Can A Company Enforce a Noncompete Provision Against Its Former Independent Sales Representative?

Can A Company Enforce a Noncompete Provision Against Its Former Independent Sales Representative?

The law of restrictive covenants is in something of a state of flux. Companies across the United States have agreements with employees, and with independent contractors, that include limits on what the hired person can do with regard both to customers and to company employees, both during the agreement and after the agreement ends. The situation is also complicated by the fact that these laws vary from State to State. There is nevertheless a recent trend towards such cases being decided in favor of the hired party and against the company. This trend was recently continued by a federal court of appeals that decided that someone who had been an independent contractor for a dozen years for Ag Spectrum, an Iowa business selling fertilizer, nutrients, and crop-management services, was not bound by his written agreement not to compete following the end of his contract.

Overview

Vaughn Elder worked as an employee for Ag Spectrum from 2000 until 2005. In 2005, he became an independent contractor to Ag Spectrum, under an agreement that described him as an “Area Manager.” Under that agreement he was only permitted to sell Ag Spectrum products. The agreement was governed by Iowa law, and Elder served a customer base in Kansas, Colorado and Nebraska. While California law is settled insofar as agreements with employees that flatly prohibit competition after the employment ends are void, there are conflicting decisions under some other scenarios. This article, however, will focus on interstate developments.

When Mr. Elder became an independent contractor to Ag Spectrum in 2005, he had to supply, at his sole expense, all the materials needed for his work. He was not an employee for tax purposes. He was to be “engaged in [his] own independent business” and thus was prohibited from participating in any Ag Spectrum employee benefit plan. He was not covered by Ag Spectrum’s workers’ compensation insurance. And he had no authority to contract on Ag Spectrum’s behalf.

Elder sold Ag Spectrum products directly through his own efforts, and indirectly through dealers working under him. There was conflicting testimony on the extent of support provided by Ag Spectrum to Elder. Elder testified that “virtually all” of his sales were to people he had “developed relationships with over the course of [his] life” or to his dealers. Only two of Elder’s customers came to him through Ag Spectrum. Under their written agreement, Elder also agreed not to compete with Ag Spectrum by marketing to, selling to, or consulting with its customers about similar products for three years after terminating the agreement.

Like most States, Iowa law permits enforcement of non-compete provisions only when the provision is reasonably necessary to protect the employer’s business and does not unreasonably restrict the employee’s rights or harm the public interest. As stated by a court in West Virginia, “at the heart of all enforceable covenants not to compete is the principle of avoiding unjust enrichment.”

Thus, a company seeking to restrain competition bears the burden of proving reasonableness, which rarely comes down to a single fact and always depends on the particular circumstances. Several factors go into reasonableness, including: (1) the service provider’s closeness to customers; (2) the service provider’s peculiar knowledge gained through the work that provides a means to pirate the customer; (3) the amount and sophistication of company-provided training and the nature of the business; and (4) matters of basic fairness.

Importance of the Hired Parties Independent Abilities

The court’s decision analyzed these various factors, and concluded that because Elder developed his own customer base and received only minimal support from Ag Spectrum, the non-compete provision is unreasonable and therefore unenforceable.

As a “matter of basic fairness,” companies need to consider the structure of agreements such as this. As an independent contractor, Elder was not provided with any of Ag Spectrum’s employee benefits. The IRS and State tax agencies dislike independent contractor relationships because they avoid unemployment taxes, disability fund contributions, workers compensation payments, and some other employment taxes. It was thus understandable that Ag Spectrum had to exclude Elder from company employment benefits. If Ag Spectrum had not been careful in this regard, it would have faced a risk that Elder might have claimed that he was a misclassified employee. In that event he might pursue violations of federal and State employment laws, and seek reimbursement of years of social security contributions and penalties for employment law violations.

On the business operations side, it is likewise understandable that Ag Spectrum’s marketing department would want Elder to sell only Ag Spectrum products. With an independent contractor, however, that is often a fateful choice legally. Someone in Elder’s position can probably only make a reasonable living in the future only if he can continue the same kind of work. Indeed, Elder’s attorneys in the case argued that non-compete provisions should always be invalidated as to independent contractors. The court would not go that far, however.

What did it take for the court to declare that an unambiguous provision in the parties’ working agreement of a dozen years was unenforceable? It was a combination of the fact that in this case it was Elder who built the distribution business from his own efforts and investment with minimal support, and that barring someone who has not received employee benefits for more than a decade from working in perhaps the only field in which he is qualified would violate the requirement of basic fairness. While there continues to be some variation in these cases from one State to another, this is both the trend and the likely outcome in most States.

Alan Haus
ahaus@rroyselaw.com
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