This is the first of two articles covering the subjects of restraint of trade and trade secrets. The second part, which will appear in the November issue of Agency Sales, examines trade secret protection.

© Jonathan Stutz | stock.adobe.com

“Legally Speaking” articles in Agency Sales magazine have often emphasized the importance of carefully crafting the terms of independent sales representatives’ contracts with principals to avert any number of potential problems. Where possible, reps should use their own terms of agreement. But realistically, principals often want to impose their own terms. Reps naturally focus on the commission terms, territory, and exceptions such as house accounts and commission splits. But one term that can have particularly serious effects beyond the rep’s immediate concerns is the non-compete clause that principals often insist upon to protect against the rep soliciting customers for competitors after termination.

In the excitement of the moment of entering into the rep agreement with a new principal, the rep may not want to dwell on the eventual termination of the relationship that would trigger the non-compete clause. That lack of focus could be a serious mistake not just because the non-compete clause may inhibit the rep’s ability to represent competing lines after termination, but also because the very existence of the non-compete clause can change the dynamics of the relationship between the rep and principal before termination.

If the rep agrees at the outset to a far-reaching non-compete clause that is enforceable under the controlling state law, then the principal knows that the rep has little option but to continue to work with that principal, regardless of whether the principal is dealing fairly with the rep. When enforceable under applicable state law, non-compete clauses can lead to court injunctions to stop the rep from undertaking acts that violate the terms. Even when an injunction is not available, violations of the non-compete clause can give rise to damages claims by the former principal that can far exceed whatever commissions a rep may earn. The mere threat that the principal can tie up the rep and customers in litigation over potential violations of non-compete terms is often enough to discourage reps from representing any competing lines to customers.

Negotiating the Non-Compete

Principals sometimes cast their non-compete clauses as “standard language” that should be non-negotiable. But seasoned reps and their lawyers know that there is no such thing — terms of non-compete clauses vary widely in rep agreements, and sometimes are omitted entirely. The broadest terms try to prohibit the rep from engaging in any work in the same industry as the principal for some fixed number of years. Others specify a particular geographic region or market segment that is said to be off-limits to the rep for some years. Some terms specify that customers developed during the rep’s tenure with the principal are forbidden fruit. Some non-compete clauses shift the focus to prohibit attempts to hire away employees of the principal, which can be important to some principals.

Determining the Controlling Law

The enforceability of such varying terms also varies considerably based on the particular state law applicable to the agreement. For this reason, one of the most important facts to know about a non-compete clause is often not found in that term — it is the separate term stating the controlling law for the contract. The controlling law may be omitted and left for a court to determine on its own, but more careful reps and principals will express an agreement on the controlling state law. Generally, the law of any state having any substantial relationship to a residence or place of business of at least one of the parties, or where the agreement will be performed, can be agreed upon.

When it is stated expressly, a term reciting the controlling state law should never be disregarded as trivial boilerplate — it can be one of the most important terms in the agreement. Among many other reasons that the controlling law term is important is the fact that states vary as to how they enforce non-compete clauses. Many states have laws that will enforce agreed non-compete terms if they are considered “reasonable” in nature, scope and duration. The term “reasonable” signals a very fact-specific inquiry, the outcome of which can be difficult to predict accurately. Terms that prohibit former reps from presenting competing product lines to customers who were actually serviced by the rep on behalf of the principal, and limited in some way by the duration of the rep’s engagement, are among those most likely to be considered reasonable and enforceable in many states.

Negotiating Leverage

One point of negotiating leverage that the rep has is that the broader and more enduring the contract’s stated limitation on the rep’s ability to engage in business after the contract is terminated, the more likely it is that a state court would find the limitation unreasonable and either limit it or refuse to enforce it. Savvy principals are usually not well advised to vastly overreach when negotiating non-compete terms, and savvy reps can encourage their principals to be reasonable by pointing out that the more reasonable the limitation the more likely it is to be a valid one that both sides can live with.

The variation among state laws on non-compete terms is one reason it can be important for reps to consult with counsel familiar with the controlling law when entering into new agreements. California law is among the most strict in the country against non-compete terms in agreements, due to California’s long-standing public policy and statutory protection affirming that “every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.” Particularly if you are a California-based rep, it can be worth insisting that California law applies to your agreements, or at least applies to any non-compete term that a principal insists on including.

Don’t Assume You’re Immune

Regardless of where a rep is based, reps should always pay close attention to the terms of the non-compete clause in a principal’s proposed agreements. Some reps like to think that they are free to disregard even the most onerous non-compete clause because they live in states like California, Montana or Oklahoma, which have strong public policies against restraints of trade. But it could be a potentially costly mistake to disregard an unacceptably broad non-compete clause on that ground alone.

First, as discussed above, the controlling state law, and the venue for any litigation or arbitration, may not be the rep’s home state unless that was expressly agreed at the time of contracting. In the right circumstance, strong public policies like California’s might be applied to protect a rep who is a citizen of that state, even if another state’s law is agreed to be applicable under the contract. But the rep should not bet on it: It may prove to be wishful thinking to assume that, just because the rep lives in California, a foreign state judge will inevitably apply California’s public policy against a non-California principal. The foreign state judge will also be thinking about his or her own state’s public policy, the locally based principal, and the fact that the rep already agreed non-California law should apply.

If you negotiate the law of a favorable jurisdiction like California to control your agreement, or at least to control the non-compete term, there is another trick to making sure you get the benefit of that favorable law: Try to include language to the effect that “California law is controlling without regard to its conflict of laws rules.” It can be a trap for the unwary that a controlling state’s law usually comes freighted with that state’s “conflicts of laws” rules that can sometimes force a court to apply another state’s laws, such as when the principal and the activity are located out of the subject state. If you’ve agreed to apply the law of a favorable jurisdiction, you want to do your best to keep that law applicable and not suffer the surprise of a court deciding that another state’s laws may be more applicable to your circumstance. Conversely, if the controlling law is unfavorable to the rep, the rep may be better off leaving out that extra language, to be able to argue that the unfavorable states’ conflict of law rules should apply. This somewhat counterintuitive point of negotiation is another reason that consulting a qualified attorney is a good step for a rep.

Anti-Restraint of Trade Laws

Another reason not to be complacent is that, even if the rep’s own state law is generally favorable and controls the agreement, anti-restraint of trade laws in many states are designed to protect former employees, not necessarily independent agents like non-employee sales representatives. This is especially so if the contract is between the principal and a rep agency rather than an individual rep, which may be regarded as a business-to-business arrangement that can be subject to greater restraint of trade. Even in California, there is very little authority clearly expressing that the state’s powerful prohibitions against restraints of trade apply to agreements made between business entities.