The short answer is…. well, there is no short answer. What? Do independent contractors and non-compete agreements mix or not? Maybe. Most often probably not, but sometimes yes. OK, that’s more double-talk than usual. What gives? When can and can’t a company compel an independent contractor to sign a binding non-compete without risk of liability for worker misclassification? That is this week’s loaded question, which we will parse out after the jump…
Generally speaking, if a person or entity truly is an independent contractor, a non-compete clause or agreement will not be enforceable against him/her/it. Why not? Two basic principles are involved here. The first speaks to whether the non-compete is the only effective means for protecting a company’s legitimate business interests.(Click here, here and here to review the basics of non-competes.) Most often, with an independent contractor, whose relationship with your company is, by definition, more limited than that of an employer and employee, confidentiality, nondisclosure and non-solicitation agreements will be sufficient to protect whatever legitimate business interests do exist. Those will often be enforceable against an independent contractor. But an independent contractor is in business for themselves and the services/products it provides you are its business. Generally speaking, you cannot compel an independent contractor to forfeit their livelihood just because you honored it by giving it your business.
The second principle speaks to worker classification. The contract and the non-compete suggest a level of control exercised by an employer over an employee then the contract. Similarly, if the “independent contractor” is so integral to your company’s operations that a non-compete is the only effective means available to protect your legitimate business interests, then s/he is probably not engaged in an independent enterprise–and, once again is probably acting–and being treated by you– as an employee.In those cases, having your “independent contractor” sign an agreement including non-compete provisions puts you at serious risk of owing penalties, overtime pay, benefits, workers compensation premiums and contributions to the state unemployment insurance benefit funds.
Occasionally, however, a court will enforce restrictive covenants against independent contractors. Those cases however are few and far between and most often involved very specific circumstances that the court felt justified them–and will therefore, most likely, remain the exception rather than the rule. Let’s take a look at just two cases for fun. ( I know I really need to get out more.)
In Metro Public Adjusters v Houck, a Pennsylvania case, Houck and another consultant signed an independent contractor agreement for new insurance adjusters that included a non-compete clause. The noncompete barred the former consultants from doing business in those states where Metro Public Adjusters did business for two years after termination of their business relationship. The problem is that the former consultants set up a competing company while they were still working with Metro Park Adjusters, and upon terminating the contract, sought to do business in those states where Metro Park Adjusters did business. The court also pointed out that the consultants had no prior public adjusting experience prior to their relationship with Metro Park Adjusters. They received training from Metro Park and used certain of Metro Park’s proprietary information to gain a an unfair competitive advantage.
Now, don’t get too excited about this ruling. The court also noted that the contractors worked exclusively for Metro Park Adjusters and followed Metro Park’s methods and instructions. In other words, the contractors, in all likelihood, were really misclassified employees; effectively the court was enforcing a noncompete against an employee. Furthermore, if Houck had counter sued and claimed misclassification, Metro Park Adjusters might well have been on the losing side.
In Tax International, LLC v. Rasheme Kilburn et al the US District Court in Virginia refused to dismiss a claim by a tax preparation firm against two former consultants, who left to start their own firm and directly compete with Tax International. The former consultants had signed an agreement with a noncompete that point-blank forbade them to “work as a tax consultant and or implore (sic) Tax International Strategies for another company ever” and confidentiality provisions. Tax International sued for misappropriation of trade secrets, copyright infringement and violation of their noncompetes. While the court did find that the noncompete was necessary to protect legitimate interests, that finding did not actually decide the case itself. It merely decided whether there was enough basis for Tax International’s claim to go forward and maybe go to trial (if the parties do not settle). Also, the case primarily involved misappropriation of trade secrets and copyright infringement issues. Whether the restrictive covenant, with unlimited duration or geographic scope is ultimately enforceable is at best arguable. (In my humble opinion, it shouldn’t be).
And now for the answer to our original question: What do you get when you mix independent contractors and noncompetes? Are you ready? Here it is: Nothing good. Because even when you win, you can still lose– a lot! So, by all means, include confidentiality and non-solicitation clauses in your independent contractor agreements. By all means include language that protects intellectual property, and if you insist on including a noncompete (aka restrictive covenant) do so at your own risk! Oh, and make sure your independent contractors are properly classified as such or you risk worker misclassification liability.
Stay tuned, I still intend to post about FLSA and DOL issues not previously covered here — if something else doesn’t grab my attention! See you next week!
Disclaimer: Contents of this post are for educational/informational purposes only, are not legal advice, and do not create an attorney-client relationship. Consult with competent employment counsel in the state(s) in which you employ people with your specific questions.
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I do not agree. Read:
https://fashionbylaw.com/index.php/2017/06/08/how-to-work-with-designers-as-independent-contractors/
Hi Luci, thank you for writing in. Please note that the court case you are referring to is from Canada, and we are discussing American law. While they may be similar, there are likely also some differences. Since I am not a Canadian attorney, I do not feel it is appropriate for me to comment on what Canadian law may or may not allow or require.
Do you have an example of a case where the court held the restrictive covenant unenforceable due to independent contractor status of he restricted party? My research indicates they generally can be used with independent contractors.
Hi Jeff,
Sorry for taking a while to get back to you on your question.
First, the thrust of my post was to let businesses know that a non-compete clause in an independent contractor agreement might actually lead to a finding that the independent contractor is really a misclassified employee. Generally a court will use the same analysis for non-competes used in employment agreements. In other words it will look at all the relevant facts to determine if a non-compete under those circumstances is the least restrictive means available for protecting the business’ reasonable interests. If the business is dealing with an independent contractor, however, then realistically the business is likely to have a higher burden of showing that a non-compete is reasonable. Again, it’s a fact-sensitive analysis.
With that somewhat long-winded introduction, and example of my point is an 8th Circuit Court of Appeals case decided last August, Ag Spectrum Co v Elder. No it does not say that non-competes in independent contractor agreements are per se unenforceable (and neither was I saying that) but it did find the non-compete in that matter to be unreasonable and therefore unenforceable. I hope this clears some things up for you. If not, feel free to email me privately with any other questions.
Scenario: A Pilates studio owner has bristled at the fact that its instructors are systematically being offered higher pay for part time hours at other studios. In response she (wisely) makes them sign a confidentiality agreement but stops short of making them sign a noncompete… however, she stipulates that once you sign this you agree that you will not necessarily be considered for pay increases, not have first pick of hours and risk termination as she sees fit – is that in-effect a noncompete contract because “it compels the independent contractor to forfeit their livelihood just because you honored it by giving it your business.”? The owner is throwing words around like “loyalty.” What is your take?