Restrictive Covenants Move from Common Law to Statutory Regulations
Posted on Feb 28, 2022 on Employment-at-Will / Restrictive Covenants by
February 25, 2022
Restrictive covenants are the rules that limit a former employee’s ability to take a job with a competing business. Today, 30 states and the District of Columbia have laws limiting the use of restrictive covenants in the workplace. What was once the exclusive province of state common law (court made law) has become more and more the purview of state legislatures which are either codifying existing common law or looking to expand restrictions beyond the state’s current common law. Currently, all restrictive covenant statutes are state specific; however, there are proposals pending in Congress and at the Federal Trade Commission that if passed would create federal restrictions. And, unlike state statutes that regulate trade secrets, which primarily mirror the Uniform Trade Secrets Act, state statutes governing restrictive covenants very greatly from state to state. The state specific nature of these statutes causes confusion and uncertainty for employers operating in multiple states.
The three core areas being addressed by state restrictive covenant statutes involve:
- Restrictions on investing in or providing services to a competitor;
- Restrictions on soliciting an employer’s employees/customers or otherwise interfering with those relationships; and
- Restrictions on disclosing an employer’s confidential information.
This article will take a closer look at some of the most recent state statutes governing restrictive covenants, which document an increasing hostility towards restrictive covenants in state legislatures. After a close examination of these trends, it becomes apparent the need for employers to reevaluate their existing restrictive covenant agreements to make sure they are in compliance with any new statutes or shifting common laws.
The Illinois Freedom to Work Act (“IFWA”) already imposed certain restrictions on an Illinois employer’s ability to use non-compete and non-solicitation agreements (with a bright line exception for those involving the sale of a business). IFWA’s most recent amendment, which went into effect earlier this year, expands upon the state’s comprehensive approach to regulating restrictive covenants. The amended statute now prohibits employers from:
- Having non-compete agreements with employees expected to earn/actually earning less than $75,000. This amount is set to increase by $5,000 every five years until 2037 when it shall be set at $90,000.
- Entering into non solicitation agreements with employees expected to earn/actually earning less $45,000 per year. This amount is set to increase by $2,500 every five years until 2037 when it shall be set at $52,500.
In addition to these minimum compensation levels, there are separate requirements for “adequate consideration” for agreements with non-compete and non-solicitation provisions. These require the employee receive something of value for these agreements to be enforceable.
In addition, the new provisions void non-competition and non-solicitation agreements unless:
- the employee has been advised in writing by the employer that she should consult with an attorney before signing; and
- the employee is provided with a copy of the agreement no less than 14 calendar days before her employment begins or she has been given at least 14 calendar days to review the agreement.
Finally, the amendment allows courts to modify or sever terms in an agreement rather than to only refuse to enforce the entire agreement. This allows courts much more ability to do what it deems “fair.”
IFWA also allows employees to recover costs and reasonable attorney’s fees if he/she defeats a claim by the employer.
Colorado’s new restrictive covenant statute is unique in that it imposes criminal liability for employers who violate it with penalties up to 120 days in jail and/or a fine up to $750. The statute comes with four basic exceptions (i) contracts for the purchase and sale of a business, (ii) protection of trade secrets, (iii) contracts to recover education/training expenses for employees employed less than two years, and (iv) contracts with executives and management personnel.
While the exceptions may appear simple, execution will likely be much more difficult. For example, will a suit filed by an employer to enforce its restrictive covenant be routinely countered by a parallel criminal proceeding initiated at the request of the employee who feels the restriction is not permissible under Colorado law? Also, has anyone decided exactly what each of these exceptions means?
It is too early to tell how this will play out in Colorado; however, if successful it could prove to be the framework for other states to follow.
Nevada has also recently amended its statute that governs non-compete agreements. Its approach is more modest and straight forward than most in that it attempts to proscribe two common overreaches which often occur when employers try to enforce non-competes.
First, the courts will look to see if the employer has a “protectable interest?” To simplify this question, Nevada’s statute now imposes a simple rule: “if employees are paid hourly, there is no protectable interest.” As a result, Nevada hourly employees are no longer subject to non-competes.
Second, the amended statute has created a safe harbor for former employees who go to work for prior customers. This safe harbor is activated when the former employee leaves and the customer chooses to follow the employee voluntarily and without solicitation by the employee. Proving this is likely to be an uphill battle in all but the most egregious of cases.
Oregon recently made amendments to its non-compete statute. Those amendments went into effect at the first of this year and make void all non-competes unless (i) the mandates for both procedural and substantive due process have been satisfied and (ii) the restrictions associated with the non-compete do not exceed 12 months.
- “Procedural due process” refers to the notice required to be given pre-employment and post-employment.
- “Substantive due process” speaks to types of restrictions being placed on the employee, which include the type of job held, total compensation earned per year and whether employee has access to trade secrets or competitively sensitive information.
There is an exception to this statute. Employers can buy their way out of coverage if the employer agrees to pay the greater of (i) 50% of the employee’s annual base salary, plus commissions and (ii) 50% of $100,533, which is to be adjusted annually for inflation.
It is also important to note, the statute does have two exceptions relating to bonus payout for violating valid non-compete and breach of non-solicitation agreements.
And finally we will look at the new law scheduled to go into effect in Washington, D.C. on April 1, 2022. It basically outlaws non-compete agreements on and after April 1, 2022. The new statute prohibits employers from requiring an employee who performs work in D.C. to sign a non-compete agreement. There is a carve out relating to the sale of a business, but the rest of the statute is as stringent or more than California law, which is currently regarded as the most pro-employee in this regard.
The D.C. law is so strict that it even prohibits exclusivity provisions in an agreement during employment. It is not clear how a duty of loyalty to one’s current employer will survive this clause. And, if an employer retaliates against an employee for providing competitive services, the employer would be subject to fines. Stay tuned as we begin to see how this restriction is, or is not, enforced!
What Employers Can Expect
Employers take heed. The trends seen here are quickly taking hold across the country and could be coming to your state in the near future. When that happens, we urge you to work closely with counsel to develop new covenants which conform to your new state laws in order to avoid any legal peril.
Brody and Associates regularly advises management on complying with the latest state and federal employment laws. If we can be of assistance in this area, please contact us at firstname.lastname@example.org or 203.454.0560.