United States: Tightening Restrictions On Noncompetes

Last Updated: August 2 2019
Article by Amber Shubin

Many employers have long used noncompetition agreements, or noncompetes, as an important tool for preventing former employees from unfairly competing against them. Although only a few states outright ban noncompetes with employees,1 most states permit employers to use noncompetes as long as they are reasonable and limited to protecting the employer's legitimate interests. In recent years, however, state legislatures have increasingly begun chipping away at the power of noncompetes by passing laws limiting the scope of those agreements. And many other states are considering similar restrictions.

An Overview of Recent Changes

In the last several years, many states, including California, Idaho, Illinois, Nevada, New Mexico Massachusetts, and Washington, have enacted laws restricting the use of employee noncompetes. Although the types of restrictions vary by state, those limitations generally include: 

  • Limiting the post-employment duration of noncompetes;
  • Banning noncompetes for certain "low wage" workers who are nonexempt under the Fair Labor Standards Act or who make less than a certain hourly rate;
  • Requiring employers to pay former employees during the period of the post-employment restriction;
  • Invalidating noncompetes for employees who were terminated without cause; and
  • Requiring noncompetes to be governed by the law of the state where the employees work.

Some of the most sweeping changes to noncompetes were passed in Washington and Massachusetts.

Washington State

On May 8, 2019, the Washington governor signed House Bill 1450 into law imposing significant limits on noncompetes. The new law, which goes into effect on January 1, 2020, places a number of roadblocks for employers intending to issue new noncompetes for their employees or even to enforce existing agreements. Some of the more significant requirements include:

  • Invalidating post-employment noncompetes of 18 months or more, unless an employer can demonstrate with "clear and convincing evidence that a duration longer than 18 months is necessary to protect business or goodwill";
  • Barring the use of noncompetes for employees earning less than $100,000 per year or independent contractors earning less than $250,000 per year (with both numbers adjusted annually for inflation); 
  • Requiring employers to disclose noncompete terms to certain candidates in writing before they accept an offer of employment, including candidates who are offered annual pay below the earning thresholds listed above;
  • Mandating "independent consideration" beyond continued employment if an employee enters a noncompete during his or her employment;
  • Continuing to pay an employee's base salary during the post-employment restricted period for employees who are terminated due to a "layoff" (what constitutes a layoff is undefined); and
  • Requiring Washington law to govern any noncompete applicable to a Washington-based employee.

Washington law goes further than other state noncompete laws by penalizing employers for noncompliance. If a court or arbitrator rejects, reforms, modifies, or, even, partially enforces a noncompete, it must require the employer to pay the employee the greater of $5,000 or the employee's actual damages plus the employee's costs and attorneys' fees. This applies to all noncompete proceedings commenced after January 1, 2020 to enforce the restriction, regardless of when the noncompete was entered. 

Massachusetts

Massachusetts' new law restricting noncompetes went into effect on October 1, 2018.  Like Washington, Massachusetts added a number of new requirements for noncompetes with Massachusetts based employees. Some of the more onerous requirements include:

  • Limiting the duration of noncompetes to twelve months post-employment, unless the employee breaches his or her fiduciary duties to the employer or unlawfully takes the employer's property, in which case the duration can be up to twenty-four months;
  • Mandating employers pay at least half of the employee's highest base salary in the two year period prior to termination of employment, or other "mutually agreed upon consideration";
  • Requiring more than continued employment as the consideration necessary to support a noncompete;
  • Requiring the noncompete to be governed by Massachusetts law, and, if the agreement includes a forum selection provision, it must, with limited exceptions, require disputes be litigated in Massachusetts courts;
  • Prohibiting noncompetes for employees classified as nonexempt under the Fair Labor Standards Act or employees who are laid off or terminated without cause; and
  • Requiring ten days written notice of the noncompete to prospective employees, with at least 10 days' notice.

Hostile Trend Towards Noncompetes Likely To Continue

The increasing number of noncompete laws is likely to continue as more states consider issuing similar laws limiting noncompetes with employees. Indeed, as many as 20 states and the federal government are seeking to weaken noncompetes in some way. On the federal level, Senator Marco Rubio of Florida has introduced a bill that would ban noncompetes for most employees classified as nonexempt under the Fair Labor Standards Act. Arkansas, Vermont, and Pennsylvania have pending bills seeking to completely ban the use of noncompetes for employees in those states, though like California, these laws would probably not apply to noncompetes in the sale of business context. The New Jersey Senate is also considering a bill with restrictions largely emulating those instituted by Massachusetts. 

Legislatures are not alone in tightening restrictions on noncompetes. Both the Illinois and New York Attorneys General have pursued enforcement actions against employers who use noncompetes, including entering into a settlement agreement with Jimmy John's to prevent it from having noncompetes with its sandwich makers.  More recently, WeWork entered into a settlement agreement with the New York and Illinois Attorneys General, in which WeWork agreed to rescind noncompetes for certain categories of employees, narrow the scope of those agreements with others, and use new, less restrictive language in its noncompete agreements going forward.

What This Means for Employers

Given the growing number of limitations placed on noncompetes, employers may need to rethink their strategies for using noncompetes to prevent their former employees from unfairly competing. Long-used form agreements may need to be rethought, alternative ways to prevent unfair competition may need to be explored, and existing agreements with key employees may need to be redrafted. 

Companies operating in multiple jurisdictions should revisit their noncompete agreements, particularly if they are using the same template agreement across their organization. Noncompetes that are lawful in one state may now expose the employer to liability if signed by, for example, a Washington-based employee. Employers should consider working closely with in-house and outside counsel to ensure that any noncompetes protect the employers' interests rather than endanger them.

Employers may also want to consider whether other types of post-employment restrictions, such as nonsolicitation or nondisclosure agreements, could achieve their goals. Notably, the growing chorus of state noncompete laws generally do not apply to agreements prohibiting former employees from soliciting the employer's employees or customers or prohibiting disclosure of the employer's confidential information. In some instances, nondisclosure and nonsolicitation agreements may be equally effective as noncompetes in protecting the employers from unfair competition. Employers might also consider agreements that do not expressly prohibit an employee from working for a competitor, but encourage them not to compete.   For example, some states, like New York, apply a relaxed standard of review for agreements that require former employees to forfeit post-employment payments if they work for a competitor.

Footnote

1 States currently banning noncompetes restricting employees from working for a competitor after their employment are California, North Dakota, and Oklahoma.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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