In a non-compete clause, one party promises not to compete with the other. In IT contracts, customers sometimes ask their professional services providers for non-compete terms. The service provider promises not to serve the customer’s competitors. (Click here for a sample clause from The Tech Contracts Handbook — and see bullet 8 below.) And in some cases, the service provider promises not to compete directly with the customer, in the customer’s line of work. The customer wants the language because the service provider could learn business secrets and pick up important skills through the services. And it could use those secrets and skills to help the customer’s competitors — or to compete directly. [We discuss this and other services terms in our webinar, IT Professional Services Contracts, next offered on November 17, 2022, 11-12 PST. Register here].
In some cases, the concern runs the other way. The service provider asks the customer for non-compete terms. And some clauses work both ways. But we’ll focus on the more typical customer-focused terms.
Below are issues to consider before adding noncompete terms:
- You could go to jail! A non-compete clause could violate state or federal antitrust law. And that could call for criminal penalties. See the next bullet.
- Antitrust and unfair competition civil legal trouble. State and federal laws forbid “combinations” — deals — that restrict free trade. That includes many non-compete provisions. Even non-competes between companies in different fields — e.g., IT provider and its brick/mortar customer — could get you in trouble. And deals between companies in the same business — competitors — present an even greater risk. So if you want a non-compete clause, consider advice from an antitrust lawyer. And if the parties could be considered competitors, get that advice no matter what.
- No restrictions on direct competition. If the parties don’t compete, the customer doesn’t need restrictions on direct competition. Its only legitimate concern relates to the service provider using customer secrets and new skills to help the customer’s competitors. So the non-compete clause should only address indirect competition: service provider assistance to customer competitors. (Again, the terms should look like the sample clause linked here.)
- NDA instead. Ask if you need a non-compete (and all the trouble listed above). A typical nondisclosure agreement will often achieve the customer’s goal — will ensure that the service provider does not use the customer’s secrets to serve competitors or to compete directly.
- Define “competitor.” Don’t just say, “Service Provider shall not provide services to Customer’s competitors.” Define that term. Ideally, use a list of the competitors. But if that’s not an option, recognize that you have an unusually difficult drafting task on your hands. Ask yourself questions like, what products/services compete with ours? And, does a company become a competitor if it has a sub or sister company that competes? The more detail, the better. And the narrower the definition, the less chance you have of unpleasant attention from antitrust authorities.
- Limit restricted services. Don’t restrict all service provider work for competitors. That’s unreasonable and, again, likely to create antitrust problems. Limit restricted services to those likely to impart sensitive knowledge or skills to the customer’s competitors.
- Limit duration. Don’t require that the service provider never serve the customer’s competitors. Limit the restriction to the year following the end of services. Or use a longer period if necessary, but recognize that longer restrictions probably increase your chances of antitrust troubles.
- Liquidated damages. You’ll probably find damages hard to establish if you ever pursue a claim under a non-compete clause. To limit future legal battles, use a liquidated damages provision. And of course, use a reasonable estimate of the customer’s loss for your liquidated damages figure. Finally, add liquidated damages justification language, like the clause here.
Want to do tech contracts better, faster, and with more confidence? Check out our training offerings here: https://www.techcontracts.com/training/. Tech Contracts Academy® has options to fit every need and schedule: Comprehensive Tech Contracts Master Classes™ (four on-line classes, two hours each), topical webinars (typically about an hour), customized in-house training (for just your team). David Tollen is the founder of Tech Contracts Academy and our primary trainer. An attorney and also the founder of Sycamore Legal®, P.C., a boutique IT, IP, and privacy law firm in the San Francisco Bay Area, he also serves as an expert witness in litigation about software licenses, cloud computing agreements, and other IT contracts.
And, consider also the 3rd edition of David Tollen’s best-seller, The Tech Contracts Handbook, available to order (and review) from Amazon here, or purchase directly from its publisher, the American Bar Association, here.
© 2021, 2022 by Tech Contracts Academy, LLC. All rights reserved.
Thank you to Pixabay.com for great, free stock images!