Three main types of restrictive agreements can be used to protect a company’s sensitive information disclosed to employees. These restrictive agreements, commonly referred to as “restrictive covenants,” include:
- Non-compete: A contract in which an employee agrees to not compete with a company during employment and/or for a certain period of time and within a certain geographic area after employment ends;
- Non-solicit: A contract in which an employee agrees not to solicit the company’s clients, employees, or other individuals during employment and/or for a certain period of time after employment ends;
- Non-disclosure: A contract in which an employee agrees not to disclose the company’s confidential information
Companies are generally not limited to choosing one of these; many companies bind their employees with more than one of these restrictions. Additionally, companies should follow certain formalities in order to ensure that their restrictive covenants are upheld. A company’s ability to legally restrict an employee or former employee’s actions is limited based on the circumstances. This paper will focus mainly on the limitations and formalities required for creating enforceable non-compete agreements.
Restrictions on Agreements
Companies must analyze the facts relevant to an employee in order to determine which types of covenants may be appropriate to that specific employee. As a general rule, companies will always be able to restrict their employees’ disclosure of confidential information through non-disclosure agreements (with limitations such as prohibitions on non-disclosure agreements that prohibit legally mandated reporting, whistleblowing, etc.), but non-compete or non-solicit agreements must be limited in time, scope, and geographic reach, and not overly burden an employee’s ability to continue to work after leaving the company’s employ. California, Oklahoma, and North Dakota ban non-compete agreements altogether, and D.C. will also likely implement a ban starting in the spring of 2022.
In 2019, 19 Attorneys General submitted a letter to the Federal Trade Commission (FTC), requesting that the FTC use its rule-making power to end the “abusive use of non-compete clauses in employment contracts.”[1] Support for this type of action has only grown since then. In July of 2021, President Biden signed an executive order that similarly encouraged the Chair of the FTC to “consider working with the rest of the Commission to exercise the FTC’s statutory rule-making authority under the Federal Trade Commission Act to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”[2]
Part of the pushback against non-competes is the idea that if potential employees have to compete against one another for jobs, then companies should have to compete against each other for employees. Additionally, there is research that shows that non-competes limit wages, decrease employee mobility, and decrease entrepreneurship, all of which, from a policymaker perspective, act as an overall drag on the economy. (There is less evidence regarding whether non-solicitation agreements might have some of the same effects on the overall economy.)
In order to better understand the concerns and the current limitations and uses of restrictive covenants, an analysis of the common limitations follows.
- Legitimate Business Interest
A non-compete is enforceable only if it protects a company’s legitimate business interest. A company’s legitimate business interest, sometimes referred to as a “protectable interest,” can be similar for all three types of agreements but is the most important in the analysis of non-competes. What is considered a legitimate interest can range broadly based on state laws, but can include protecting trade secrets, intellectual property, client/customer lists, goodwill, knowledge of company business practices, profit margins and costs, other financial information, specialized and unique training that involved substantial expense by the company on behalf of the employee, and other confidential information. Creating a monopoly or discouraging employees from leaving the company to pursue other opportunities are not protectable interests.
Some legitimate interests may be recognized in certain states but not others, and what constitutes a legitimate interest may shift over time. For example, for agreements entered into before 2022 in Illinois, legitimate business interests were simply based on the totality of the facts and circumstances of the case, considering factors such as: trade secrets, confidential information, and near permanent business relationships. Beginning in 2022, with the passage of Illinois’ new non-compete law, legitimate business interests factors include: the employee’s exposure to the company’s customer relationships or other employees, the near-permanence of customer relationships, and the employee’s acquisition, use, or knowledge of confidential information through the employee’s employment.
Furthermore, any interest of the company has to be weighed against the employee’s interest, not only in their freedom to work, but also in the customer relationship. For example, if an employee brought a customer in and had an active role and robust relationship with that customer, it would would be harder to enforce a restrictive covenant against the employee if that employee wanted to pursue an opportunity with that customer after leaving employment with the company.
Employees have a right to work in their chosen fields for their preferred companies. One of the reasons that there are current reform efforts attempting to limit the use of non-compete agreements is that the non-compete is seen as an overly broad, blunt tool that restricts an employee’s freedom when other, more precise tools could protect the same legitimate interests without impinging upon the employee’s right to work. A non-solicit agreement can protect clients lists and specialized techniques of business development, and a non-disclosure agreement can protect trade secrets and other intellectual property.
All three types of agreements can be used to protect companies. However, a company should always evaluate whether it is choosing the best covenant/set of covenants to accomplish its legitimate interests. By putting employees under restrictive covenants that more directly target a company’s protectable interests, a company strengthens the likelihood that the agreements between it and its employees will be upheld if they are ever brought into question in court.
- Professions and Industries
Restrictive covenants must be limited in terms of how they prevent employees from working in a given profession or industry. Some professions are generally seen as providing a unique public benefit, and so, if the practitioners are prevented from serving clients or patients based on previous employers, there is a likelihood that the public will be underserved. Almost all states exempt lawyers, and many exempt certain health care providers such as doctors, from non-compete agreements although they can all still be subjected to non-disclosure and non-solicitation agreements. Other professions, such as nurses, social workers (Massachusetts), broadcasters, and journalists, may also be protected because of the unique public goods they provide.
States often have special rules that apply across a profession. Texas, for example allows noncompetes for physicians but requires that the non-compete allow for continuity of care (a physician would not be required to deny treatment to a patient they had seen in the last year or during the course of an acute illness) and contain a provision allowing the physician to buy out the non-compete agreement for a reasonable price.
Many states are prohibiting non-competes for low-wage or low-skilled workers. Some examples of states that have in some way banned non-compete agreements include:
- Illinois – banned for employees earning $75,000 or less;
- Washington – banned for employees earning less than $100,000;
- Oregon – banned for employees earning less than $100,533;
- Maryland – banned for employees earning less than $31,200 annually or $15 per hour;
- Nevada – banned for all employees paid an hourly wage; and
- Massachusetts – banned for all non-exempt employees under the Fair Labor Standards Act.
Other states with income thresholds include Maine, New Hampshire, Rhode Island, and Virginia. These bans are targeted at what are considered the ‘more egregious’ abuses of non-competes by some companies that prevent low-wage or low-skilled workers who had no particular trade secret or other “insider” knowledge from moving to jobs within the same industry. Fast food restaurants required hourly restaurant employees whose jobs included making sandwiches or running cash registers to sign non-competes that prevented them from going to work with competing fast food restaurants. Courts, and now a growing number of legislatures, have determined that those types of restrictions on competition go too far and do not meet the reasonableness requirements generally imposed when determining the enforceability of restrictive covenants.
- Time Period
The length of time of a restrictive covenant must also be reasonable in order for the covenant to be enforced. The shorter the time period included in a restrictive covenant, the more likely it is to be considered reasonable. Additionally, the time that qualifies as reasonable may vary from job to job and from employee to employee (for example, what is reasonable for a senior level manager may not be reasonable for a junior level employee on the same team).
Although most states do not have a bright line rule, a non-compete of one year is likely to be reasonable, assuming there is a legitimate business interest. Courts typically view time restrictions over two years skeptically. There is a fair amount of variability in how cases have come out and the laws in effect in different states. In Arkansas, a time period of 2 years is presumptively reasonable, but that presumption can be rebutted, while in Idaho the rebuttable presumption is that 18 months is reasonable. In Louisiana, anything over two years is automatically invalid, and in Utah, any non-compete agreement that exceeds one year is void.
Some states, including Illinois and Maine, also have a time restriction related to when a non-compete can go into effect—they require that the employee have been employed for a certain period of time before the non-compete can become valid.
- Geographic Scope
Generally, restrictive covenants also have to be limited in their geographic scope in order to be upheld. (This rule does not typically apply to non-disclosure agreements, however.) When determining whether a limitation on an employees’ right to compete is reasonable, a court will consider things such as the former employee’s territory during their employment. A geographic limitation based on the locations of the company’s current clients or the clients the employee worked with could also be considered reasonable. In some states, courts have upheld non-compete restrictions that are national or even worldwide because of the breadth of the employee’s influence, territory, and/or reach during their employment.
The majority of states, including Connecticut, Delaware, Iowa, Pennsylvania, and South Carolina, require that non-competes be limited geographically to what is reasonable given the legitimate business interest and the employee’s role. Arkansas is an example of a state that will potentially uphold non-competes that do not include a geographic restriction as long as the time and scope limit the agreement appropriately.
- Scope of “Competition”
The majority of states will require that the scope of a restrictive covenant be limited and clearly defined. Even non-disclosure agreements need to be governed by this standard. For example, while a company always has an interest in protecting its clearly defined intellectual property, some companies consider some of their practices to also qualify as trade secrets, but a generically worded, undefined employment agreement that does not explain what qualifies as a trade secret cannot be enforced.
For non-competes, the definition of what qualifies as competition is critical. If the agreement is overly broad, it will be unenforceable. An agreement that restricts an employee from working for a direct competitor on a competing product has clearly defined the scope by explaining what would qualify as competition. However, an agreement that generally limits the employee from working in the industry at all fails to take into account factors such as: what role the employee was performing for the original employer versus what role the employee is performing for the new employer; what industry the original employer is in versus the industry of the new employer; and what type of organization would qualify as a “competitor”.
An example of how the definition of the scope of the agreement informs the enforceability of a non-compete: an employee moving from a large, international public relations firm that handles multinational clients to a smaller firm whose clients are all smaller than the original firm’s customer base may be doing the same job in the same industry as at the original firm but is not doing it for a “competitor.” In limiting the scope of their non-compete agreements in Ohio, for example, companies should consider whether the agreement would seek to stifle an employee’s skills in such a way as to stifle ordinary competition versus stifling unfair competition. While this may not be as clearly stated in other states as it is in Ohio, it is a good rule of thumb for companies to consider when determining the contours of the scope of their non-compete agreements.
The Formalities
In order for restrictive covenants to be enforceable, there has to be some consideration offered by both parties. Typically, the consideration comes in the form of foregoing an action on the part of the employee (i.e., not sharing confidential information, not going to work for a competitor after they leave the company, or not soliciting the company’s clients or employees, etc.) and offering employment on the part of the company. The offer of initial employment is sufficient consideration in almost all states (but not Illinois or Massachusetts). However, if a company wants a current employee to enter a restrictive covenant, continued employment may not be sufficient. Some of those states that require more consideration than continued employment for current employees include: Kentucky, Massachusetts, Minnesota, Missouri, Montana, Oregon, Pennsylvania, South Carolina, Texas, Washington, West Virginia, and Wyoming.
As non-competes come under more scrutiny by legislatures, new types of consideration requirements and offers are starting to emerge. For example, Massachusetts requires companies to provide “garden leave” or “other mutually agreed upon consideration” to enter into non-compete agreements. “Garden leave” is where a company provides payment to a former employee during the non-compete period after the employment ends. In Massachusetts, garden leave is half of the employee’s salary. Essentially, the company is paying consideration for the employee’s observance of the non-compete during the non-compete period. Other types of consideration, such as lump sum payments, raises, or promotions are also increasingly offered to strengthen the likelihood that a non-compete will be upheld.
In addition to offering consideration, a growing number of states require that an employee or prospective employee be given notice regarding the non-compete and its contents. In Illinois, a company must advise the potential employee to consult with an attorney and provide a copy of the non-compete at least 14 days before the employee begins work. In Massachusetts, companies must meet the same requirements but only need to provide the agreement ten days before the employee would start work or prior to a formal offer. In Washington, companies must disclose the terms of a non-compete agreement before an employee’s acceptance of the offer of employment or before the agreement becomes effective. Under the current version of Washington D.C.’s new law, the company is required to disclose to the employee that non-competes are unlawful there. Oregon, New Hampshire, and Maine also require some type of notice to the employees, with the notice period in Oregon matching Illinois at two weeks before the commencement of employment.
Trends in Non-competes
As described at the beginning of this article, there are some states that ban non-competes altogether, and the federal government is pushing for the FTC to issue rules that would crack down on the unfair or abusive use of non-competes by companies. Currently, three states ban employee non-competes: California, Oklahoma, and North Dakota. D.C is set to join that group in April 2022 although there is an effort to amend and rein in that new law before it goes into effect. Other states have laws that significantly limit the use of non-competes. Those states include: Colorado, Illinois, Maine, Maryland, Massachusetts, New Hampshire, Nevada, Oregon, Rhode Island, Virginia, and Washington.
In 2021 alone, there were 66 non-compete bills introduced in 25 different states spanning the political spectrum from Mississippi to Vermont. While some states have been more active in legislating in this area, the overall trend shows a strong interest in ensuring that non-competes do not inhibit overall economic activity and that states’ workforces are able to adapt to changing circumstances in dynamic ways.
Penalties and Judicial Enforcement
State prosecutors have been aggressive in going after companies who abuse non-competes, particularly in going after companies that subject low-wage workers to these agreements. In Washington, companies face penalties of $5,000 per violation plus attorney’s fees for violating non-compete law. One company in Washington was recently forced to pay $110,000 and end its use of illegal non-compete agreements. State attorneys general in Illinois and New York have also been active in prosecuting companies for violating non-compete rules. In Virginia, violations carry a $10,000 per violation penalty. When D.C.’s non-compete ban goes into effect in 2022, the penalties attached to it will range from $350 to $1,000 per violation.
Summary
The amount of legislation aimed at the use of restrictive covenants, particularly non-competes, is increasing. We can expect more states to impose bans on non-competes for low-wage workers. Additionally, we are likely to see more states begin to implement notice requirements, informing potential employees that signing a non-compete is a condition of employment and giving them time to review the terms of the agreement.
There is a rapid trend at both the state and federal level to restrict the use of non-compete agreements. At the same time, many companies have expanded the number of states they have employees in because they have moved toward a remote workforce. These two facts mean that many companies may be using non-compete agreements that have not been reviewed recently enough to reflect legal updates or the laws of new jurisdictions where they now have employees.
Because of the rapid changes and increasing number of factors to consider, companies should not be using non-competes as a matter of course in every employment contract. Companies should take a fresh look at their use of non-competes, remembering that they should consider these factors: their legitimate business interest, the reasonableness of the restrictive time period, the geographic scope, whether the scope of the activity meets the definition of competition, income thresholds, prohibited professions, industry limitations, consideration, and notice periods.
Companies should also consider using non-solicitation and nondisclosure agreements as tools to more directly accomplish their business interests. A combination of a well-crafted, balanced, and appropriately limited non-compete agreement with non-disclosure and non-solicitation agreements can accomplish a company’s goals while avoiding problematic litigation and attorney general investigation that could arise if a company were to attempt to subject its employees to overly broad, legally questionable non-compete agreements.
[1] Attorneys’ General Letter to the FTC, dated 15 November, 2019. Accessible here.
[2] Executive Order 14036. 9 July 2021. Accessible here.
