United States: Inside: Differences In State Law Could Sink Your Non-Competes

Last Updated: November 18 2013
Article by Jeffrey S. Boxer and Emily Milligan

Differences in state laws governing restrictive covenants pose significant challenges to employers seeking to implement and enforce such covenants. Many states apply a common law reasonableness standard to restrictive covenants.

While there are some differences in how states approach this common-law standard, restrictive covenants will generally be enforced in such states if the covenants protect a legitimate interest of the employer and are reasonable in geographic scope and duration and are not harmful to the public. In contrast, California has essentially outlawed non-compete agreements. A number of other states have tried to reach a middle ground. For example, a Colorado statute voids non-compete covenants unless they relate to the sale of a business, the protection of trade secrets, the recovery of education or training expenses, or executive and management personnel. Georgia permits post-employment non-competes only with respect to certain classes of employees.

Further complicating matters, a number of states have recently enacted or are contemplating enacting statutes that will create further differences in state law governing restrictive covenants. New Hampshire passed a statute in July 2012 requiring that employers provide a copy of any non-compete agreement to employees prior to or concurrent with making an offer of employment or change in job classification. Failing to do so would render the restrictive covenants void. Proposed legislation in Massachusetts would create a presumption that any non-compete longer than six months is unreasonable. In New Jersey, proposed legislation would invalidate restrictive covenants covering any employees who are eligible for unemployment benefits. A bill pending in Minnesota would bar non-competes except in connection with the sale or dissolution of a business.

Judge-made law also continues to create wrinkles to enforcement in many jurisdictions. For example, an Illinois court recently held that if the consideration for a restrictive covenant is an offer of employment or continued employment, the employee must be employed for at least two years following execution of the restrictive covenant for the covenant to be enforceable.

The variations in state law create practical drafting challenges, particularly for employers with personnel in multiple states. A single agreement may not satisfy each state's laws, and it may not be practical to adopt different agreements for employees located in different states. Even where an employer only has employees in one state, enforcement problems may arise if an employee moves to another state before engaging in activity that violates a restrictive covenant.

Given these potential complications, some employers seek to apply a uniform law to their contracts. A choice of law clause alone, however, may not save a restrictive covenant in a jurisdiction where enforcement is disfavored. In contrast, a choice of law clause, when paired with a forum selection clause, often can make a difference.

Courts in most jurisdictions enforce choice of law clauses unless (a) the chosen state has no substantial relationship to the parties and there is no other reasonable basis for choosing that state's law or (b) application of the law of the chosen state would violate a fundamental policy of the forum state. Courts in states that are more skeptical of restrictive covenants often apply their own law to the enforcement of those covenants as a matter of fundamental policy regardless of the parties' choice of law clause, even if the parties' choice is rational and reasonable.

Use of an appropriate forum selection clause in tandem with a choice of law clause can enhance the chances of enforcement. Forum selection clauses are prima facie valid in most courts and generally will be set aside only if the clause is unreasonable as a result of fraud or overreaching, would result in serious inconvenience to a party or would violate a strong public policy of the local forum if enforced. Courts — including courts that have refused to enforce choice of law provisions in restrictive covenants — have enforced mandatory forum selection clauses in employment agreements with restrictive covenants, at times requiring employees to litigate disputes relating to the enforcement of restrictive covenants in a distant forum that is of greater convenience to their former employer. Conventional wisdom suggests that forum selection clauses may be a useful tool in close cases where the parties have substantial relationships to more than one state because in such cases a court may be more likely to select local law with which it is more familiar and comfortable.

The ideal scenario for uniform choice of law is where an employer's nerve center or principal office is located in a jurisdiction with law favorable to enforcement. Where the nerve center is in an unfavorable jurisdiction, the best hope for enforcement may be the use of state specific contracts applicable to employees outside the main office. Including reasonable choice of forum and choice of law clauses in either of these scenarios will not guarantee a particular outcome, but they may enhance the likelihood that litigation regarding restrictive covenants will take place in the desired forum using the desired law.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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