Should You Have Non-Compete Agreements for Independent Contractors?

Non-compete agreements for independent contractors might seem like a great way to protect your company’s secrets from the competition. Even though you can have non-competes with your independent contractors, the question is: should you?

This article explains what non-compete agreements are, when they are unenforceable, the potential problems they can cause, and how an NDA can be a more suitable alternative.

What Are Non-Compete Agreements?

A non-compete agreement, also known as a non-compete clause or covenant not to compete, is a legal contract between an employer and a worker that prohibits the latter from working with one of your competitors or starting a rival firm. These agreements are typically signed at the beginning of an employment relationship and stay in place for a specific period after their employment ends.

The purpose of a non-compete agreement is to protect a company’s trade secrets, confidential information, and goodwill from being shared or used by a former or current employee or independent contractor to benefit a competitor. This protection is especially useful in industries where a team member’s knowledge and relationships are critical to the success of a business.

If an independent contractor violates a non-compete agreement, the company that issued the non-compete contract may take legal action against them. They can file a lawsuit seeking damages, a court injunction prohibiting the worker from engaging in competitive activities, or both.

When Are Non-Compete Agreements Unenforceable?

Non-compete agreements can be disputed and are unenforceable whenever they are overly restrictive or contravene state laws. Every state has its own law regarding the use of non-competes. For example, in California, they are deemed illegal, except when selling a business or a shareholder’s stock or dissolution of a partnership; while in Florida, they are allowed but are subject to strict scrutiny.

When determining whether a specific non-compete is enforceable, courts often look to several factors: the agreement must not cause undue hardship for the employee or contractor or harm the public, and it must have a reasonable period and geographic scope.

The most common reasons why a non-compete agreement may be unenforceable are as follows:

1. Unreasonable restrictions. In this context, unreasonable refers to clauses that might be overzealous in their attempt to limit when and where a former employee or contractor could start working for a competitor, for example, forbidding an employee from working for a competitor in any capacity for a decade. What is ‘reasonable’ can vary by state, but typically, a duration of six months to a year and a geographic scope that is limited to the company’s relevant market are considered reasonable.
2. No legitimate business interest. A non-compete agreement must serve a legitimate business interest, such as protecting trade secrets or confidential information. If the contractor doesn’t have access to confidential information or trade secrets, a non-compete agreement may not be necessary and consequently considered unenforceable.
3. Inequitable. This refers to a situation when a non-compete agreement is one-sided, with terms and conditions that are excessively favorable to the employer.
4. Lack of adequate consideration. A non-compete agreement might not be enforceable if the contractor signed the agreement without receiving any additional compensation or benefits after starting work.
5. Coercion. If the employee or contractor faced job loss if refusing to sign the agreement, it could be considered invalid.

Non-compete agreements are not always enforceable, and their legality varies by state and country. In some jurisdictions, non-compete agreements are prohibited, while in others, they are subject to strict limitations regarding duration, scope, and geographic coverage.

If you choose to issue a non-compete agreement, you need to ensure that it is drafted appropriately and is compliant with applicable laws, or you risk it being unenforceable. Your independent contractors will likely know they should review the contract terms and consult an employment lawyer before signing it. 

What Problems Can Arise From Having Non-Compete Agreements?

While non-competes can be useful for protecting a company’s trade secrets and confidential information, they can also have some ripple effects on both independent contractors and employers, including:

• Limiting job opportunities. Non-compete agreements can make it challenging for independent contractors to find new work in the same field.
• Decreased innovation. An independent contractor's non-compete agreement can stifle innovation, as it can prevent workers from taking their knowledge, skills, and ideas to competitors or starting a business of their own. Some studies also found that the strict enforcement of non-compete agreements in certain states also decreases the spread of academic findings. The restricted sharing of information naturally hinders innovation.
• Potential legal challenges for the employers. Non-compete agreements can be challenged in court by independent contractors who feel they are being unfairly restricted from working in their industry. This can result in lengthy and expensive legal battles and costs that could be otherwise prevented.
• Misclassification of independent contractors. Employers who impose non-compete agreements for independent contractors may find that this changes their classification from contractors to regular employees. This change of circumstances can result in new obligations for the company, including having to pay taxes, benefits, and overtime pay, which can be costly.
• Negative impact on the job market. Non-compete agreements have been criticized for potentially stifling economic growth and negatively affecting the job market. The fear of facing legal repercussions from a former employer can discourage job mobility among workers, creating what is commonly known as a “chilling effect.” Workers may choose to remain in their current job or switch to a completely different industry to avoid the risk of a lawsuit, even if the contract they signed is not legally binding in the state. In this regard, President Biden recently signed an executive order to encourage the Federal Trade Commission (FTC) to explore nationwide restrictions on non-compete agreements to help curb unfair clauses and ensure that workers have greater job mobility and opportunities to grow in their careers.

Should You Have Non-Compete Agreements With Independent Contractors?

We recommend businesses not implement these sorts of confidentiality agreements, especially if those contractors work in accounting, finance, software development, and other industries where freelance work is common.

Many contractors like to take on side projects as a way to learn new skills, gain experience, and earn extra money. Non-compete agreements would limit these opportunities and even hinder their professional development. It could also make acquiring and retaining top talent more challenging for your company.

Instead, consider creating strong nondisclosure agreements (NDAs). NDAs can cover everything related to how your business is operating, including tools, practices, SOPs, and other proprietary information.

When independent contractors sign NDAs, they agree not to share sensitive information with a competing company. They will also be aware of the legal consequences if they break the NDA. This way, you’ll be able to protect your secrets without restricting the contractor’s ability to work in their field or pursue other freelance projects. 

As long as the contractor works the agreed-upon hours and fulfills their responsibilities, you should not care about what the contractor does in their extra time. By allowing contractors to take on additional projects, your company can actually benefit from their increased skills and knowledge gained from side projects.

Bottom Line

According to research, 30 million workers, or 18% of the American workforce, are currently bound by non-compete agreements, while 37% were subject to one at some point in their careers.

Seeing that so many employers subject their workers to non-competes, the instinct to go with the bandwagon might seem like an attractive solution. While they do protect your business’s secrets, subjecting independent contractors to nondisclosure agreements might bring more hassle than it’s worth. Namely, changes in your employment relationship with them, having unnecessary costs due to the risks of lawsuits, and decreasing your chance of finding and sourcing great talent due to the limitations a non-compete imposes on independent contractors.

Before deciding whether to implement non-compete agreements or NDAs with your independent contractors, you should seek legal advice from an employment lawyer. 

Finding a partner, like Near, who can help you answer this and similar questions will eliminate the stress of building your team with independent contractors. If you want to accelerate your remote team growth, book a complimentary consultation with us today.