Post-employment restrictive covenants have been under unprecedented attack, legislatively and in litigation, in recent years. These restrictions include non-compete, non-solicitation, and other confidentiality/trade secret obligations. Courts have always considered these restrictive covenants to be “disfavored” under the law as an attempt to restrain trade, free employment mobility and competition, and therefore scrutinize these obligations narrowly to ensure that only legitimate business interests are being protected in the least intrusive manner possible. Recently, however, some states have banned enforcement of these restrictive covenants entirely, and others have restricted them to apply solely to “high earning” employees. There is currently pending federal and Minnesota state legislation which, if enacted, would that place similar limits on enforcement. Even in the absence of this legislation Minnesota courts have generally applied even more strict scrutiny when asked to enforce these obligations, resulting in numerous recent published decisions rejecting attempts to enforce these obligations. Finally, the impact of the COVID19 pandemic has undoubtedly affected the analysis applied in evaluating these restrictive covenants, where courts throughout the country are more reluctant to find “irreparable” harm and deny a departing employee a new employment opportunity potentially in conflict with a non-compete obligation. This blog summarizes these developments.
Legislation and Executive/Agency Actions
Three states (California, North Dakota, and Oklahoma) and the District of Columbia (recently passed laws effective April 1, 2022) largely ban non-compete agreements, while almost a dozen other states prohibit or significantly limit the use of these restrictive covenants to “high earning” employees. In 2021, Illinois, Oregon, Nevada, and Virginia joined this group of states in significantly restricting the category of employees against whom these agreements can be enforced, generally requiring that the affected employee either pass an income threshold or be considered “exempt” from FLSA overtime requirements.
There is a proposed bill in Minnesota which would restrict, but not prohibit, non-compete agreements. This bill (HR 999) was approved by a bipartisan House Panel on February 22, 2022 but has yet to become law. This Bill would:
(1) limit non-competes to employees with an annual salary from the employer at least equal to the median family income for a four-person family in Minnesota, and,
(2) require employer agreement to pay the employee on a pro rata basis during the entirety of the restricted period of the covenant not to compete at least 50 percent of the employee’s highest annualized base salary paid by the employer within the two years preceding the employee’s separation from employment.
While this legislation has yet to pass, the content reflects the concerns which courts have frequently expressed when limiting enforcement of these agreements.
In July 2021, President Biden issued an Executive Order entitled “Promotion of Competition in the American Economy,” which addressed and criticized non-compete clauses “that may unfairly limit worker mobility.” Section 5(g). The Order encourages the Federal Trade Commission (FTC) to consider issuing federal regulations limiting the use of non-compete agreements to high-earning employees, require notice to prospective employees when such agreements will be a requirement of the job, and require that any such agreements be limited temporally (by geography and duration). This potential FTC action has sparked significant debate in the legal and business communities, as sweeping federal action regulating non-compete agreements would be unprecedented, as this area has traditionally been left to states to regulate and there may be significant legal challenges to sweeping federal action.
The “Freedom to Compete Act” (S.2375) was re-introduced in Congress on July 15, 2021 (after first being introduced in July 2019) on a bi-partisan basis but is currently stalled in Committee and faces an uncertain future. This Act proposes banning non-compete agreements for non-exempt workers under the FLSA and imposes other notice and temporal limitations on the use of non-compete agreements. Similar legislation entitled The Workforce Mobility Act (HR 1367) was introduced on February 25, 2021, and would, among other things, limit the use of non-compete agreements in the sale of a business or dissolution of a partnership, and create a private right of action for aggrieved employees.
The Freedom to Compete Act would amend the FLSA to prohibit employers from enforcing, or threatening to enforce, non-compete contracts for entry level and lower wage workers (tracking the FLSA minimum wage and non-exempt standards) and would be enforced by the Department of Labor under the existing FLSA framework for minimum wage and overtime violations.
Recent Court Decisions
Despite these state and federal legislative developments, post-employment restrictive covenants remain enforceable in most states, albeit under a “disfavored” standard. Non-compete agreements will thus generally be enforceable if there is consideration for the agreement, there is a legitimate business interest being narrowly enforced, the agreements terms are reasonable temporally (i.e., geographically and in duration), and irreparable harm can be demonstrated by the threatened breach. Recent published decisions in Minnesota and elsewhere reflect, however, the growing reluctance to enforce these agreements.
In summary, these decisions require the scope of the non-compete to be very narrow and apply only to specifically defined competitors. The departing employee generally has to have actually been exposed to sensitive, protected confidential information that was treated in that fashion by the employer. If there is any ambiguity in the language, it will be construed strictly against the employer and not be enforceable, and injunctions are extremely hard to secure unless there is a compelling showing of irreparable harm – not simply conclusory allegations of the threat of this harm.
We are at an inflection point in terms of the enforceability of non-compete agreements. While these agreements are still considered enforceable in the majority of jurisdictions, courts’ reluctance to find irreparable harm, and construe any and all ambiguities against the employer, suggests an ever stricter enforceability standard is developing. When this is combined with the significant state and federal legislative developments described above, it appears that the future of broad non-compete agreements is bleak. There is a growing consensus that these agreements should only apply to “high earning” employees, that they need to be very narrowly drafted, supported by adequate consideration at formation and during the non-compete period, and that notice of this obligation should be transparent in any recruitment or employment screening process. All developments suggest strongly that these kinds of standards will either soon be imposed by legislation or adopted by courts as litigation over the agreements unfold.
If you are concerned about a non-compete obligation, the attorneys at Schaefer Halleen are experienced in this field and understand how all these developments can be used to defend against any threatened enforcement.