Protecting Your Business in Colorado with Non-Compete Clauses: A Legal Overview
By Austin Rahskopf
Are non-compete clauses in Colorado legal? Well, as with many things in the law, that depends. Non-competes are agreements that protect trade secrets and ensure that employees don’t use business practices or secrets to undermine the business. Small business owners and franchisors in Colorado may want to include non-compete clauses in their employment and franchise agreements, but there are certain nuances in Colorado law to be aware of. In Colorado non-competes are considered void if the agreement restricts the right of any person to receive compensation for performance of skilled or unskilled labor for any employer. Given that, there are exceptions to this rule--read on to find out if your small business or franchise can include a non-compete clause in Colorado.
By Colorado statute an agreement not to compete (non-compete) will apply to:
A) Any contract for the purchase and sale of a business or the assets of a business;
B) Any contract for the protection of trade secrets;
C) Any contractual provision providing for recovery of the expense of educating and training an employee who has served an employer for a period of less than two years;
D) Executive and management personnel and officers and employees who constitute professional staff to executive and management personnel.
Colorado made non-competes valid in these four areas, but what do they actually mean to a business owner or franchisor, and what are their limitations? I will unpack each category bellow, so that you as a business owner can protect his or her business while operating in Colorado.
I. For the purchase and sale of a business or the assets of a business
Oftentimes, a business owner will want to sell their business or business assets, which could lead to some of their proprietary information becoming available. In Colorado this is the type of contract where a non-compete clause would be enforceable. However, just having the words non-compete in a contract for the sale of a business or of business assets does not make the non-compete valid. The courts in Colorado want to see that the non-compete is reasonable. To pass this “reasonable” requirement, the terms of the duration and the geographical scope must be reasonable.
Well what is a reasonable duration and geographical scope?
The easy answer is to show what is not reasonable. National Graphics Company discovered one way to be unreasonable was to be silent as to the duration and the geographical scope. By not specifying how long its employees had to refrain from competing, and in what areas they were prevented from competition, the Colorado courts made the entire non-compete clause void, even though it was for the sale of assets of a business. If a non-compete clause is silent as to geographical scope and duration, then a Colorado court may just find the whole thing to be invalid.
Take franchises, for example. When franchise owners re-sell their franchise to a third party, the franchisor has the capability via a non-compete clause to restrict the selling franchise owner from opening a competing business. However, as stated above, in order for that clause to be valid, it must include a geographical scope with a duration.
II. For the Protection of Trade Secrets
This category of enforceable non-competes in Colorado is necessary for a competitive market. Why would anyone invent a new technique or business strategy if they could not protect those trade secrets? A small business owner would risk their competitive advantage every time they hired a new employee, or a vendor to do some repairs, or audits. Luckily, in Colorado non-competes are allowed for instances of trade secret protection. Trade secrets could include: design, process, procedure, formula, improvement, confidential business or financial information, listing names, addresses, or telephone numbers, or other information relating to any business or profession which is secret and of value.
It is important as a small business owner or Franchisor to understand that the court will evaluate the trade secret under six factors to determine if it is a secret that should be protected. Simply calling your procedure a trade secret is not enough in Colorado to warrant protection by a non-compete clause. The court will look at (1) the extent to which the information is known outside the business; (2) the extent to which it is known to those inside the business, such as the employees; (3) the precautions taken by the holder of the trade secret to guard the secrecy of the information; (4) the savings effected and the value to the holder in having the information as against competitors; (5) the amount of effort or money expended in obtaining and developing the information; and (6) the amount of time and expense it would take for others to acquire and duplicate the information. Colo. Rev. Stat. § 7-74-102(4) (2010).
Business owners should use this statute as a guide writing their employment agreements to ensure that the non-competes will be upheld (but a better choice is to have a small business lawyer draft the employment agreement!) The most important thing a business owner or franchisor could do if they believe they possess a trade secret is document in as much detail as possible how valuable the trade secret is, how much time or resources it took to develop it, measures installed to protect it, and how unique it is. Making every vendor and employee sign a confidentiality clause to work on the premises is a great way to show measures have been taken to protect the information. Also, only allowing managers to handle the information shows limiting measures to prevent other individuals from acquiring the information. This protection element is key, because if the information is available to everyone who enters the place of business or is known to the public it is not a trade secret and therefore does not warrant protection.
III. Any contractual provision providing for recovery of the expense of educating and training an employee who has served an employer for a period of less than two years.
This third exception to Colorado’s public policy against non-competes involves training of employees. If you are a business owner or a franchisor that runs a business that requires a paid training period, a non-compete will be found valid if you include in the Employment Agreement a clause requiring reimbursement of training expense. This does not have to be monetary but could require the employees to work for the company for a reasonable time that would allow the company to get a return on their training investment. Without this reimbursement clause, employees can receive training from one company and change jobs to another and the non-compete will not be upheld. To protect your investment and ensure your training programs benefit your company and not a competitor, remember to include a training reimbursement clause in your Employee Agreement.
IV. Executive and management personnel and officers and employees who constitute professional staff to executive and management personnel.
The final exception is for management personnel. So, is anyone with a management title bound by a non-compete? The answer is not necessarily. Like the other three exceptions the court requires the business owner to demonstrate that the exception should be allowed. To show this for management personnel, the business owner must show that the employee acts autonomously, is the "key man" and oversees the business operations, and constitutes the "heart of business."
This is easy to show for high management positions but can be tricky when trying to determine if a supervisor constitutes a “key man” or a technical employee who is the only one with the knowledge to run the operation. Like in exception two (Trade Secrets), the key is to document everything. If your new hire is indeed going to oversee business operations and have "key man" responsibilities, your employee agreement should state these things explicitly. But, just listing the job responsibilities without actual performance of those responsibilities is not sufficient. The employee would actually have to have a role as the heart of the business and he or she has access to sensitive company information that needs to be protected from public knowledge. If a business owner can show that the employee held a management position, had access to company information and oversaw personnel, it is likely a Colorado Court will uphold the non-compete.
A non-compete clause in Colorado must meet one of the four exceptions listed in the statute and must pass the reasonable standard. Always document what is being protected, the value of its protection, measures taken to protect it, the need to profit off any training provided, and the managerial status of the employees who help run the business.
If you'd like more information or you are unsure how to draft non-competes in an Employee Agreement, feel free to ask us at Paperbark Law.