Employment contracts: Will Noncompete agreements soon be obsolete?
A common issue that arises in the workplace is whether a company may prevent departing employees from competing against it, soliciting its customers, or using the company’s information and data for their own purposes. In recent years, lawmakers and courts have continued to demonstrate hostility toward these types of noncompete agreements, also referred to as restrictive covenants or covenants not to compete. The ongoing trend includes state-specific limitations governing restrictive covenants, court actions, and new federal activity concerning noncompete agreements.
What is a restrictive covenant?
A noncompete agreement is a restrictive covenant or agreement between an employer and employee that the employee will agree not to work for a competitor immediately after leaving employment with the current employer. Generally, it includes a timeframe and defines the geographic area where the employee can work. Non-solicitation agreements prevent a departing employee from soliciting the previous employer’s customers or workforce to do business or work with a new employer.
A non-solicitation agreement must not be overly restrictive and must include consideration. In other words, there must be some benefit to the employee to compensate for the post-employment restriction. In addition, the agreement must be reasonably necessary for the employer’s protection and reasonable in time, geographic scope, and scope of the prohibited activities.
State trends
More and more states are banning or severely limiting restrictive covenants. For example, in 2022, Colorado enacted a law that significantly limits the use of noncompete and non-solicitation agreements and has imposed significant financial penalties on employers for violating the law. The Colorado Restrictive Employment Agreement Act (HB 22-1317) bans most noncompete agreements unless the employee is a “highly compensated” worker; the noncompete is for the protection of trade secrets. It is no broader than is reasonably necessary to protect the employer’s legitimate interest in protecting trade secrets.
Similarly, Illinois, Maine, Maryland, New Hampshire, Oregon, Rhode Island, Virginia, and Washington state prohibit noncompete agreements unless the worker earns above a certain salary threshold. Other states, such as California, North Dakota, Oklahoma, and Washington, D.C., ban noncompete agreements with few exceptions. Many of the new state laws contain extensive “notice requirements” that employers must provide to employees.
In D.C., for example, employers with noncompete policies must provide the written notice of all policies to new hires within 30 days of acceptance of employment; notice must be provided any time there is a change to the employer’s policies; and 14 days advance written notice must be provided to employees when entering a noncompete with highly compensated employees.
Most of these new state restrictions took effect within the last three years—during the COVID-19 pandemic—which tightened the labor market in many industries. Following the pandemic and the mass exodus of employees leaving their jobs, employees continue to be hard to hire and retain. This phenomenon has led to noncompete agreements being scrutinized now more than ever and a corresponding rise in noncompete disputes across the country.
Federal trends
The federal government is also taking steps to limit the use of employee noncompete agreements. President Joe Biden issued an Executive Order (EO) on “Promoting Competition in the American Economy” on July 9, 2021. It also encouraged the Federal Trade Commission (FTC) to ban or limit noncompetes.
Subsequently, on January 5, 2023, the United States Federal Trade Commission (FTC) proposed a new rule (the “Proposed Rule”) that, if implemented, could dramatically restrict the use of noncompete agreements throughout the United States. The Proposed Rule (PR) would ban employers from entering post-employment noncompete agreements with their workers, drastically limit the availability of sale-of-business noncompete agreements, and require employers to rescind many existing noncompete agreements.
Even while the PR is under consideration and subject to revision, it may influence some courts to assess whether to enforce noncompete agreements. Employers that utilize non-compete agreements should consider the possible implementation of a broad federal prohibition on post-employment noncompete agreements in deciding how extensively to use noncompete agreements in the future. The PR is consistent with a trend at the state level in recent years to restrict the use of noncompete agreements.
Employer takeaways
Although most states have historically permitted noncompete clauses, President Biden’s EO, the FTC’s Proposed Rule, and recent trends from several states forecast a notable change in direction. Employers drafting noncompete agreements in 2023 should stay current with the applicable state and federal laws and the possibly shifting legal analyses defining valid agreements.
As a general rule, employers should make sure their noncompetes are reasonable and not too restrictive on the employee’s right to secure future employment. Considering current trends, a covenant beyond what is reasonably necessary to protect a company’s legitimate interests will likely be at risk of being invalidated.
