Practical Considerations When Including Restrictive Covenants in Employment Contracts
While still enforceable in a vast majority of states, restrictive covenants in employment contracts have recently been the subject of state and federal regulation limiting their scope, while new laws restricting their enforceability continue to be proposed and make their way through legislatures and administrative agencies. These new laws not only place various limits on restrictive covenants, but in some cases, impose penalties on employers for violations of the law. Employers should be mindful of this evolving landscape when including restrictive covenants in employment contracts, both to ensure that the agreements’ terms are enforceable under the law, and to avoid potential civil penalties and damages.
Types of Restrictive Covenants
Restrictive covenants in the labor and employment context are agreements between an employer and employee that restrict the activities of an employee following a separation of employment. Their purpose is to protect an employer’s intellectual property, goodwill, relationships, confidential and proprietary information, and trade secrets from falling into the hands of competitors. These covenants typically take the following forms, either as provisions to an employment or separation agreement, or as separate standalone contracts:
- Noncompete. A noncompete is an agreement or contractual provision between an employer and employee that prohibits the departing employee from engaging in, or performing services for, a competing business for a period of time following their separation of employment.
- Nonsolicitation. A nonsolicitation clause prohibits a departing employee from soliciting the clients, customers or employees of their former employer for a specified period of time following their separation of employment.
- Nondisclosure. A nondisclosure agreement requires employees to keep confidential, and prohibits employees from disclosing, proprietary and confidential information and trade secrets that were disclosed to employees during their employment with the employer.
Enforceability of Restrictive Covenants
Restrictive covenants are primarily governed by state law, and their enforceability can vary significantly from state to state. In a majority of states, restrictive covenants will be enforced, provided they are reasonable in duration and geographic scope. What constitutes a reasonable duration for a restrictive covenant varies by jurisdiction but typically will range from six months to two years, though in some cases longer durations have been held reasonable under the circumstances. Likewise, the geographical scope of a restrictive covenant generally must be limited to where the employee provided services and where the employer does business. A majority of jurisdictions will also weigh whether the restrictive covenant is necessary to protect the employer’s legitimate business interest, whether it imposes an undue hardship on the employee, and whether it is injurious to the public. Because noncompetition clauses, in particular, limit a former employee’s ability to make a living, they are often subject to more judicial scrutiny and treated less favorably than the other restrictive covenants, such as confidentiality agreements and nonsolicitation clauses. Moreover, as described below, noncompete agreements have recently been subject to state and federal legislation limiting their reach.
State Regulation of Noncompetition Agreements
A number of states have recently enacted statutes providing that noncompete agreements in the employment context are unenforceable, or nearly so. In California, Colorado, North Dakota and Oklahoma, noncompete agreements restricting post-employment conduct are either per se unenforceable subject to narrow exceptions, or subject to significant limitations. In January 2021, the District of Columbia passed one of the broadest prohibitions in the country on the use of noncompete agreements. The Ban on Non-Compete Agreements Amendment Act of 2020 prohibits employers in Washington, D.C. from requiring an employee to sign a noncompetition clause.
Other states have enacted statutes that, while still allowing for noncompetition clauses, limit their enforceability against lower-wage workers. Illinois, Maine, Maryland, Massachusetts, Nevada, New Hampshire, Oregon, Rhode Island, Virginia and Washington have all passed laws prohibiting employers from entering into noncompete agreements with workers who earn below a certain wage threshold. Almost all of these laws were passed, or amended to increase their scope, within the last three years.
Some states (Florida, Massachusetts, Louisiana, Oregon, Utah and Washington) have also recently enacted statutes limiting the acceptable time period of a noncompete, ranging from one to two years. Further, many states bar the use of noncompetes with respect to certain industries, professions and types of workers.
One of the recent trends in this area is requiring noncompete provisions to be supported by additional independent consideration. Under the common law of most states, an offer of at-will employment constitutes adequate consideration. However, some states now require more. In Massachusetts, noncompete agreements must be supported by a “garden leave” clause that requires the employer to compensate the employee during the noncompete period or provide other mutually agreed consideration.
In Illinois, sufficient consideration must consist of at least two years of continued employment or other independent consideration. Other states, by statute and common law, require consideration in addition to continued employment to enforce noncompetes entered into after the commencement of employment. What constitutes sufficient consideration for a noncompete varies on a state-by-state basis.
Federal Regulation of Noncompetition Agreements
At the federal level, on July 9, 2021, President Biden signed an Executive Order on Promoting Competition in the American Economy. The order, among other things, encourages the Federal Trade Commission (FTC) to exercise its statutory rulemaking authority under the Federal Trade Commission Act to curtail the use of noncompete clauses and other clauses or agreements that may limit worker mobility.
In February 2021, a bipartisan group of legislators introduced the Workforce Mobility Act in the House and the Senate. The Workforce Mobility Act would prohibit the use of noncompete agreements except in the context of the sale of a business or the dissolution of a partnership, give the FTC and the Department of Labor enforcement authority, and create a private cause of action for violations of the statute, among other things. The Workforce Mobility Act is currently in committee review.
While the FTC has not yet promulgated any rules with respect to noncompetes and the Workforce Mobility Act has not been signed into law, these executive orders and proposed legislation demonstrate the federal government’s view of noncompetes, and its intention to limit their scope in the future.
“Blue Penciling” Overbroad Covenants
When a restrictive covenant is overbroad in duration or scope, many states permit their courts to “blue pencil” the offending provisions. “Blue penciling” is the term used when a court modifies an overbroad covenant to a level that is acceptable and enforces the modified version. There are notable variations among the states in the treatment of overbroad restrictive covenants and the availability of blue penciling.
In certain jurisdictions, including New York, courts will only allow blue penciling in the absence of overreaching in the first place, and where the employer had in good faith tried to reasonably protect a legitimate business interest. In other words, employers cannot simply draft knowingly overbroad and overreaching restrictive covenants with the expectation that the courts will modify it to an acceptable level.
Notably, for years Georgia had a strong public policy against restrictive covenants in employment agreements. Georgia courts disfavored blue penciling and would strike down restrictive covenants in their entirety if they were unreasonable in whole or part. With the passage of the Georgia Restrictive Covenants Act in 2011, the law allows Georgia courts to blue pencil overbroad restrictive covenants entered into after May 11, 2011. Recent cases in Georgia, however, have construed the Act quite narrowly, with courts declining to use their discretion to rewrite vague and overbroad restrictive covenants. To increase the likelihood of enforcement, employers in Georgia should take extra care to draft clear, narrowly tailored restrictive covenants.
Employers looking to protect their business interests, intellectual property, goodwill, confidential information and trade secrets from departing employees will need to do so within the changing landscape of state and federal laws. Employers should work closely with legal counsel to craft employment contracts and restrictive covenants that comply with the law when written, and that will be enforceable going forward.