Non-Compete Agreements

Legislative efforts to limit or ban the use of non-compete provisions in employment agreements have proliferated in the early months of 2018.

Perhaps most eye-catching was legislation (titled the “Workforce Mobility Act”) introduced in the U.S. Senate in late April 2018 that would prohibit employers from enforcing or threatening to enforce non-compete agreements with employees and require employers to post prominently a notice that such agreements are illegal.  Co-sponsored by Democratic Senators Chris Murphy (CT), Elizabeth Warren (MA) and Ron Wyden (OR), the bill envisions the Department of Labor enforcing the non-compete ban by levying fines on employers of $5,000 for each week that a violation of the Act occurs.  The bill also provides for a private right of action for workers to pursue damages in federal court.  A companion bill was introduced in the House of Representatives.  If enacted into law, the Workforce Mobility Act would have sweeping effects in the workforce.

Efforts by state legislatures to curb non-competes have continued apace, but such bills generally are drafted with more limited scope than the Workforce Mobility Act bill.  For example, on May 10, 2018, the New Jersey Assembly Labor Committee advanced Assembly Bill A1769, which would bar the use of non-compete agreements with respect to certain types of workers (mostly low-wage workers), and set a one year limit on employee non-compete agreements with respect to employees who are terminated by a company.

Massachusetts legislators have long tried (unsuccessfully so far) to enact legislation restricting non-competes, and they are at it again.  On April 17, 2018, Massachusetts House Bill 4419 was introduced, and it seeks, among other things, to prohibit enforcement of non-competes against certain low-wage employees, to limit the geographic and temporal scope of non-competes, and to require employers to provide advance notice to prospective employees if entering into a non-compete is a condition of employment.

Earlier this year, Utah and Idaho passed or amended their statutes dealing with post-employment restrictions on competition.  Colorado passed new limitations on non-competes involving physicians.

Employers should stay aware of these legislative efforts regarding non-competes, as they could, if enacted, invalidate some or all of the employers’ non-competition provisions with their employees.  In evaluating that possibility, employers should consider whether they are adequately protecting their legitimate business interests in their trade secrets and client relationships through other means as well, such as confidentiality/non-disclosure, non-solicitation agreements, and/or “garden leave” provisions.  As Ben Franklin said, “By failing to prepare, you are preparing to fail.”

A recent decision from an Arkansas appellate court raises two important issues of enforceability of non-competition agreements: (1) the enforceability of a non-compete after expiration of the contractual non-compete period and (2) the applicable standard for determining whether a valid protectable interest exists.

In Bud Anderson Heating & Cooling, Inc. v. Neil, the plaintiff Bud Anderson Heating and Cooling, Inc. (“BAHC”), a HVAC vendor and service provider, appealed a lower court’s denial of BAHC’s petition for a one-year prospective injunction seeking to enforce an expired non-compete agreement with defendant Neil, which was allegedly violated when Neil joined a competitor located within BAHC’s territory and subsequently successfully solicited a BAHC customer.  Before addressing the merits of BAHC’s complaint, the appellate court considered—and ultimately rejected—Neil’s argument that BAHC’s appeal was moot since the injunction sought extended beyond the contract’s one-year-from-date-of-termination period.  In so holding, the court relied on (1) caselaw from other jurisdictions finding that extension of a noncompetition period is within a court’s broad equitable powers and (2) application of the “capable-of-repetition-yet-evading-review exception to the mootness doctrine,” previously unapplied in this context.

Turning to the merits of the appeal, the appellate court found that the trial court should have applied an “able to use,” not an “actual use” standard in determining whether to grant BAHC’s injunction. Under an “able to use standard,” a petitioner need only demonstrate the ability of a former employee to use the former employer’s proprietary information to obtain an unfair competitive advantage; proof that the employee actually used such information is not required.

The Bud Anderson decision is noteworthy in two respects.  First, Arkansas employers may be able to enforce non-competes after expiration of the non-compete period, thereby achieving longer non-compete periods that would ordinarily be deemed by courts unreasonable and invalid.  Second, Arkansas employers seeking to enforce non-competes can take advantage of an “able to use” standard, which is easier to meet than an “actual use” standard.  However, given that the Bud Anderson decision presents not one but two issues of first impression, it would not be surprising if the case were to ultimately end up before the Arkansas Supreme Court.

Notwithstanding these developments in Arkansas, employers should note that other courts have reached different conclusions on both of these issues. As always, it is critical to know the state-specific law in the applicable jurisdiction.

We non-compete lawyers often rely on an old rule of thumb when analyzing the enforceability of a non-compete: if the restriction is so broad that it would even prohibit an employee from working as a janitor for a competitor, then it is very unlikely to be enforced by a judge. And so when a federal judge expressly endorses such a rule of thumb, the urge to blog about it is simply irresistible.

In Medix Staffing Solutions Inc. v. Daniel Dumrauf, Judge Ellis of the Northern District of Illinois addressed the enforceability of a restrictive covenant which prohibited employment in any capacity at another company in the industry.  The defendant argued that this restriction was so broad that it “would bar him from even working as a janitor at another company.”  While Judge Ellis described that example as “a bit far-fetched,” she nonetheless found “no language in the Covenant that makes it an inaccurate statement of [the Covenant’s] prohibitions.”  Accordingly, she held that the restriction was unenforceable on its face and that “[t]here is no factual scenario under which it would be reasonable.”  Accordingly, she held that “[t]his is an ‘extreme case’ where dismissal at the motion to dismiss stage is permissible and appropriate.”

And while noting that courts have the power to modify overbroad restrictive covenants, Judge Ellis refused to do so here, holding that Medix must instead “live with [its] decision” not “to draft an appropriate restrictive covenant.”

So, employers, the moral of the story is this: if your non-compete really would block an employee from working as a janitor for a competitor, it is time to update your non-compete, paying due heed, of course, to issues of adequacy of consideration for any such modification and other case law and statutory developments.

Two western states, Utah and Idaho, have recently passed or amended their statutes dealing with post-employment restrictions on competition.  This continues a national trend in which new state law in this area is increasingly the product of legislative action rather than judicial interpretation.  Thus, even if an employer has no current presence in these states, it is worth one’s time to understand these changes because they could soon be coming your way.

In Utah, the legislature amended the two-year old Post-Employment Restrictions Act (which we had written about before) to limit the enforcement of non-compete agreements against employees in the broadcasting industry.  The statute (HB 241) imposes a compensation test that precludes non-competes for broadcast industry employees making less than $47,476 annually, limits broadcast company employment contracts to four years or less, and nullifies any restriction that would limit competition beyond the original contract expiration date (meaning that an employee with a one year restriction who leaves a broadcast employer three months before contract expiration would have a three-month non-compete rather than a one-year non-compete).  The amendment also allows enforcement only if the employee is either terminated “for cause,” or the employee breaches the employment contract “in a manner that results in” his or her separation, curious language that seems to leave unaddressed whether a non-compete can be enforced where a non-breaching employee simply resigns.  While this amendment is certainly part of the trend of states (Arizona, Connecticut, the District of Columbia, Illinois, Maine, Massachusetts, and New York) having statutes specific to non-compete agreements in the broadcasting industry, it also fits in the broader trend of industry-specific limitations targeting an expanding list of industries and the even broader attack on non-compete agreements more generally.

The Idaho legislature also took action recently by amending its non-compete statute to remove an important pro-employer presumption applicable to non-compete agreements for “key” employees.  The Idaho statute, Idaho Code §44-2701 et seq., had since 2016 included a provision (§44-2704(6)) providing that an employer would be entitled to a rebuttable presumption of irreparable harm when a key employee found that employer likely to succeed on its claim that the employee had violated the covenant.  The legislature, in S 1287a, repealed that provision, restoring Idaho law to its pre-2016 status, as Idaho’s governor noted in his statement concerning the bill.  The governor did not sign the bill, but simply allowed it to become law without his signature.  He stated that he refrained from signing the bill because there was “no consensus” in the business community or the tech sector on such agreements, and went on to note that the next session of the legislature should re-adopt a modified version of the presumption provision just jettisoned.  As in Utah, this legislative back-and-forth illustrates the continued attention states are paying to non-compete issues in political, rather than judicial, forums.

Earlier this month, Colorado amended its law governing physician non-compete agreements (C.R.S. § 8-2-113(3)).  Since its enactment in 1982, that statute generally has prohibited agreements restricting the rights of physicians to practice medicine, but has allowed contractual provisions requiring a physician to pay damages arising from his or her competition if the damages are reasonably related to the injury suffered by the employer or other contracting party.  Under the amended statute, “a physician may disclose his or her continuing practice of medicine and new professional contact information to any patient with a rare disorder…to whom the physician was providing treatment.”   The goal of the amendment is to avoid interruptions to the continued care of individuals with rare disorders.  The statute looks to the National Organization for Rare Disorders, Inc. to maintain a database of diseases considered “rare disorders.”

Colorado physician practices should review and, if necessary, update any restrictive covenants in their physician agreements to ensure they are enforceable under the amended statute, bearing in mind that physicians now have the right to communicate personal contact information to patients suffering from rare disorders. Going forward, to avoid future disputes, physicians and their employers or practices may even wish to agree upon the language departing physicians can use to communicate information regarding their new practice to persons with rare disorders.

Also, any such review of physician agreements should consider the recent Colorado Supreme Court decision limiting the damages physicians’ practices can recover against physicians in breach of their non-compete agreements.

A little-noticed decision from earlier this year rendered by the Supreme Court of New York, Westchester County, demonstrates how enforcement of post-employment restrictive covenants will often boil down to a single question: does the restriction protect a legitimate business interest of the employer?

In Cindy Hoffman, D.O., P.C. v. Raftopol, plaintiff applied for a preliminary injunction against its former employee, a physician’s assistant, who began working for a competitor in technical violation of her past employment non-compete restriction which barred her for two years from working for competitors located within fifteen miles of any of the plaintiff-employer’s several offices.  Plaintiff asked the court to apply relaxed scrutiny to the covenant, arguing that the physician’s assistant position could be considered to be a “learned profession” in which her services performed were unique and extraordinary.  The court declined to apply such deference where the defendant was not in fact a physician.  Examining the two year restriction under New York’s traditional reasonableness standard, the court still was reluctant to enforce it as written.  Instead, Justice Terry Jane Ruderman blue-penciled the agreement and granted the preliminary injunction only to the extent of preventing the defendant from affirmatively soliciting clients of the plaintiff’s practice for a period of two years.

Safeguarding the plaintiff’s client relationships was the true legitimate business interest worthy of protection, and the court was willing to go no further than that in granting its injunctive relief.

The Colorado Court of Appeals, in Crocker v. Greater Colorado Anesthesia, P.C., recently examined several unique enforceability considerations with respect to a physician non-compete agreement.  Of particular interest was the Court’s treatment of a liquidated damages provision in the agreement.  Pursuant to a Colorado statute (8-2-113(3), C.R.S. 2017), the Court held that the provision was unenforceable because the liquidated damages were not reasonably related to the injury actually suffered.

Michael Crocker, a former physician-shareholder at Greater Colorado Anesthesia (Old GCA), signed an employment agreement with Old GCA that contained a non-compete provision that prohibited Crocker from practicing anesthesiology within 15 miles of a hospital serviced by Old GCA, for two years following termination of the agreement. The employment agreement also included a liquidated damages clause that required a former employee who violated the non-compete agreement to pay “(1) the three-year annual average of the gross revenues produced by the doctor’s practice; (2) minus the three-year annual average of the direct cost of [Old GCA] employee; (3) multiplied by two, to reflect two years of competition; and (4) plus $30,000 to cover the estimated internal and external administrative costs to terminate and replace the competing doctor.”

In January of 2015, Old GCA’s shareholders voted to approve a merger. Crocker dissented. Crocker severed his employment relationship with Old GCA and later began working for another anesthesiology group within the non-compete area outlined in his employment agreement. After the merger, New GCA sought damages for Crocker’s breach of his non-compete. The district court determined that the non-compete was unenforceable. The Court of Appeals affirmed the district court’s decision on several grounds, including hardship on Crocker and Crocker’s rights as a dissenting shareholder with respect to the merger.

The court also independently rejected New GCA’s request for liquidated damages, determining that the company suffered no damages, and that the liquidated damages clause was unenforceable because it was not reasonably related to “any injury [New GCA] actually suffered due to Crocker’s departure.” Citing the Colorado statute governing liquidated damages clauses in physician non-compete agreements, the court explained that “a damages term in a non-compete provision such as here is enforceable only if the amount . . . is reasonably related to ‘the injury suffered’ in the past tense. Under this plain language, the reasonableness of the relationship between the two amounts must be demonstrated, and it cannot be analyzed prospectively; by definition, it can only be determined upon the termination of employment.”

This case underscores the need for employers seeking to enter into restrictive covenants with their employees to consult with counsel when drafting such covenants. In the circumstances of this case, there was a state statute specifically bearing upon the liquidated damages provision in the physician non-compete agreement, which effectively prevented that provision from being enforced against the employee. The world of restrictive covenants can be tricky and compliance with state laws (statutes and case law) is crucial when the time comes to enforce them.

In managing workforces, particularly when addressing employee turnover, employers often find themselves facing issues regarding how best to safeguard their confidential business information and how to protect their relationships with clients and employees. In recent years, the legal landscape underlying these issues has been evolving, as lawmakers and judges grapple with the tension in these matters between protection and free competition.

In this Take 5, we examine recent developments, both in the courts and legislative bodies, concerning trade secrets and employee mobility:

  1. Antitrust Action Against No-Poaching Agreements: The Trump Administration Continues Obama Policy
  2. Drafting “Garden Leave” Clauses in Employment Agreements
  3. Will Insurance Cover a Company Sued in a Trade Secrets Lawsuit?
  4. Defend Trade Secrets Act Developments in 2017
  5. New and Proposed State Statutes and Federal Legislation Limiting Non-Compete Agreements

Read the full Take 5 online or download the PDF.

Of the various types of post-employment restrictions imposed on employees, a restriction on the recruitment of former co-workers (sometimes referred to as a “no-poach” or “anti-raiding” clause) is the type most likely to be enforced by a court. As a result, this is one type of post-employment restriction that is frequently drafted without the careful thought generally put in to traditional non-competes and client non-solicitation clauses.  But in what could be a foreshadowing of closer judicial scrutiny of co-worker non-solicitation clauses nationwide, the Wisconsin Supreme Court recently held that the Wisconsin non-compete statute applies to such clauses, and that the particular clause in question was unenforceable because it was not “reasonably necessary for the protection of the employer.”

Specifically, in Manitowoc Company v. Lanning, 2018 WI 6 (Jan. 19, 2018), the Wisconsin Supreme Court ruled that Wisconsin’s non-compete statute, Wis. Stat. § 103.465, broadly applies to restrictions on competition, including post-employment restrictions on the ability to solicit former co-workers.  In Lanning, the defendant, an engineer and former employee of the plaintiff, resigned and immediately began working for the plaintiff’s direct competitor. Defendant did not have a non-compete agreement but he did sign an employment agreement that included a non-solicitation clause that prohibited him from soliciting or inducing any employees from the plaintiff’s company to join a competitor within the two-year period following his resignation. After joining the competitor, defendant allegedly began to recruit employees to join the competitor company. Plaintiff argued that the defendant’s actions violated the non-solicit provision and sued him. The Wisconsin Supreme Court held that the non-solicitation provision was an unreasonable restraint on trade which failed to meet the statutory requirement that the restriction “be reasonably necessary for the protection of the employer.”

Wis. Stat. § 103.465 sets forth five requirements that must be met for a restrictive covenant to be enforceable. The restraint must: “(1) be necessary for the protection of the employer, that is, the employer must have a protectable interest justifying the restriction imposed on the activity of the employee; (2) provide a reasonable time limit; (3) provide a reasonable territorial limit; (4) not be harsh or oppressive as to the employee; and (5) not be contrary to public policy.”

Here, the court looked to several factors when determining that the non-solicit provision was an unreasonable restriction on trade, including the fact that the provision contained no limitation based on the employee’s position, no limitation based on the employee’s “familiarity with or influence over a particular employee,” and no geographical limitation. The company argued that the provision was written to protect the company’s “investment of time and capital involved in recruiting, training and developing its employee base from ‘poaching’ by a ‘former employee who has full awareness of the talent and skill set of said employee base.’” The Court rejected this claim, instead determining that the provision was overbroad and restricted competitors’ access to the labor pool.

This case sends a message to employers that all types of post-employment restrictions on employees, even those which are not traditional non-compete agreements, should be drafted narrowly to protect legitimate business interests of the company, and should be no broader than necessary.