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Differing State Laws on Restrictive Covenants

August 2017Articles The Corporate Counselor

One of the most controversial areas of employment law, the enforceability of restrictive covenants — which often take the form of noncompete agreements, non-solicitation clauses, or non-disclosure agreements — can be very difficult for employers to navigate. With the increasing mobility of the American workforce and the ease of access to sensitive information brought on by modern technology, drafting an effective and enforceable restrictive covenant is essential to protecting your interests as an employer as well as the interests of the company as a whole. According to recent research, as much as 18% of the American workforce has entered into some form of a restrictive covenant, most commonly in the form of a noncompete agreement. Because the laws vary widely from state to state, knowing the law of your jurisdiction is crucial in drafting an enforceable restrictive covenant that adequately protects your business interests.

Both the nature of the agreement and the context into which it is entered will affect the enforceability of the agreement. This ultimately turns on which state’s law applies –€” often depending on where the dispute is litigated. Although choice of law and venue provisions may ensure that the dispute is litigated in a favorable venue of your choice, some states, such as California, impose restrictions on these clauses as well. However, most states have adopted some version of the Second Restatement of the Conflict of Laws, which applies a “significant relationship” test for agreements without a choice of law provision.

In the States

The law on restrictive covenants varies significantly from state to state, and is governed by the common law, statutes, or a combination of both. For example, some states will examine the agreement under the common law governing contracts, generally upholding agreements that are “reasonable” under the circumstances. See, e.g., Mich. Comp. Laws § 445.774a(l) (restrictive covenant is enforceable to the extent it’s reasonable); Tex. Bus. & Com. Code Ann. § 15.50(a) (noncompete allowed if “time, geographical area, and scope of activity to be restrained … are reasonable and do not impose a greater restraint than necessary”); Marsh United States, Inc. v. Cook, 354 S.W.3d 764, 768-69 (Tex. 2011) (although freedom to contract protected by Texas Constitution and entering a noncompete is a voluntary act of consent for both parties, the legislature may impose reasonable restrictions in line with public policy) (discussing the Covenants Not to Compete Act); Boulanger v. Dunkin’ Donuts, 815 N.E.2d 572, 577 (Mass. 2004) (determining reasonableness of noncompetes on a fact-specific, case-by-case basis).

Other states have enacted statutes specifically governing restrictive covenants, which tend to be more hostile toward the agreements. Florida, for example, has an entire statutory scheme with express limitations on the duration or geographical scope of agreements that are considered presumptively reasonable or unreasonable. See Fla. Stat. § 542.335(1)(d) - (e) (detailing the duration and scope of restrictive covenants that are per se reasonable or unreasonable). Additionally, noncompetes are being used less frequently in employment agreements with executives and senior managers because, unlike in the past, advances in technology have reduced the shelf-life of sensitive information.

Using Fox Rothschild’s 50-State Survey on Restrictive Covenants, traversing the law in every jurisdiction across the United States becomes simpler. For example, some states, such as California, are seen as “employee-friendly,” imposing strict requirements that rarely uphold noncompete agreements. See, e.g., Cal. Bus. & Prof. Code §§ 16600 (general prohibition on noncompetes); Nev. Rev. Stat. § 613.200(1) (willful conduct by an in-state entity, officer, or agent intended to impede any person who for any cause left or was discharged from employment from obtaining employment elsewhere in the state, is a gross misdemeanor, punishable by up to $5,000).

Conversely, “employer-friendly” states, like Michigan, provide more leeway for employers wishing to limit a former employee’s conduct in the workforce. See Mich. Comp. Laws § 445.774(l) (allowing restrictive covenants to “prohibit[] an employee from engaging in employment or a line of business after termination of employment”). In an area of law that has traditionally remained static, with most changes coming from the courts on a case-by-case basis, state legislatures have recently stepped in to make procedural and substantive changes to the enforcement of restrictive covenants. This article highlights some of the major changes and differences between the states. For more information or for a summary of the law in your jurisdiction, see Fox Rothschild’s 50-State Survey on Restrictive Covenants. Joshua Horn, Earnest Badway, Ian Meklinsky, Jeff Polsky, National Survey on Restrictive Covenants in Employment, Fox Rothschild LLP (2016), available at http://bit.ly/2rRaYdd.

Complete Prohibition on the Enforcement of Noncompete Agreements

While states such as California, Oklahoma, Rhode Island and North Dakota have historically taken a hostile approach toward noncompete agreements, Massachusetts, Missouri and Oregon have recently proposed similarly restrictive legislation. See, e.g.Id.; 15 Okl. St. § 217; Cranston Print v. Pothier, 848 A.2d 213, 219 (R.I. 2004) (noncompetes are “disfavored and subject to strict judicial scrutiny” in Rhode Island); Earthworks v. Sehn, 553 N.W.2d 490, 493 (N.D. 1996) (North Dakota statutory law “invalidates provisions in employment contracts prohibiting an employee from working for a competitor after completion of his employment”).

These states view noncompete agreements as anti-competitive because they limit employees’ ability to advance their career in their field of choice, and prevent them from earning a living. Although generally prohibited by a handful of states, some states such as California and North Dakota recognize limited exceptions whereby a noncompete may be enforceable, for example, in the sale of a business. See Cal. Bus. & Prof. Code §§ 16600 (general prohibition), 16601, 16602.5 (listing exceptions).

Although California — largely considered the most hostile toward restrictive covenants — prohibits noncompete agreements almost across the board, it does recognize some forms of nondisclosure and non-solicitation of employee (anti-raiding) agreements if the information the employer seeks to protect rises to the level of a trade secret. However, non-solicitation of customer agreements may not receive the same favorable treatment: The Supreme Court of California has held that non-solicitation agreements of customers are unenforceable because they restrain employees from engaging in their chosen profession or trade. See Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 946 (2008). Note, however, that even if a nondisclosure or nonsolicitation agreement is upheld as valid, it is often the most difficult to police because of the difficulty in monitoring the communications and conduct of a former employee when they are permitted to work for a competitor. By the time employers find out about a breach, the damage may have already been done.

Previously, savvy employers were able to rely on choice of law or forum selection provisions to avoid litigating the dispute in California altogether. Even where an employee lives and works in one jurisdiction, many states will recognize a choice of law or forum selection provision for a different jurisdiction if the employer and employee had a meaningful connection to that jurisdiction. Employers often demonstrate this by shifting the focus of the inquiry –€” instead of focusing on where the employee was working, the employer frames the issue as involving one of its protectable interests in another state.

The California legislature recently closed this loophole by enacting California Labor Code § 925, effective Jan. 1, 2017, which applies to all employees who “primarily reside and work in California,” and restricts choice of law and venue clauses in disputes arising in California.

Colorado, although not as strict as California, also prohibits noncompete agreements unless they are related to the purchase or sale of a business, the protection of trade secrets, the recovery of training expenses for individuals employed for less than two years, or executive employees or their professional staff. See Colo. Rev. Stat. §§ 8-2-113(2) (restrictive covenants are facially void in CO), 8-2-113(a)-(d) (listing exceptions).

Although Georgia has historically disfavored noncompete agreements, the Georgia Restrictive Covenants Act, passed in May 2011, represents a shift toward a more employer-friendly policy. Specifically, this statute now allows for judicial modification of an overly broad covenant and permits courts to consider non-solicitation agreements and noncompete agreements separately, with the ability to enforce one regardless of the enforceability of the other.

Industry-Specific Prohibitions on Noncompete Agreements

Although permitting noncompete agreements generally, some states have passed legislation that prohibits noncompetes in certain industries where free competition is deemed to be in the public interest. A common example is in the medical industry, where many states have limited the enforcement of restrictive covenants against physicians so that patients are free to seek their health care professional of choice. See Valley Med. Specialists v. Farber, 194 Ariz. 363 (1999) (indicating a strong disfavor of restrictive covenants against physicians).

Rhode Island, West Virginia and Connecticut have all enacted legislation targeting the enforcement of noncompete agreements for physicians, ranging from complete prohibition to less severe limitations. Legislation focused on noncompete agreements with regard to other healthcare professionals has been introduced in Pennsylvania, Minnesota, Oregon and New Mexico, proposing limitations on the enforcement of noncompete agreements for home care workers, certified nurse practitioners, and other home health aides. Connecticut has also introduced legislation seeking to extend the limitations it already has in place on enforcement against physicians to other health care professionals as well.

However, industry-specific prohibitions on restrictive covenants are not limited to the healthcare industry. Other industry-specific prohibitions include: insurance agents (Minnesota), broadcasting (Ohio), and information technology (Hawaii).

Garden Leave Provisions

Imported from the UK and other European countries, garden leave provisions are becoming increasingly common in the United States, especially in the financial services industry. Garden leave provisions require a departing employee to provide early notice of resignation to his or her employer (usually between three and six months before departure) in exchange for full compensation and benefits during the notice period. Even though the departing employee remains employed by the company during the notice period, he or she is not required to perform any other services/work for the company. In exchange, they are not permitted to work for anyone else and are required to maintain a duty of loyalty to their employer during that time. Due to the novelty of garden leave provisions, there is little case law on their enforceability.

Non-Solicitation Agreements

Non-solicitation agreements are viewed as less restrictive than noncompetes or garden leave provisions because they merely limit the activities of a departing employee for a period of time, instead of impeding their future employment. However, some non-solicitation clauses seek not only to bar the employee from soliciting business from the employer’s clients, but also from accepting business for a period of time, regardless of whether the former employee actively solicited such business. Although courts in New York and Florida have enforced such restrictions, courts in South Carolina and Georgia regularly strike these provisions as overly broad and unenforceable, because they are viewed as harmful to the general public in limiting consumers from their choice of service providers or suppliers.

Although Oklahoma courts deem unenforceable noncompete agreements that prohibit an employee from engaging in the same or a similar business as the former employer, Oklahoma law also prohibits former employees from directly soliciting “the sale of goods or services … from the established customers of the former employer.” 15 Okl. St. § 217. Thus, even without a non-solicitation provision, the employer’s customer list is protected from the solicitation of former employees.

Even though commonly coupled with noncompete agreements as a less-restrictive alternative, it is important for the employer to include severability provisions so that, in the event one of the provisions is unenforceable, the court may uphold the remaining provisions.

Fox Rothschild’s 50-State Survey on Restrictive Covenants

These are just a few of the many areas in which state laws differ on restrictive covenants, showing the degree to which the choice of law and venue can dramatically impact enforceability. Employers with employees in multiple jurisdictions must know the law, because a covenant that is enforceable in one jurisdiction may be unenforceable in another. Fox Rothschild’s survey allows employers to stay on top of the various aspects in which state laws diverge on restrictive covenants, giving them the opportunity to ensure that their current employment contracts are up to speed with the laws of a particular state.

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