Non-competition covenant

Non-competition agreements prevent employees from working for competitors or starting competing businesses during their employment and for a specific time period after they leave. Hedge funds commonly use these contractual restrictions in partner agreements and key employee contracts to protect their business interests.

These agreements serve important business purposes. They protect confidential information like investment strategies, prevent departing employees from stealing clients, and preserve relationships that took years to build. When written properly, courts will enforce these restrictions in most states. However, the agreements must be reasonable and cannot place excessive burdens on employees or simply eliminate competition for the sake of eliminating competition.

Courts use established legal tests to decide whether non-competition agreements are valid and enforceable. Judges examine whether the restrictions are reasonable in terms of how long they last and where they apply. The restrictions should only extend as far as necessary to protect specific business interests like confidential information, proprietary trading strategies, or established client relationships.

Courts apply what's called a "balancing test" when reviewing these agreements. This test weighs three factors: whether the covenant protects genuine employer interests, whether it creates undue hardship for the employee, and whether it serves the public interest. For example, a restriction that prevents a portfolio manager from working anywhere in the finance industry for five years would likely fail this test because it's too broad and creates excessive hardship.

The compensation or other benefits provided in exchange for agreeing to non-compete restrictions also matters. Courts are more likely to enforce agreements when the employee received meaningful consideration, such as a signing bonus, equity participation, or guaranteed compensation during the restricted period.

The enforceability of non-compete agreements varies dramatically depending on which state's laws apply. Some states severely limit these agreements or ban them entirely, while others are more willing to enforce them when properly written.

California takes a particularly restrictive approach under Business and Professions Code Section 16600. This law was strengthened in 2024 with new requirements that employers notify employees about void agreements and expanded enforcement mechanisms. California generally refuses to enforce non-compete agreements, viewing them as harmful restraints on trade.

New York courts take a different approach. They will enforce properly structured restrictive covenantsContractual provisions that limit what departing partners can do after they leave the firm, such as restrictions on competing with the former employer or soliciting clients. when they protect legitimate business interests like trade secrets or unique client relationships, rather than merely preventing competition. The restrictions must still meet reasonableness standards for both scope and duration.

At the federal level, the Federal Trade CommissionFederal agency responsible for enforcing consumer protection and antitrust laws, including HSR Act compliance. attempted to implement a nationwide non-compete ban in 2024. However, federal courts blocked enforcement of this rule, and the FTC dismissed its appeals in September 2025. This leaves enforcement up to individual state jurisdictions. The regulatory activity signals increased scrutiny of non-compete practices and suggests this legal area will continue evolving.

Most courts accept post-employment restrictions Post-employment restrictions Post-employment restrictions are contract rules that limit what a hedge fund employee can do after leaving their job. These rules typically include agreements not to compete with the former employer, not to recruit clients or coworkers, and not to share confidential information. The goal is to protect the firm's business secrets and competitive advantages. that last between six and twelve months, though no specific timeframe automatically makes an agreement enforceable or invalid. The key question is whether the restricted period matches how long the protected information stays valuable and confidential.

For instance, if a hedge fund's investment strategy becomes publicly known or loses its competitive advantage after eight months, a two-year restriction would likely be too long. Courts also examine whether the covenant's scope appropriately targets the specific interests that need protection rather than broadly restricting the person's entire career.

Enforceable covenants typically focus on clearly defined interests and minimize interference with the individual's future employment opportunities. A restriction preventing someone from managing similar investment strategies for direct competitors would be more reasonable than one preventing any work in the entire financial services industry.

Investment management firms typically weave non-competition covenants into broader departure and compensation frameworks. Violating restrictive agreements commonly triggers the loss of "sunset payments" and other post-employment compensation arrangements.

Sunset payments are deferred compensationCompensation arrangements where payment is postponed until a future date, often subject to specific tax treatment and reporting requirements. amounts paid to departing employees over time after they leave the firm. Partnership agreements Partnership agreement A partnership agreement is the primary governing document for a hedge fund structured as a limited partnership. It establishes the relationship between general partners and limited partners. The agreement details rights, obligations, economic terms, and operational provisions for all parties involved. and operating documents frequently include "bad leaverAn employee or partner who departs a firm under circumstances that trigger forfeiture provisions, typically including termination for cause, breach of restrictive covenants, or voluntary resignation to join a competitor." provisions that cause employees to forfeit this deferred compensation if they breach their non-compete agreements.

When departing professionals continue to receive compensation during restricted periods—particularly where restrictions apply only to termination for cause or voluntary departure—courts may be more willing to enforce the agreements. The continued compensation helps demonstrate that the restriction serves a legitimate business purpose rather than simply punishing the departing employee.

Investment managers increasingly use forfeiture-for-competitionContractual provisions that require employees to forfeit previously earned compensation if they engage in competitive activities after leaving their employment. structures as alternatives to or supplements for traditional non-compete restrictions. Rather than outright prohibiting competitive activity, these provisions establish that engaging in competition triggers the loss of otherwise available benefits such as sunset payments or deferred compensation.

New York courts recognize an "employee choice doctrineA legal principle recognized by New York courts that enforces forfeiture-for-competition provisions without traditional reasonableness analysis for non-compete agreements, allowing individuals to choose between competing and losing benefits or not competing and preserving benefits." for these arrangements. Under this doctrine, courts enforce forfeiture provisions without the traditional reasonableness analysis required for non-compete agreements. The key is that individuals can choose between competing (and risking benefit loss) or not competing (and preserving benefits).

Employers can rely on this doctrine when they demonstrate continued willingness to employ the restricted person or when termination occurs without cause. These provisions work particularly well when the potential forfeited compensation creates sufficient financial incentive to discourage competitive activity during the payment period.

For example, if a portfolio manager would forfeit $500,000 in deferred compensation by joining a competitor, that financial consequence might be more effective than a legal restriction that could be challenged in court. The employee makes a clear economic choice rather than facing an outright prohibition on working.