Section 13 Covenants Against Competition

• Library: Commercial Law 2007

Covenants not to compete vary in scope, but some distributor agreements preclude the distributor or its principals from engaging in a business similar to that engaged in by the distributor during or for some period following termination of the agreement.

Agreements not to compete are unenforceable or limited in scope under statutory laws of a few states. See, e.g., Cal. Bus. & Prof. Code §§ 16600 et seq. (Westlaw through 2006 legislation); Indiana Deceptive Franchise Practices Act, Ind. Code §§ 23-2-2.7-1 et seq. (Westlaw through 2006 legislation). Counsel should determine if the covenant is enforceable under applicable law.

As a general rule, covenants restricting competition are valid if the restrictions are “reasonable.” What is considered reasonable will vary with the circumstances of each case. The party seeking to enforce the covenant has the burden of proving the necessity
and reasonableness of it. Carboline Co. v. Lebeck, 990 F. Supp. 762, 765–66 (E.D. Mo. 1997); Armstrong v. Taco Time Int’l, Inc., 635 P.2d 1114 (Wash. Ct. App. 1981).

Courts often apply factors that are relevant for determining the validity of covenants not to compete in employment or sale of business contracts in determining whether to enforce a covenant not to compete that is ancillary to a franchise agreement. See generally Robert A. Brazener, Annotation, Validity and Construction of Restrictive Covenant Not to Compete Ancillary to Franchise Agreement, 50 A.L.R.3d 746 (1973). A majority of courts appear to apply the same standard that is used to decide whether a covenant not to compete in a sale of business is enforceable to a covenant in a franchise agreement. See, e.g., H & R Block E. Tax Servs., Inc. v. Vorpahl, 255 F. Supp. 2d 930, 934 (E.D. Wis. 2003). If a franchise agreement is considered as similar to an employment agreement, the covenant is given stricter scrutiny than if an agreement is likened to a contract for the sale of a business. See H & R Block, Inc. v. Lovelace, 493 P.2d 205, 211–12 (Kan. 1972); S. Bend Consumers Club, Inc. v. United Consumers Club, Inc., 572 F. Supp. 209 (N.D. Ind. 1983); H & R Block Tax Servs., Inc. v. Circle A Enters., Inc., 693 N.W.2d 548, 554–55 (Neb. 2005).

Under Missouri law, the reasonableness of restrictive covenants is usually judged by three separate standards.

1. The covenant must be reasonably necessary to protect a legitimate interest of the party enforcing the covenant.

2. The covenant must be reasonable in terms of...