proposition in mind: Employment agreements purporting to restrict the right of an employee or an independent contractor to work for a competitor are illegal and void in Colorado. Mgmt. Recruiters of Boulder, Inc. v. Miller, 762 P.2d at 765 (holding that noncompete provisions are void); Colo. Supply Co., Inc. v. Stewart, 797 P.2d 1303 (Colo. App. 1990) (holding that C.R.S. § 8-2-113 applies to independent contractors). This restriction is a creature of statute, C.R.S. § 8-2-113(2), which, because of its importance to these issues, is set out in its entirety here.

(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.

The purpose of the statute is to protect "employees from non-competition clauses except in carefully defined circumstances." Colo. Accounting Mach. v. Mergenthaler, 609 P.2d 1125, 1126 (Colo. App. 1980). Any such clause that does not fall within one of the statutory exceptions is "void, not merely voidable." Id. at 1127. Colorado courts also have held that such clauses are void as contrary to public policy. DBA Enters., Inc. v. Findlay, 923 P.2d 298 (Colo. App. 1996). Accordingly, even noncompete clauses that fall under one of the statutory exceptions must be reasonable as to both geographic scope and duration. Nat'l Graphics Co. v. Dilley, 681 P.2d 546 (Colo. App. 1984).

Whether a restriction is reasonable is determined "as of the time the agreement is entered into, and not as of any time thereafter." Phoenix Capital, Inc. v. Dowell, 176 P.3d 835, 840 (Colo. App. 2007). The reasonableness of the scope and duration of the restriction is dependent "on the facts of each case." Energex Enter., Inc. v. Anthony Doors, Inc., 250 F. Supp. 2d 1278, 1283 (D. Colo. 2003). This examination first focuses on "the circumstances of the contracting parties to determine whether a restrictive covenant is justified" in the first place. Id. If a covenant is warranted, "then the specific terms" of the provision are scrutinized "to determine the reasonableness of their effect." Id. (citing Miller, 762 P.2d at 766). "The central concern in both determinations is whether the restrictive provision is necessary to safeguard the plaintiff's business." Energex Enter., Inc., 250 F. Supp. 2d at 1283.

There appears to be no reported decision in which a Colorado court has stricken a time limitation as being unreasonable. See Axelson v. Columbine Laundry Co., 81 Colo. 254, 254 P. 990 (1927) (six month provision held enforceable); Weber v. Nonpareil Baking Co., 85 Colo. 232, 274 P. 932 (1929) (perpetual covenant held enforceable). Similarly, the Colorado courts take an ad hoc approach to whether a geographic scope provision is "reasonable." Colorado courts have enforced a range of provisions, from county-wide restrictions, Gibson v. Angros, 30 Colo. App. 95, 491 P.2d 87 (1971), to nation-wide restrictions. Trans-American Collections, Inc. v. Continental Account Servicing House, Inc., 342 F. Supp. 1303 (D. Utah 1972) (applying Colorado law). No Colorado case has addressed the issue of a world-wide restriction.

Nutting v. RAM Southwest, Inc., 106 F. Supp. 2d 1121, 1127 (D. Colo. 2000) (holding that world-wide, perpetual restrictive covenant was unreasonable).

The enforceability of any restrictive covenant thus will depend on the facts surrounding its creation, and whether it is sufficiently narrow. This in turn will depend on its duration, geographic scope, and the nature of the business interests being protected.

§ 34.1.1—Statutory Exceptions

There are three exceptions to the prohibition against noncompete covenants contained in C.R.S. § 8-2-113(2). Reasonable restrictive covenants are enforceable in the case of the purchase and sale of a business, for the protection of trade secrets, and in the case of executive and management personnel. C.R.S. § 8-2-113(2)(a), (b), and (d). Each of these exceptions will be addressed in turn. C.R.S. § 8-2-113(2)(c) allows for the recovery of education and training expenses if an employee has been employed for less than two years. This provision will be examined briefly at the end of this section.

Purchase and Sale of a Business

A covenant not to compete may be included in a contract for the purchase and sale of a business or business assets. C.R.S. § 8-2-113(2)(a). In the case of an asset purchase, one might reasonably inquire as to what proportion of assets is required in order to take advantage of the business sale/purchase exception in the statute. There is no Colorado case law answering this question. However, the general purpose of this exception is to allow a buyer "to protect its enjoyment of [the good will of the purchased business] and establish itself in the industry without competition from the former company or its owners." Reed Mill & Lumber Co. v. Jensen, 165 P.3d 733, 737 (Colo. App. 2006). Thus, the asset purchase contemplated by the statute likely is one that involves the purchase of all or substantially all of a business's assets for the purpose of continuing operation of the business.

This exception also has been held to apply to noncompete provisions imposed on a buyer of a business. This situation often arises in the purchase of a franchise. Keller Corp. v. Kelley, 187 P.2d 1133 (Colo. App. 2008); Gold Messenger, Inc. v. McGuay, 937 P.2d 907 (Colo. App. 1997). Once the franchisee terminates the franchise relationship, he or she is subject to the provisions of the noncompete clause assuming that it is otherwise reasonable in scope and duration and necessary for the protection of the franchisor's business. Gold Messenger, Inc. v. McGuay, 937 P.2d at 911 (holding that noncompete provision necessary for the protection of franchisor's trade secrets); Keller Corp., 187 P.2d at 1139 (observing that franchisor has a protectable interest in protecting the "goodwill created by the franchisor and its business methods").

The exception also has been held to apply

to transfer of business assets from husband to wife as part of a divorce proceeding, In re Marriage of Fischer, 834 P.2d 270, 273 (Colo. Ct. App. 1992), to a covenant executed by a partner in a new business for the benefit of an investor contributing substantial funds for the business, Harrison v. Albright, 40 Colo. App. 227, 577 P.2d 302, 304-05 (1977), and to a covenant in an employment contract coupled with a corporate buy-sell agreement, Boulder Medical Ctr. v. Moore, 651 P.2d 464 (Colo. Ct. App. 1982).

Nutting v. RAM Southwest, Inc., 106 F. Supp. 2d 1121, 1126 (D. Colo. 2000). A restriction has even been held to apply against a non-signatory to a purchase contract, where that person has a close relationship to the business or where he or she has assisted the signatory in violating the contract. Gold Messenger, Inc. v. McGuay, 937 P.2d at 912. This is because "a covenantor will not be allowed to do through others what he or she could not do directly." Id. Of course, if the business purchased ceases to exist, any noncompete covenant becomes unenforceable and void. Gibson v. Eberle, 762 P.2d 777, 779 (Colo. App. 1988).

The reason restrictive covenants are allowed in the acquisition of a business is that the buyer must be allowed to "enjoy the business good will for which it paid." Reed Mill & Lumber Co., Inc. v. Jensen, 165 P.3d 733, 736 (Colo. App. 2007). "Such protection . . . [prevents] the former owners from benefitting from the company's good will, [gives] buyer time to convert that good will to its own, and [dissipates] the extent to which the marketplace [identifies] the company with the former owners." Id. at 737. Nevertheless, the duration and scope of such a covenant cannot be "greater than necessary to protect legitimate interests." Id. As such, any covenant contained in a purchase and sale agreement is subject to the same reasonableness analysis as any other situation.

In Reed Mill & Lumber, Jensen was a part-owner of the company. The company was sold to new owners, and Jensen agreed to a noncompete provision as part of the transaction. Specifically, Jensen agreed that he would not compete for a period of three years after he terminated his employment. All of the other prior owners resigned from the company after the purchase. However, Jensen continued to work for the company for another six years, and thereafter resigned to go to work for a competitor. The court held that the duration of the noncompete agreement was unreasonable. The court observed:

For the first three years after the sale, buyer enjoyed the absence of competition from any former owner, including Jensen. In addition, Jensen did not benefit personally from old Reed Mill's good will. Instead, as one employee of new Reed Mill's employees, he participated in buyer's efforts to convert that good will to its own, preserve the patronage of past customers, and establish itself in the locale and industry. Thus, during this time, buyer's rights to the good will were protected.

Id. at 737. The court held that the six-year period of time after the company was purchased (and during which Jensen continued to work for the plaintiff) was sufficient to protect the plaintiff's good will interests, and that therefore the three-year post-resignation noncompete period was...