What is a Subcontractor Non-Compete?
A non-compete is an agreement where a person or entity agrees not to compete with another. Subcontractor agreements often have a non-compete clause that applies to the subcontractor for a fixed period after the subcontractor’s performance is complete. Depending on the situation, it may be appropriate for a person or entity to agree not to compete with you after its services are no longer required .
In some cases the non-compete may extend to a more narrow market – such as the "[insert region] region" or "[insert position] jobs." In some cases, the non-compete extends to non-similar job positions. For example, in some cases an executive might agree not to compete for jobs as a manager for two years while still being allowed to compete for jobs as a consultant. A wider or narrower non-compete may depend on the sophistication of the parties and their bargaining power in the negotiations.
The Components of a Subcontractor Non-Compete
A non-compete clause is an agreement between a subcontractor and contractor designed to prohibit the subcontractor from competing with the contractor after the contractor-subcontractor relationship ends. In Delaware, a non-compete clause will likely be enforceable if it is "no broader than is reasonably necessary to protect the [contractor’s] interests," meaning that its duration, geographic scope, and the work or type of business it covers must be suitable.
As a general rule, the majority of non-compete clauses restrict a subcontractor from working with a competitors in either a certain time period after the end of the contract and/or a specific distance from the contractor’s place of business. Further, most non-compete clauses limit the work or type of business that a subcontractor would be engaged in.
For example, when looking at duration, a non-compete clause typically might stop a subcontractor from working with competitors for a year after the end of the contract between the subcontractor and contractor. When assessing geographic scope, a reasonably acceptable distance could prevent the subcontractor from working with competitors within 50 miles of the contractor’s place of business. And for type of work, a non-compete clause may prevent a subcontractor from working with competitors that are in a contractor’s trade or field.
Enforceability of Subcontractor Non-Compete Clauses
Given the gulf in expertise between a general contractor and a subcontractor, under some circumstances a non-compete clause against a subcontractor may be unenforceable as against public policy. As a general rule, non-competition clauses in employments are void as against public policy unless they are reasonable with respect to a number of competing factors. Those factors include the (i) length of time the employee is bound not to engage in competitive work, (ii) the territorial extent of the restriction, (iii) the nature of the employment, and (iv) the period of time necessary to establish with a new employer a relationship of trust, confidence, and good reputation with customers. The trend in Canadian jurisprudence is to uphold such clauses in employment contracts as long the clauses are reasonable in the eyes of the law and protect the legitimate interests of the employer.
A number of factors will determine whether or not the clause is enforceable. Only the public interest, as expressed by public policy, can limit the freedom to contract. The courts consider the entire context of a subcontractor’s business and the role of the non-competition clause. The rule that an employee cannot be placed in a position where there is no profit in continuing is irrelevant in a non-employment relationship. The courts will not allow the commercial interests of a subcontractor to prevail over those of a general contractor. The question here will really be one of degree and degree of reliance. The greater the reliance, the greater the commitment, the better the chance of a finding against a subcontractor who is seeking to break the clause. In HDH Electric Ltd. v. Gallo, the court found that the subcontractor’s trade secrets included customer contacts, pricing, credit, terms and more. These are things that the subcontractor "needs to do business."
In Cason v. Johnson & Johnson (1997), 33 C.P.R. (3d) 129 (B.C.S.C.), the court invalidated a one-year non-compete covenant against a sales representative where: (i) the territory was not defined and the customers were not identified; (ii) the contract did not specify the kind of personal knowledge of customers that the ex-employee had; (iii) the ex-employee was not involved in the purchasing decision or in negotiating the selling price; and (iv) there was no evidence that the ex-employee was or would be in a position to offer a competitive advantage to the new employer. In Berger v. Sandberg, [2004] A.J. No. 473, the Alberta Court of Appeal considered whether a covenant preventing a former employee from soliciting the employer’s clients for two years was enforceable. The court stated that "the covenant should not go beyond that which the parties may reasonably consider necessary for the protection of the worthwhile interests of the employer." The court will consider whether the clause restricts the employee’s right to choose their occupation or profession. Any doubt must be resolved in favour of the former employee.
The burden is on the employer to prove that the non-compete clause is reasonable. Canadian courts have generally refused to enforce non-solicitation or non-competition agreements where the customer list was publicly available. In Alexander Manufacturing Ltd. v. Whittal, [1986] 2 S.C.R. 575, the court found that the appellants’ customer list was not confidential because it was the result of publicly accessible efforts. Factors to be considered in a non-compete clause thus include: (i) the territorial extent; (ii) the duration of the restriction; (iii) the employee’s degree of knowledge of the employer’s affairs; (iv) the effect of the restriction upon the employee’s ability to earn a livelihood; and (v) the extent that the restriction goes beyond what is necessary to protect the employer’s legitimate business interests.
Pros and Cons of Subcontractor Non-Competes
For the subcontractor, the benefits and drawbacks to agreeing to such a provision are both obvious and not-so-obvious. On the one hand, a non-compete provision in the subcontractor agreement might promote the client’s contractual goals by protecting confidential information and creating a "level playing field" between the general contractor/contractor and his/her subcontractors. On the other hand, a subcontractor may find itself bound to an organization where its business models conflict with each other, thereby creating animosity in their relationship with one another, and possibly selling itself short of its bottom line profit potential.
It is also important to understand that for the subcontractor, as well as for the general contractor/contractor, a non-compete provision may be simply unenforceable. A subcontractor who regularly does work for several different general contractors does not benefit from agreeing to a broadly worded non-compete provision that prevents it from working with other contractors who may offer similar or identical services. It would be impossible for an organization that routinely works in a competitive field to go a period of months (and even years) without working on at least one project for a competitor of its general contractor/contractor employer. Further, if the subcontractor works frequently in a state where non-compete clauses are unenforceable, then agreeing to such a provision will have no practical effect on that subcontractor.
Negotiating an Acceptable Subcontractor Non-Compete
To ensure that a non-compete clause is fair and defensible, subcontractors should negotiate the "geographic area" the clause governs. If a contractor requests that a subcontractor stay out of a broad, defined area, the subcontractor should ask for a more limited area. A "start or stop" distance may be a reasonable solution. For example, the language of the clause could read: "For a period of six months from the date of the termination of this Agreement, the Subcontractor shall not solicit work from any of the Customers within a twenty-five mile radius of each jobsite."
Further, the jobsite can be defined as any site where the contractor has performed work within the last two years, or has jobs or any contracts pending. The rationale for this limitation is that a contractor has to stay aware of potential jobsites. Without such a limitation, the subcontractor could potentially be barred from hundreds of miles away.
Contractors can also limit the duration a subcontractor cannot work on jobs at certain locations. For example, the non-compete clause can state that the subcontractor cannot perform work for a customer for six months. The Court has not reviewed this novel question , but it seems reasonable to apply a six month period as the enforcement remedy.
The Court’s ruling also suggests that contractors should not be allowed to impose non-compete clauses without a clear business justification. The valid purposes for non-compete provisions in an employment context include the protection of trade secrets, confidential information or customer relationships. The Court has identified additional reasons to limit competition, like the sale of a business, a one-time provision in an employment contract, and protecting a small geographic area. The practical limits to these reasons require a narrow interpretation of the word "employer." A contractor is not a "principal," the business entity the subcontractor has entered into a direct relationship with for the specific job and time period.
Also of note, the statute does not have a post-employment provision. That means a person who was not an employee of a contractor cannot be bound by a non-compete clause based on the relationship of a subcontractor with that employer, as there is no defined employment relationship.
Alternatives to Subcontractor Non-Competes
Many businesses who use subcontractors opt not to pursue a non-compete clause in their subcontracts. This is for a number of reasons: first, many businesses believe that non-competes are too restrictive, especially if the contractor has a large customer base. They may also be hesitant to enforce a non-compete because it could negatively impact their relationship with the subcontractor, as well as any goodwill built up with their clients over the years. Third, many subcontractors are being hired for specific projects, not necessarily on a continuing basis. As such, the likelihood of a subcontractor taking customers after finishing a project for their new contractor is relatively low, although not impossible.
There are, however, certain provisions that can be added to subcontractor agreements to protect your business and customers that do not involve a non-compete. These include confidentiality agreements, in which the subcontractor agrees that any information about your company, customers, or employees is proprietary to you, and that they will not use or disclose it at any time without your permission. These provisions are crucial for protecting your business, because no matter what line of work you are in, you have certain information that is vital to your success. Your business has probably encountered issues along the way and implemented certain successful solutions – these solutions are your competitive edge. Agreeing to a contract to keep such information private protects you from unauthorized disclosure against your interests.
You may also want to include a non-solicitation clause, in which the subcontractor agrees that, for a set period of time after leaving work with you, they will not work for any of your competitors, solicit financing or investors from anyone, or solicit business from any of your customers. These provisions protect your client base, and therefore, your business.
Reviewing Compliance with Subcontractor Non-Competes
A thorough review of these clauses before signing a contract is an absolute necessity. Once it’s on the books, you could be bound by it for a long time, even if you have terminated your subcontractor agreement. Generally, the clause will extend for up to two years after termination, but some agreements contain even longer duration clauses.
The restrictive covenant will require that the subcontractor, partner or other individual engaged by the contractor not interfere with the business of the contractor for a period designated in the specializing agreement. Such non-compete clauses apply to contractors, third parties or any other independent agents and even the subcontractor themselves. Essentially, it says that if you do not want to lose money, the subcontractor agrees not to work , partner or engage with another business that is in competition with the contractors. Moreover, the language described above usually includes a geographical restriction. It may say that the subcontractor is precluded from working with a competitor that has a principal place of business within, for example, 50 miles of the contractors main office. Basically, this means that the contractor will need to carefully read their agreements, and if there is a question, consult a lawyer. Once again, generally speaking, the employee should only be treated with "the client’s permission, which would not be granted if the client did not like or approve of the subcontractor". If the relationship between the contractor and subcontractor terminates but the subcontractor violated the non-compete clause, they could be sued for damages.