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Avoiding Some of the Uncertainty of Non-Compete Agreements: Fiduciary Duties of Minority Shareholders as a Basis For Enforcing Non-Compete Agreements

Evaluating the enforceability of a non-compete agreement under Massachusetts law involves an inherent degree of uncertainty.  This is because courts use subjective standards to determine whether to enforce a non-compete agreement based on whether it is: (1) reasonable in scope, length of time, and geographic area; (2) protective of a legitimate interest of the employer; and (3) supported by adequate consideration.  Thus, enforceability depends on the facts of a particular case.  Employers can increase the likelihood that a non-compete agreement will be enforced as written by tailoring non-compete agreements based on the guidance of past court decisions.  To that end, non-compete agreements should be limited to a duration of no more than 1-2 years. The geographic scope of a non-compete agreement should be limited to the area actually served by the employer or where the employer has specific plans to expand.  Non-compete agreements should also be presented to employees before hiring.  If the employee is already employed, employers should include some form of additional consideration, such as a raise or one time payment, for added certainty that a non-compete agreement will be enforced as written. 

In addition to keeping abreast of recent court decisions, employers must be aware of potential legislative developments in the area of non-compete law.  Last week the Massachusetts Joint Committee on Labor and Workforce Development met to hear testimony on five bills relating to the legality and enforcement of non-compete agreements.  The bills the committee considered ranged from moderate reform to a complete ban on non-compete agreements in Massachusetts similar to California.  So far, Governor Charlie Baker has not taken a position on non-compete agreements but has said through a spokeswoman that he will consider any measure that makes it through the Legislature.

Given the potential changes and uncertainty in the area of non-compete law, employers may need to be creative to ensure that former employees can be prevented from competing.  One possible way to achieve greater certainty is through stock grants.  In Massachusetts, shareholders of a close corporation are fiduciaries of each other and the company.  Last year, the Supreme Judicial Court held in Selmark Associates, Inc. v. Ehrlich that even where a minority shareholder is improperly fired, the terminated employee still owes fiduciary duties to the company and may not compete so long as the employee owns shares of the company.  Based on this precedent, so long as the employee is an owner of the shares of a closely held company, the employee may not compete with the company.  Thus, employers should consider issuing shares to employees along with a carefully worded shareholder agreement that provides for the buyback of the shares over a period of time commensurate with the desired non-compete period.  This approach could add more certainty for employers who could invoke fiduciary principles, in addition to contract law principles, to prevent an employee from competing before the buyback is complete.

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