Non-Compete Agreements

Thomson Reuters Practical Law has released a new edition of “Preparing for Non-Compete Litigation,” a Practice Note co-authored by our colleague Peter A. Steinmeyer of Epstein Becker Green.

Following is an excerpt:

Non-compete litigation is typically fast-paced and expensive. An employer must act quickly when it suspects that an employee or former employee is violating a non-compete agreement (also referred to as a non-competition agreement or non-compete). It is critical to confirm that there is sufficient factual and legal support before initiating legal action. Filing a complaint for monetary damages or a request for an injunction can backfire if an employer is not prepared with sufficient evidence to support its request. This Note discusses the steps an employer can take to best position itself for successful enforcement of a non-compete and the strategic considerations involved with initiating non-compete litigation. In particular, it discusses:

  • Best practices for investigating a suspected violation and gathering relevant evidence.
  • Key steps for evaluating the likelihood a court will enforce a non-compete.
  • Factors to consider before initiating legal action.
  • The options for enforcing a non-compete through legal action and the key decisions relevant to each option.

Click here to download the full Note in PDF format.

States across the country have been using enforcement actions, legislation, and interpretive guidance to limit employers’ ability to enforce restrictive covenants against low wage workers. The recent decision in Butler v. Jimmy John’s Franchise, LLC et. al., 18-cv-0133 (S.D. Ill. 2018) suggests this trend may extend to federal antitrust law.

The Butler case relates to the legality of certain restrictive covenants in Jimmy John’s franchise agreements.[1] The Complaint alleges that Jimmy John’s required franchisees to agree not to hire any job applicants who worked for a different Jimmy John’s franchise in the previous year. Franchisees also agreed not to solicit one another’s employees. The franchise agreements also named all other Jimmy John’s franchisees as third party beneficiaries of the agreement. This meant that if Franchise B hired a Franchise A employee, Franchise A could sue to enforce the agreement between Franchise B and Jimmy John’s Franchise LLC (the franchisor).

In determining claims of antitrust violations, the distinction between “horizontal” and “vertical” agreements is highly significant. Challenges to vertical agreements are analyzed under the “rule of reason” under which plaintiffs must prove market power and that the challenged practices actually harm competition. This generally requires sophisticated economic analysis. Horizontal agreements not to compete, in contrast, are generally deemed “per se” unreasonable and do not require any proof regarding market context.

In Butler, the Court characterized the franchise agreements as horizontal agreements. Such a characterization permitted the plaintiffs to state a claim without alleging that a particular franchisor has sufficient market power to effect the market for employees in an entire geographic region. In other words, the plaintiffs did not have to prove that Jimmy John’s on its own had enough market power to depress the wages of delivery drivers in a particular city.

To keep things in perspective, Butler is an isolated district court decision which may remain an outlier. However, it serves as another example of how subjecting low wage workers to restrictive covenants can impose heightened litigation risk. Butler provides another reason (on top of the joint FTC/DOJ Antitrust Guidance for Human Resources Professionals and DOJ enforcement actions following through on that guidance) for employers to ensure their restrictive covenants are not only enforceable but compliant with antitrust law.

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[1] Jimmy John’s has since agreed to remove the challenged provisions from their franchise agreements.

On September 19, 2018, the New York Attorney General (“NYAG”) released a Frequently Asked Questions document (“FAQ”) regarding non-compete agreements in New York. The FAQ posits and answers the following basic questions about non-competes:

  • What is a non-compete agreement?
  • Are non-competes legal?
  • Do I have to sign a non-compete?
  • How could a non-compete affect me?
  • How do employers enforce non-competes?

In addition, the FAQ advises employees on specific steps to take before signing a non-compete, as well as actions employees can take if they signed a non-compete and are contemplating leaving their job. The FAQ concludes by emphasizing the NYAG’s efforts to end overly broad non-competes for rank-and-file employees who do not have access to trade secrets or confidential information, noting several recent settlements in this space and legislation introduced by the NYAG that would prohibit non-competes for workers earning below $75,000 per year (which is still pending).

The publication of the FAQ is not only a useful resource to employers and employees alike, but also another notable development in the close scrutiny that state attorneys general, nationwide, are applying to non-compete agreements.

On April 13, 2015 we blogged about the decision of the Ninth Circuit in Golden v. California Emergency Physicians Medical Group, 782 F.3d 1083 (9th Cir. 2015). There, the Ninth Circuit considered whether, under California law, an employee could be ordered to sign a settlement agreement that included language that restricted him, inter alia, from future employment with his former employer.

Dr. Golden is an emergency-room doctor who sued California Emergency Physicians Medical Group (“CEP”), among others, regarding his loss of staff membership at a medical facility.  His lawsuit was based on various state and federal causes of action, including racial discrimination.  The parties orally agreed in open court to settle the case and the settlement terms included “a substantial monetary amount,”  dismissal of the action, a release of CEP and a waiver of any and all rights to employment with CEP or at any facility that CEP may own or with which it may contract in the future (the “no-employment provision”).  Dr. Golden refused to sign the written agreement and attempted to have it set aside.  His attorney moved the court to withdraw as counsel, moved the court to intervene and further moved the court to enforce the settlement agreement so he could collect his contingency fee. In further proceedings, a magistrate judge recommended that Dr. Golden be ordered to sign an amended agreement, and that recommendation was adopted by the district court judge who concluded the settlement agreement was not within the ambit of Business and Professions Code § 16600, which makes unlawful in California (with limited exceptions) any contract to the extent it restrains someone from engaging in a lawful trade, business or profession.  Dr. Golden refused to sign the agreement and filed a notice of appeal.

On appeal, the Ninth Circuit Court of Appeals reversed the district court’s enforcement of the settlement agreement and remanded the case to the district court to determine whether a no employment provision in the agreement is a “restraint of substantial character” to the Plaintiff’s medical practice.

On remand, the district court again ordered Dr. Golden to sign the settlement agreement, concluding that the no-employment provision was not a restraint of substantial character. Dr. Golden again appealed.

In its July 24, 2018 decision, the Ninth Circuit surveyed California law and noted first that a contractual provision imposes a restraint of substantial character if it significantly or materially impedes a person’s lawful profession, trade, or business.  The Ninth Circuit noted that a provision need not completely prohibit the business or professional activity at issue, nor need it be sufficient to dissuade a reasonable person from engaging in that activity.  Rather, the “restraining effect must be significant enough that its enforcement would implicate the policies of open competition and employee mobility that animate Section 16600.”  The Court noted that it “will be the rare contractual restraint whose effect is so insubstantial that it escapes scrutiny under Section 16600.”

Looking to the provision in the settlement agreement at issue, the Ninth Circuit noted that it impeded Dr. Golden’s ability to practice medicine in three ways.

First, the settlement agreement prohibited Dr. Golden from working or being reinstated at any facility owned or managed by CEP.

Second, the settlement agreement prohibited Dr. Golden from working at any CEP-contracted facility.

Third, the settlement agreement provided that if CEP contracts to provide services to, or acquires rights in a facility where Dr. Golden is currently working as an emergency room physician or hospitalist, CEP has the right to terminate his employment with no liability.

The Ninth Circuit held that the first provision, which barred Dr. Golden from future employment at facilities owned or managed by CEP did not impose a substantial restraint on his medical practice. The Ninth Circuit further held, however that the second and third provisions did substantially restrain Dr. Golden’s practice of medicine and were therefore barred by Section 16600.  These two provisions limited employment with third parties based merely on whether CEP contracted with them. As a result, if Dr. Golden was employed by a hospital that later contracted with CEP to provide, for example, anesthesiology services, Dr. Golden would be ineligible for employment with the hospital.

Given the size of CEP’s business in California—it staffs 160 facilities in the state and handles between 25% and 30% of the state’s emergency room admissions, these provisions were a substantial restraint on Dr. Golden’s trade.

The Ninth Circuit’s ruling may leave open whether a provision in a settlement agreement that permits an employer to terminate the employment of an employee where it acquires the employee’s new employer will pass muster under Section 16600.  The provisions at issue in Golden were extremely broad: Plaintiff was prohibited from employment with entities with which CEP contracts to provide services to, or “acquires rights” in.  A different, more limited provision that prohibited employment at entities as to which the employer acquires outright may be held not to impose a substantial restraint on trade.  Further, the Ninth Circuit relied in part on CEP’s broad reach in the state of California.  This leaves open that smaller employers may be able to impose restrictions that larger employers with more market share may not.

Effective as of October 1, 2018, Massachusetts will become the 49th state to adopt a version of the Uniform Trade Secrets Act (leaving New York as the only holdout). Massachusetts did so as part of a large budget bill recently signed into law, which also resulted in the adoption of the Massachusetts Noncompetition Agreement Act. (The text of the Massachusetts version of the Uniform Trade Secrets Act is set out on pages 47-52 of the bill, H. 4868, while the effective date is set out on page 117. Here is a link to the entire budget bill.)

While there are differences from existing Massachusetts law regarding trade secrets, the new law is similar in most respects to the federal Defend Trade Secrets Act (“DTSA”). Nevertheless, the remedy provisions of the two laws are not identical, and there will be situations where greater relief is available under one statute than the other. For example, ex parte seizure orders are only available under DTSA, and attorney’s fees and exemplary damages are only available under DTSA if certain required disclosures about whistleblower immunity were made in agreements containing confidentiality provisions. The new Massachusetts law allows attorneys’ fees in circumstances of willful and malicious misappropriation and/or where claims or defenses are pursued in bad faith.

Additionally, employers should be aware that the Massachusetts statute does not apply to “misappropriation occurring prior to” October 1, 2018 or to “continuing misappropriation that began prior to” that date but continued after it.

On August 10, 2018, the Governor of Massachusetts signed “An Act relative to the judicial enforcement of noncompetition agreements,” otherwise known as The Massachusetts Noncompetition Agreement Act, §24L of Chapter 149 of the Massachusetts General Laws. (That bill was part of a large budget bill, H. 4868, available here; the text of the provisions relevant here at pages 56-62 of the bill as linked). The Act limited non-competition provisions in most employment contexts to one-year and required employers wishing to enforce such a one-year period to pay their ex-employees for the time that such employees are sidelined. The Act also precluded enforcing such provisions against employees laid-off or terminated without cause or against employees classified as non-exempt under the Fair Labor Standards Act. These and the other requirements noted below become effective and apply to employee noncompetition agreements entered into on or after October 1, 2018, and the Act curiously contains some significant exceptions as well. Below we will highlight material aspects of the new law, which was recently featured on Employment Law This Week.

Requirements for Enforcement Start Early

In connection with a non-compete agreement provided to an employee at the start of employment, an employer must provide it to the employee at the time of the offer of employment or ten business days prior to starting employment, whichever is earlier. Act, lines 1282-1291, at page 58-59. (The Act defines such agreements as “an agreement between an employer and employee, or otherwise arising out of an existing or anticipated employment relationship, under which the employee or expected employee agrees that he or she will not engage in certain specified activities competitive with his or her employer after the employment relationship has ended.” Act, lines 1264-1267, at page 57-58)

For a non-competition agreement presented to an employee during employment, the employer must provide it to the employee ten business days before it takes effect and such an agreement must be supported by “fair and reasonable consideration independent from the continuation of employment.” Act, lines 1287-1297, at page 58-59.

The Act also requires that a non-competition agreement “expressly state that the employee has the right to consult with counsel prior to signing.” Act, lines 1289, at page 59.

Further, the Act applies to all employees and independent contractors working in Massachusetts regardless of whether the agreement has a choice-of-law provision specifying the law of some other jurisdiction applies. Act, lines 1249-51, at page 57. (How it will apply to sales personnel with multi-jurisdiction territories remains to be seen, and its provision purporting to apply its requirements to those who are a “resident of” Massachusetts as opposed to those working there certainly appears one likely to be litigated as well. Act, lines 1346-1349, at page 61.)

The Death of Reasonable Pro-Employer Restrictions In Massachusetts?

The Act certainly requires employers to pay attention. But it preserves many tools for employers to use with employees, so it seems that reports of the death of such restrictions is greatly exaggerated. When employers understand a core of four concepts about the new law, they will be able to structure their approach accordingly.

First and foremost, the Act requires that most non-compete periods be limited to one-year during which the employee receives garden-leave pay or some “other mutually agreed-upon consideration.” Act, lines 1318-1330, at page 60. The Act defines garden-leave pay as payment of at least half of the employee’s highest base salary during the two years preceding the restricted period but it does not define in any way the phrase “other mutually agreed-upon consideration.” Id. The Act also allows the one-year period to be extended to two years and the obligation to pay compensation to vanish where the employee has breached fiduciary duties or has taken property belonging to the employer. Act, lines 1305-1313, at page 59-60. In the end, the Act states that such provisions “must be no broader than necessary to protect one or more . . . legitimate business interests of the employer” but also that “[a] noncompetition agreement may be presumed necessary where the legitimate business interest cannot be adequately protected through an alternative restrictive covenant, including but not limited to a non-solicitation agreement or a non-disclosure or confidentiality agreement.” Act, lines 1298-1304, at page 59.   But the Act also notes that courts may “reform or otherwise revise” such agreements to be consistent with the Act and Massachusetts public policy. Act, lines 1331, at page 60 and Act, lines 1343-1345, at page 61.

Second, the Act precludes enforcement of non-competition agreements against certain classes of employees. An employer may not enforce non-competes against employees who are (i) nonexempt under the Fair Labor Standards Act, (ii) undergraduate or graduate students who are in an internship program or other short-term employment relationship with an employer (whether paid or unpaid) while enrolled in a full-time or part-time undergraduate or graduate educational institution, (iii) under age 18, or (iv) terminated without cause, though “cause” and “without cause” are undefined. Act, lines 1332-1342, at page 61. Still, the Act expressly states that a number of traditional restrictions fall outside its requirements, and may continue to be used by Massachusetts’ employers, including the following as agreements unaffected by the Act:

  • those “not to solicit or hire employees of the employer”
  • those “not to solicit or transact business with customers, clients, or vendors of the employer”
  • those “made in connection with the sale of a business entity or substantially all of the operating assets of a business entity or partnership, or otherwise disposing of the ownership interest of a business entity or partnership, or division or subsidiary thereof, when the party restricted by the noncompetition agreement is a significant owner of, or member or partner in, the business entity who will receive significant consideration or benefit from the sale or disposal”
  • those “outside of an employment relationship”
  • “forfeiture agreements,” which are defined as “an agreement that imposes adverse financial consequences on a former employee as a result of the termination of an employment relationship, regardless of whether the employee engages in competitive activities following cessation of the employment”
  • nondisclosure or confidentiality agreements
  • invention assignment agreements.

[Act, lines 1268-1281, at page 58.]

Perhaps of greatest interest, employers may still extract longer non-competes “made in connection with the cessation of or separation from employment if the employee is expressly given seven business days to rescind,” which means that noncompetition agreement may be part of a severance agreement. Id. How that will play out where one enters into a severance agreement with one who would otherwise be terminated without cause will prove interesting.

Third, the Act also limits both geographic scope and precludable competitive activities. It does so by limiting scope to those geographic areas employee actually worked in and those services the employee actually provided—during employee’s last two years of employment. This is seen in the statutory language that says “[a] geographic reach that is limited to only the geographic areas in which the employee, during any time within the last two years of employment, provided services or had a material presence or influence is presumptively reasonable” and that “[a] restriction on activities that protects a legitimate business interest and is limited to only the specific types of services provided by the employee at any time during the last two years of employment is presumptively reasonable.” Act, lines 1310-1317, at page 60.

Fourth, the Act also seems to limit venue to certain specific courts. The Act states that “[a]ll civil actions relating to employee noncompetition agreements subject to this section shall be brought in the county where the employee resides or, if mutually agreed upon by the employer and employee, in Suffolk county; provided that, in any such action brought in Suffolk county, the superior court or the business litigation session of the superior court shall have exclusive jurisdiction.” Act, lines 1350-1354, at page 60-61. The notion of “exclusive jurisdiction” will also likely be the subject of contested claims brought in federal court under the Act.

All Things Considered, I’d Rather Be In ….

As noted at the outset, the Massachusetts Act is a set of significant, material changes for employers. But they are manageable when one understands the full panoply of options that remain open to employers in Massachusetts and takes the time to plan with counsel for the October 1st transition to a new non-compete regime that in fact will continue to include much of what is already in use for sophisticated employers. So, Massachusetts will remain manageable.

So far, the year 2018 has brought an increasing number of labor and employment rules and regulations. To help you stay up to date, we are pleased to invite you to join our Employment, Labor & Workforce Management Webinar Series. Each month, we will focus on a specific industry, topic, or practice area.

Our July webinar will be hosted by Epstein Becker Green’s Health Employment and Labor (HEAL) strategic service team and Trade Secrets and Employee Mobility service team. This webinar will provide an overview of the legal landscape of non-compete agreements in the health care industry, including state law requirements and restrictions, public policy considerations, recent developments, and expected trends. The webinar will also address key considerations when drafting and enforcing non-competes, engaging in the due diligence process, and integrating providers following a health care transaction.

Tuesday, July 24, 2018
12:00 p.m. – 1:00 p.m. ET

Register for this complimentary webinar today!

On Monday, attorneys general in eleven states, including New York, New Jersey, Massachusetts, California, and Illinois, revealed that they are investigating several prominent fast food franchisors for their potential use of no-poaching or non-compete agreements restricting the ability of low wage workers to obtain a better-paying job with another franchise. To that end, these attorneys general have propounded document and information requests to these restaurants, returnable August 6, 2018.

In the Illinois AG’s press release, Attorney General Madigan stated that “No-poach agreements trap workers in low-wage jobs and limit their ability to seek promotion into higher-paying positions within the same chain of restaurants.” Madigan claims that at least 58 percent of major franchisors have no-poach provisions in their franchise agreements. This is not the first time that the Illinois AG has taken aim at non-compete agreements. Over two years ago, Madigan’s office sued sandwich chain Jimmy John’s for employing what it deemed “highly restrictive non-compete agreements,” ultimately reaching a $100,000 settlement with the franchisor. Ten months after Illinois passed the Freedom to Work Act, which prohibits private sector employers from requiring non-compete covenants of low-wage employees, defined as the greater of the applicable federal, state, or local minimum wage (currently $7.25 under federal law and $8.25 under Illinois state law) or $13 per hour, Madigan sued a national payday lender for requiring its employees, including workers who earn less than $13 an hour, to sign a non-compete agreement as a condition of employment.

Illinois is not the only state to pursue non-compete reform. Several other states recently have enacted legislation curbing the use of non-competes with respect to certain categories of workers, such as certified nurse practitioners and midwives (New Mexico) and workers in the broadcasting industry earning under a certain salary (Utah). Other states have proposed similar legislation. For example, New Hampshire bill SB 423 would ban non-compete agreements with “low-wage employees.” On the other end of the spectrum, Vermont House Bill 556 and Pennsylvania House Bill 1938 would ban all non-competes other than those formed in connection with the sale of an ownership interest in a business entity or the dissolution of a partnership or limited liability company. Even if these bills ultimately fail, they signal a rising trend of state-level restrictive covenant reform, which will likely gain momentum as state attorneys general step up enforcement in this area.

Many physicians and other health care workers are familiar with restrictive covenants like non-competition and/or non-solicitation agreements, either as employees who have been asked to sign such covenants as a condition of their employment or as business owners seeking to enforce such covenants to protect their medical practices from competition. These covenants are usually designed to prohibit physicians or other practitioners from leaving and setting up a competing practice nearby using patient contacts, information, and/or training that they received during their employment or association with the former employer.

Restrictive covenants generally are regulated by state laws and cases, which can differ markedly from one state to the next. For physicians and some other health care professionals, there can be an additional level of complexity in the analysis of such covenants, because many states, in light of the unique position the medical profession holds in the public interest, apply special rules to covenants that restrict medical practice. Courts considering such covenants may ask whether enforcement will cause a shortage of doctors in a particular area, or within a particular specialty. A paramount consideration usually is the right of patients to obtain treatment from the physician or other health care professional of their choice.

By statute, several states that may allow non-competes generally (provided they are reasonable and protect legitimate business interests) will not enforce them at all against physicians. Massachusetts was an early adopter, in 1977, of a statutory prohibition on physician non-competes. Mass. Gen. Law Ch. 112 § 12X renders void any non-compete provision restricting “the right of a physician to practice medicine in a particular locale and/or for a defined period of time.” In the early 1980s, Delaware and Colorado enacted similar laws. 6 Del. Code Ann. § 2707; Colo. Rev. Stat. § 8-2-113.[1] In 2016, Rhode Island followed suit and enacted a law just like Massachusetts’ statute. R.I. Gen. Laws §5-37-33.

Some other states do not prohibit physician non-competes but apply stricter standards to such agreements than they do to employee non-competes generally. For example, enacted in 2007 and amended several times thereafter, Tennessee’s statute allows physician (including radiologist) non-compete provisions if they: (1) are in writing; (2) last no longer than two years after the physician’s employment is terminated; and (3) either (a) are geographically limited to the greater of the county where the physician is employed or a ten mile radius of the primary practice site; or (b) there is no geographic restriction, but the physician is restricted from practicing at any facility in which the employer provided services during the physician’s time of employment. Tenn. Code Ann. § 63-1-148.

Texas law allows physician non-competes provided that the covenant must: not deny the physician access to a list of the patients seen or treated within one year of termination of employment; provide access to medical records of the physician’s patients upon proper authorization; provide for a buyout of the covenant by the physician at a reasonable price; and allow the physician to provide continuing care and treatment to a specific patient or patients during the course of an acute illness. Tex. Bus. & Com. Code Ann. § 15.50.

A New Mexico statute first enacted in 2015 prohibits provisions in agreements which restrict the right of healthcare practitioners (including physicians, osteopathic physicians, dentists, podiatrists and certified registered nurse anesthetists) to provide clinical healthcare services.[2]  (That limitation does not apply to agreements between shareholders, owners, partners or directors of the practice.) The law, however, does allow non-disclosure provisions relating to confidential information; non-solicitation provisions of no more than one (1) year; and imposes reasonable liquidated damages provisions if the practitioner does provide clinical healthcare services of a competitive nature after termination of the agreement.  In addition, healthcare practitioners employed by the practice for less than three (3) years may be required, upon termination, to pay back certain expenses to the practice, including loans; relocation expenses; signing bonuses or other incentives related to recruitment; and education/training expenses.  N.M. Stat. § 24-1l-1 et seq.

And a Connecticut law enacted in 2016, rather than prohibiting physician non-competes, limits the allowable duration (to one year) and geographical scope (up to 15 miles from the “primary site where such physician practices”) of any new, amended or renewed physician agreement.  The law also renders physician non-competes unenforceable if the physician’s employment or contractual relationship is terminated without cause.  Conn. Gen. Stat. §20-14p(b)(2).

Other states may have, or may be considering enacting, statutes restricting non-competes and related agreements for healthcare providers. The trend is certainly toward limitations on such agreements. Accordingly, consultation with local legal counsel regarding these issues is highly recommended for any person or entity practicing in the healthcare industry.

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[1] Under Delaware and Colorado’s non-compete statutes, physicians can be required to pay damages “reasonably related to the injury suffered” by a breach of any such agreement. The Colorado statute was amended in 2018 to clarify that physicians may disclose their continuing practice and provide new contact information to any of their patients who have a “rare disorder,” and not be subject to claims for damages.

[2] This prohibition was expanded in 2018 to include certified nurse practitioners and mid-wives, and to prohibit the use of choice of forum and choice of law agreements to prevent circumvention of the prohibition.