Restrictive covenants evolve from common law to statutory regulation: the 2022 turning point

February 17, 2022 – Restrictive covenants were once the exclusive jurisdiction of the common law in every state. This is no longer the case. So far, governing law remains state law (although there are pending proposals in Congress and the Federal Trade Commission that hint at regulation there). But, states are now supplementing or modifying their customary law with statutes.

Today, 30 states (including Washington, DC) have laws affecting covenants. Unlike state laws governing trade secrets (which largely follow the Uniform Trade Secrets Act), state laws governing covenants cover a wide range. A quick look at those that came into effect at the end of 2021 or come into force in 2022 will illustrate the trends in this regulation.

These changes reflect a growing hostility to covenants. As a result, 2022 is quite different from 2002 or even 2012.

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Employers need to reassess their restrictive agreements in light of these changes and understand that a “one size fits all” approach is not viable. Today, knowing the common law is far too little.

Colorado’s new law breaks new ground by imposing criminal penalties (120 days in jail, a fine of up to $750, or both) on employers who violate its restrictive covenants law.

At first glance, compliance seems easy since there are four distinct exceptions:

•Any contract for the purchase and sale of a business or the assets of a business;

•Any trade secret protection contract;

• Any contract providing for the recovery of the education and training costs of an employee who has been employed by the employer for less than two years; Where

• Any contracts for executives, management personnel and employees who constitute the professional staff of such personnel.

But, easy is often an illusion.

It is difficult to predict how vigorously this law will be enforced by state and local prosecutors. For example, will lawsuits to enforce restrictive covenants be systematically met by parallel criminal lawsuits at the request of the defendant employee?

The risk of criminal penalties is daunting for all businesses. Colorado’s new law calls on employers to minimize this risk by reducing their use of restrictive covenants: that is, to be afraid of the potential risk of criminal penalties for continuing to use restrictive covenants in a promiscuous manner. Now, restrictive covenants pose a downside risk to Colorado employers.

The Illinois Freedom to Work Act (“IFWA”) imposes limits on non-competition and non-solicitation agreements for employees (but excludes confidentiality agreements and agreements related to the sale of a company). Its recent amendments effective for 2022 expand its comprehensive approach to restrictive covenant regulation for Illinois employees.

Employers are prohibited from entering into non-competition agreements with employees unless the employee’s actual or expected annualized rate of pay exceeds $75,000 per year. This benchmark minimum will increase by $5,000 every five years until this minimum reaches $90,000 in 2037.

There is also a separate minimum for non-solicitation agreements. Employers are prohibited from entering into these types of agreements with employees unless the employee’s actual or expected annualized rate of pay exceeds $45,000 per year. This benchmark minimum will increase by $2,500 every five years until this rate reaches $52,500 in 2037.

Separately and in addition to these minimum compensation levels, there is also an independent “adequate consideration” requirement for non-competition and non-solicitation agreements.

This is defined in the IFWA as either/or:

• at least two years of work with the employer after signing a non-competition agreement or an agreement not to solicit; Where

•any other consideration adequate to support such an agreement, which could consist of a period of employment plus additional benefits or simply financial benefits on their own, such as a signing bonus or capital allocation.

Non-competition or non-solicitation agreements should provide compensation for situations where the employee loses their job due to business circumstances or government orders related to the COVID-19 pandemic. No paid garden leave is required for voluntary departures.

For involuntary departures related to the pandemic, this paid gardening leave must include compensation equivalent to the employee’s base salary at the time employment was terminated and current for the duration of the non-competition period, subtracting any compensation earned in subsequent employment during this period.

Non-competition and non-solicitation agreements are void unless:

• the employer advises the employee in writing to consult a lawyer before entering into the agreement; and

•the employer provides the employee with a copy of the agreement at least 14 calendar days before the start of employment or the employer allows the employee at least 14 calendar days to review the agreement.

These amendments to the IFWA allow the courts, at their discretion, to reform or delete provisions rather than denying application of the entire convention. In short, Illinois courts have the statutory discretion to “blue-pencil” overbroad restrictions when the court thinks it is fair, just, and just.

The IFWA also imposes a downside risk on employers: legal attorneys’ fees for an incumbent employee. Where an employee defeats an employer’s efforts to enforce a covenant in court or arbitration, the employee will be able to recover from the employer all reasonable costs and attorneys’ fees.

Nevada also changed its law governing non-competition agreements. Compared to other states’ laws, his approach seems more modest, but outlaws two of the most common excesses that occur in employment and non-competition enforcement.

In employing non-competitions, there is always the question of whether the employer has an interest to protect. Nevada has now imposed a baseline: if employees are paid by the hour, those employees do not have the status to create a protectable interest. Thus, non-competitions for hourly employees are no longer allowed in Nevada.

By enforcing non-competition, the amended law establishes a safe harbor where a former employee is prohibited from working for a previous client. This safe harbor for the departing employee is triggered when the customer voluntarily and unsolicited follows the employee and the employee otherwise honors their non-competition.

Oregon enacted amendments to its non-competition law effective January 1, 2022. These amendments provide that non-competition agreements are void unless statutory mandates for procedural and substantive due process have been respected and limit these non-competition to a maximum of 12 months.

Procedural regularity is notification. There is a notice. Employers must inform potential employees in a written job offer at least two weeks before the employee begins work that non-competition is a condition of employment. There is also a post-employment notice. Employers must send the employee a reminder copy within 30 days of termination.

The substantive due process lies in the conditions limiting the employees who can be restricted:

•Only employees engaged in administrative, executive or professional work who perform primarily intellectual, managerial or creative duties and exercise discretion and independent judgment while being compensated on a salary basis;

•Only employees whose total gross salary and commissions at the time of termination exceeds $100,533 (which will be adjusted annually for inflation); and

• Only employees for whom the employer has an interest to protect (for example, the employee has access to trade secrets or competitively sensitive confidential business or professional information).

There is, however, a backdoor pass that employers can purchase. For employees who do not meet these requirements, a non-competition agreement may still be enforceable if the employer agrees in writing to pay the greater of (i) 50% of the company’s annual base salary and commissions employee or (ii) 50% of $100,533, adjusted annually for inflation.

There are also potentially important exceptions that could provide workarounds for some employers. This Oregon law does not apply to bonus restriction agreements (i.e. reasonable non-competition agreements which, if violated, result in the loss of profit sharing or other bonuses) or non-solicitation agreements.

Washington, DC’s legislative ban on non-competition agreements goes into effect April 1, 2022, but only covers agreements signed after that time. This DC law prohibits employers from requiring or requiring an employee who performs work in DC to sign a non-compete agreement.

Historically, employers have viewed California as the toughest jurisdiction to place limits on employee mobility. Move over, California. While there is an exception for restrictions in the context of the sale of a business in DC law, everything else under that DC law is worse for employers than California.

For example, this law prohibits exclusivity agreements during employment, and retaliatory behavior by an employer against an employee for providing services to another would expose the employer to fines. In addition, employers are required to provide their current staff with written notice of this law and provide such notice to new employees within 7 calendar days of hire.

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