US State interpretation and guidance on the enforceability of non-compete agreements

21 Sep 2022 , 8:32pm

Barnes & Thornburg lawyers Terri Connolly and Christopher Rubey examine the factors that make non-compete agreements enforceable for luxury brand employers

Non-compete agreements are commonly used by employers worldwide and especially by luxury brands. They can be used to protect employers that spend the time and resources to train employees, share their unique business insights with them, or introduce them to their customers/suppliers. But many times employers have exploited restrictive covenants in seeking to restrain trade of employees without legitimate business interests – i.e. a sandwich shop attempting to prevent minimum wage employees from working at other sandwich shops.

In the United States, non-competes have increasingly been the subject of legislation and litigation focused on the minimum required criteria to find a non-compete agreement enforceable. States have taken measures to help courts determine the minimum criteria by drafting legislation that addresses:

  1. the minimum required consideration;
  2. how to handle overbroad non-competes; and
  3. other qualifications agreements need to be enforceable.

Below, we address the broad concepts of each.

What must we give our employees as consideration to ensure enforceability of a non-compete?

Typically, most states recognize new employment as sufficient consideration as long as the non-compete is issued prior to employment commencing. However, there are exceptions. Illinois’ law that went into effect in January of this year, codifies a rule that unless an employee receives some professional or financial benefit in exchange for signing an agreement (e.g., a cash payment or additional vacation time), the employee must work for the employer for at least two years after signing an agreement for it to be enforceable.

And, what about existing employees, is continued employment enough consideration for the non-compete? Some states find continued employment to be sufficient consideration to support a non-compete, for example Indiana and Ohio. In these states, employers can tell an employee to sign the agreement or be terminated.

In other states, though, there must be some consideration in addition to continued employment, such as a bonus or access to confidential information. Minnesota and Pennsylvania are examples of states where additional consideration is required.

What happens if the court determines our non-compete agreement is overbroad?

Non-compete agreements can be considered overbroad in several respects: in the geographic area prohibited, in the types of employment prohibited, and in the length. If you, like many other employers, discover your non-compete is overbroad, the first question is whether your state is a reformation state, blue pencil state, or red pencil state. Each state generally finds itself as a version of one of these three approaches. But make sure to review your specific state’s rules, as these are just the general tenets of each approach.

  • Reformation states

Reformation states are the most forgiving. Courts in these states ask: ‘Can I rewrite the non-compete language to make it reasonable?’ Essentially, a judge can cross out any language that it considers overbroad, determine the breadth of protection necessary, and rewrite the non-compete. While an employer will not have control over the scope of the non-compete that the court ultimately determines, the employer will at least have an enforceable agreement. Some reformation states are Alabama, Florida, Illinois, New York, and Texas.

As an example, Employer A in Florida seeks to enforce a non-compete of five years. Judge A finds this unreasonable, but believes two years would be appropriate. Judge A can rewrite the agreement for two years and allow Employer A to enforce the agreement.

  • Blue pencil states

Blue Pencil states, in contrast, only remove overbroad language – they do not rewrite or add any language. Courts in these states ask: ‘Is there a valid, enforceable non-compete after I remove the overbroad language?’ Some blue pencil states are Arizona, Connecticut, Indiana, and North Carolina.

As an example, Employer B in Indiana seeks to enforce a non-compete of five years. Judge B finds this unreasonable, so he removes this language. Now, the non-compete has no timeframe and Employer B is unable to enforce the agreement. 

While this is certainly harsher than reformation states, there are methods to prepare for blue pencil judicial scrutiny. Employer B could draft the non-compete to state that it is enforceable for the “greatest length the court finds enforceable: 1) five years; 2) three years; 3) one year.” Judge B, similar to Judge A, believes that two years would be appropriate. He can remove the overbroad duration of five years and three years, looking like this “greatest length the court finds enforceable: 1) 5 years; 2) 3 years; 3) 1 year.” Thus, Employer B has an enforceable agreement for one year.

  • Red pencil states

The harshest of states are Red Pencil states. Here, any overbroad non-compete is immediately stricken and unenforceable. There is no judicial safety to rewrite or remove only overbroad language to salvage an overbroad non-compete. Examples are Nebraska, South Carolina, and Wisconsin (which was historically a red pencil state, but recent litigation suggests it may be softening).

Are there unique state requirements?

Yes, there are many unique state requirements.  The state laws are constantly changing and becoming more and more employee friendly. This is because many states have struggled with determining how a court analyzes whether a non-compete is necessary for a “legitimate” business interest. One judge may be more pro-employer than another judge. Or a judge may struggle with deciding whether a non-compete is appropriate for the employee’s position. As a result, states have created some laws to determine the floor/minimum requirements for an enforceable non-compete.

  •  Full or partial bans on non-competes

Some states/cities have found non-compete agreements void as a matter of public policy. For example, California and North Dakota have almost complete bans on non-compete agreements.

Another method is to ban non-compete agreements for certain industries. For example, in Illinois, non-compete agreements are unenforceable against public sector union employees and individuals in the construction business. And in Connecticut, employers cannot enforce non-compete agreements against broadcast employees or security guards.  

  • Salary threshold

Meanwhile some states have determined a minimum wage an employee must receive before a non-compete is enforceable. Essentially, they have determined that there is no legitimate business interest presented by anyone who earns less than this wage. Each state determines this wage differently and there is a wide discrepancy in the minimum required wage.

For example, states can focus on the hourly rate, from as little as $15 an hour required in Maryland, or a yearly salary, such as over $100,000 a year in Oregon and Washington. Others, like Nevada and Massachusetts, prohibit non-competes if the employee is paid hourly. Still others require employees to receive a salary of a certain percentage over the federal poverty level, such as Rhode Island (250%) and Maine (400%).

And, more recently, Washington D.C. joined these states by amending its proposed full ban on non-competes. Under the new law, non-compete agreements entered into after October 1, 2022 will only be enforceable against employees earning a total compensation that is or is reasonably expected to be more than $150,000 per year.

Employers would be wise to make sure their policies comply with these requirements, as some states have built-in increases for the minimum wage, such as Illinois. They should also be wary as some states have steep repercussions for violating these provisions, such as Maine, which imposes a penalty of at least $5,000.

  • Communications requirements

Some states focus on providing the employee with notice of the non-compete, so that the employee can truly consider the consequences of the agreement. For example, Illinois requires employers to provide prospective employees with the non-compete at least 14 days before their start date and advise the employee to consult a lawyer. And in Oregon, employers must provide the agreement at least 14 before the employee’s start date and a notice of the requirements after the employee’s employment ends.

  • Garden Leave Clauses

Garden leave clauses are starting to gain more usage in the United States. Garden Leave is used more commonly in the U.K. It requires an employer to continue paying an employee’s salary and other benefits during the period of time when an employee generally does not work (or performs only limited duties) but remains employed.

In the U.S., though, states have required these types of clauses to provide pay after an employee is terminated. For example, Washington requires a garden leave clause to enforce a non-compete against an employee that was part of a lay off. Or Oregon, which will enforce non-competes against normally protected employees if, for the duration of the restriction, the employer pays the employee the greater of either:

  • At least 50% of employee's annual gross salary base and commissions at termination; OR
  • 50% of $100,533 (adjusted annually for inflation).

While not required in many states, garden leave can be seen as less draconian, less punitive, and an effective argument to respond to a plaintiff’s need to earn a living. As a result, courts are more likely to enforce a non-compete with a garden leave clause.

  • Limitations on restrictions

States have also put other limits on the scope of non-competes. For example, some states have determined a maximum timeframe – such as Oregon (generally twelve-month maximum) and Washington (generally eighteen-month maximum).

  • Criminal penalties

Finally, Colorado established a criminal penalty for overbroad non-compete agreements. The statute requires the non-compete to be reasonable and for one of the specified reasons. For agreements before August 10, 2022, Colorado’s specified reasons included protecting trade secrets and the employee being either an executive or management personnel (or their professional staff).

For agreements after August 10, Colorado limited the specified reasons to protecting trade secret disclosure by “highly compensated employees” (HCE) (currently, those earning at least $101,250) and non-solicitation of customers for employees earning over 60% of the HCE salary threshold. The HCE must be met when the agreement is signed and enforced.

Under Colorado law, an employer who knowingly uses an unenforceable, overbroad non-compete agreement as a means of intimidation, forcing the employee to refrain from earning a living can be liable for 120 days in jail and/or a fine of up to $750.

Conclusion

So, how do employers avoid having courts determine that your non-compete agreements are unenforceable? Well the first step is easy, do not draft overbroad non-compete agreements.

But, as seen from the broad state interpretations, it can be hard to determine what is overboard. Thus, employers should make sure to check state/local non-compete regulations. Each state is taking a unique approach towards assessing and enforcing non-compete agreements. Even if there is a legitimate business expectation, a non-compete may be unenforceable because of the employee’s industry or wages. Employers would be wise to continuously review the non-compete laws of any state where an employee resides. These laws continue to develop and, as necessary, employers may need to revise and update their agreements to stay enforceable.

Barnes & Thornburg partner Terese “Terri” Connolly is a trusted adviser with nearly two decades of experience. She counsels and represents multinational corporations in navigating the wide range of domestic and international labor and employment related issues that arise when managing a global workforce. Terri can be reached at TConnolly@btlaw.com

Barnes & Thornburg Of Counsel Christopher Rubey prides himself on finding innovative answers to his clients’ employment concerns. He focuses his practice on counseling clients through a variety of business, commercial and employment litigation matters including restrictive covenants, defamation, discrimination, sexual harassment, wrongful termination, and shareholder disputes. Christopher can be reached at CRubey@btlaw.com.

This article was first published as a Barnes & Thornburg client alert here.