The Federal Trade Commission would like to preempt state law and make most noncompetes illegal as a matter of nationwide federal law. In January it began a rulemaking toward that end. See The FTC: Noncompete Agreements Must Go.
But that doesn’t mean you shouldn’t be looking over your shoulder now. The FTC may be coming for you, especially if you’re a large company that uses noncompetes abusively and without legal justification.
The reason for this is that, in addition to its rulemaking, the FTC has brought several cases charging companies for imposing abusive noncompetes on employees.
Shortly before it issued its notice of proposed rulemaking the FTC announced that it had taken legal action against several companies to stop them from enforcing noncompete restrictions. These cases are the first time that the FTC has filed suit to block noncompete agreements.
It’s no secret that some companies abuse noncompetes – they use them to control low-wage, unskilled employees, where there can be no legal justification for the use of noncompetes. This has caught the attention of the FTC, which contends that the use of noncompetes can violate Section 5 of the Federal Trade Commission Act, 15 U.S.C. § 45, which prohibits “unfair methods of competition.”
The FTC initiated two groups of cases.
FTC v. Prudential Security, Inc. (complaint). In this case Prudential, and a related company, required security guards to sign two-year noncompete agreements. The low-wage unskilled employees were subject to a $100,000 liquidated damages clause if they violated the noncompete.
This is the kind of noncompete that gives noncompete agreements a bad name. The security guards are unlikely to possess confidential information or have customer good will – the two justifications for noncompetes. The employees could not negotiate the agreements, and Prudential brought lawsuits to enforce them. It continued to require employees to sign them even after a court declared them unenforceable.
And, I’ve seen a lot of noncompetes, but I’ve never seen one that contains a liquidated damages clause, much less a $100,000 liquidated damages clause.
The FTC alleged that “Any possible legitimate objectives of [Prudential’s] conduct . . . could have been achieved through significantly less restrictive means, including, for example, by entering confidentiality agreements that prohibited disclosure of any confidential information.”
Ardagh Group and O-I Glass. (complaint). FTC complaints against Ardagh Group and O-I Glass – two large glass beverage container manufacturers – followed a similar pattern. Both companies required over 1,000 employees to enter into noncompetes. However, the focus in these cases was the use of noncompetes in concentrated industries, rather than using them against low-wage employees, as in the Prudential cases. In bringing these actions the FTC emphasized that the “glass food and beverage container industry in the United States is highly concentrated,” and “it is difficult for new competitors to enter the market in part because of the need to find and hire people who are skilled and experienced in glass container manufacturing.” (link)
All these companies quickly folded in the FTC actions, entering into Consent Decrees that voided their noncompetes and required them to inform all employees who had entered into noncompetes that they were no longer enforceable. In fact, the FTC announced the cases and the Consent Decrees at the same time.
And, there’s every reason to suspect that the FTC is not done – it’s likely that it is investigating other companies and considering more noncompete enforcement actions. Against this backdrop companies should assess their noncompete agreements and ensure that they are legally justified.
Coda: These cases, along with the noncompete rulemaking, have really shaken up things at the FTC. The Commission is composed of five Commissioners. One seat is vacant, and the remaining four seats are held by three Democrats and one Republican. The Democratic Chair is Lina Khan, the outspoken, controversial “hipster” antitrust advocate and author of the influential law review article, Amazon’s Antitrust Paradox. The only Republican Commissioner, Christine Wilson, has been an outspoken critic of the Commission’s actions in several enforcement areas, including noncompetes – to the extent that she has announced that she will soon resign from the FTC. Why I’m Resigning As An FTC Commissioner (“This proposed rule defies the Supreme Court’s decision in West Virginia v. EPA (2022), which held that an agency can’t claim ‘to discover in a long-extant statute an unheralded power representing a transformative expansion in its regulatory authority’”).
FTC Cracks Down on Companies That Impose Harmful Noncompete Restrictions on Thousands of Workers
There aren’t many issues in business law as divisive as non-compete agreements. Some people believe that non-competes are essential to protect trade secrets and confidential information. Critics argue that they suppress wages, reduce competition and keep innovative ideas from breaking into the market. In the eyes of many critics they are a contractual form of involuntary servitude. We’ve encountered many employees who were unaware that their employment agreements contained a non-compete clause until they tried to leave their job, or who were under the mistaken impression that noncompetes are legally unenforceable.
Despite this controversy, changes to noncompete law have been complicated by the fact that non-compete agreements are creatures of state law. Every state has its own body of non-compete law. Sometimes the law is based on statute, and sometimes it’s judge-made common law.
Among the states there is enormous variation. Some states, notably California, have laws that make non-competes unenforceable. In Massachusetts judges enforced non-competes under common law for decades until, in 2018, the state passed a law severely restricting them. In New York non-competes are enforceable, but there is no statute, just judge-made common law.
Non-compete agreements are so state specific that if a client asks us to advise on a non-compete subject to the laws of a state other than Massachusetts we have to consult a lawyer in that state who knows the intricacies of that state’s laws.
All of this may be about to change.
Federal Agency Proposals on Non-Compete Agreements
In 2016 the federal government entered the debate over non-compete agreements for the first time when the Obama administration issued reports critical of non-competes and suggesting policy changes. (2016 Treasury Report; 2016 White House Report).
This initiative was dormant during the four years of the Trump administration, but was revived in July 2021 when the Biden White House released an Executive Order on Promoting Competition in the American Economy “encouraging” the FTC to “exercise the FTC’s statutory rulemaking authority under the Federal Trade Commission Act to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”
The FTC’s Current Proposed Rule
The wheels of the law grind slowly but now – 18 months later – the FTC has proposed a rule that would ban all non-competes for both employees and independent contractors, as well as nondisclosure agreements that act as “de facto” non-competes. There are exceptions (most notably non-competes entered into as part of the sale of a business), but most non-compete agreements – including those currently in effect – would be prohibited.
The FTC’s “overview” of the proposed rule captures the “anti-non-compete” arguments:
About one in five American workers—approximately 30 million people—are bound by a non-compete clause and are thus restricted from pursuing better employment opportunities. A non-compete clause is a contractual term between an employer and a worker that blocks the worker from working for a competing employer, or starting a competing business, typically within a certain geographic area and period of time after the worker’s employment ends. Because non-compete clauses prevent workers from leaving jobs and decrease competition for workers, they lower wages for both workers who are subject to them as well as workers who are not. Non-compete clauses also prevent new businesses from forming, stifling entrepreneurship, and prevent novel innovation which would otherwise occur when workers are able to broadly share their ideas. The Federal Trade Commission proposes preventing employers from entering into non-compete clauses with workers and requiring employers to rescind existing non-compete clauses. The Commission estimates that the proposed rule would increase American workers’ earnings between $250 billion and $296 billion per year. The Commission is asking for the public’s opinion on its proposal to declare that non-compete clauses are an unfair method of competition, and on the possible alternatives to this rule that the Commission has proposed.
It’s not uncommon for federal law to preempt state law, and that would be the case under this rule – the rule would supersede any conflicting state law. In other words, the rule would render almost all state non-compete laws – statutory or judge-made – obsolete. Employers, regardless of size, would be required to notify employees that any existing noncompete clause has been rescinded.
If it became law this rule would be a sea change in noncompete law and, more broadly, employment law. Decades of established non-compete law would be wiped from the books.
The implications have many lawyers who work in the areas of non-compete agreements and employment law pinching themselves to make sure they’re not dreaming.
I’ll write in more detail about this proposed rule as the rulemaking process proceeds, but here are a few initial observations:
First, like many federal laws or agency rules the law is complex – it weighs in at over 1400 words. If it becomes effective its full implications will be understood through further explanation from the FTC and interpretation by the courts. The “de facto” provision alone – which would treat some nondisclosure agreements as non-competes – is ripe for litigation. In other words, there’s a lot to unpack here.
Second, should this rule become effective it can be challenged in court, and almost certainly will be. In fact, the sole Republican FTC Commissioner, Christine Wilson, has already issued a dissenting statement criticizing the proposed rule on substantive grounds and outlining the possible bases for challenging the FTC’s rulemaking authority for this proposed rule. The first of these is likely to be that the rule exceeds the FTC’s authority to regulate“unfair methods of competition.”
Third, federal agency rules are not statutes – they can be reversed by later rules, and in that respect they are somewhat impermanent. The implications of an “on-again/off-again” federal non-compete policy are harrowing to contemplate.
Fourth, what should you do while this rulemaking is pending? The answer is probably nothing – if you’re an employer that uses noncompetes it’s business as usual, along with “watchful waiting,” to borrow a medical term. Theres no reason to change your business practices until the proposed rule becomes effective. Worst case, any noncompetes you enter into during this period will be void. Of course you want to have a nondisclosure provision in your form of employment agreement, but you probably have that already, so it’s likely no change will be required.
If you’re a prospective employee and you’re evaluating a job offer that requires a noncompete, you should be on the defensive and negotiate terms. Again, this rule may never come to fruition, and your noncompete may be fully enforceable. Don’t assume that it won’t be.
Lastly, an essential element of rule-making is that the public gets to submit “comments” on the proposed rule, which – at least in theory – the FTC considers before finalizing the rule. However, in the world of federal agency rule-making, “comments” can include extensive legal and economic analyses and industry position papers. We can expect a flood of comments and a robust debate on this proposed rule, perhaps followed by public hearings. By the time the rule takes effect – if it ever does – it may be substantially different from what has been proposed.
When Massachusetts passed its complex and restrictive noncompete law in 2018 (the “Massachusetts Noncompete Act” or the “Act”) it was predictable that the use of noncompete agreements in the state would decline. See A New Era In Massachusetts Noncompete Law. And, in fact, until now there have been no reported cases that involve the Act. Anecdotally, with few exceptions employers have stopped asking employees to enter into noncompete agreements. It’s just too darn complicated.
As I summarized in my 2108 post, the Massachusetts Noncompete Act created eight requirements for a noncompetition agreement to be legally binding. Of these the most challenging (for employers and the lawyers who advise them) is the requirement that the agreement provide the employee with garden leave “or other mutually-agreed upon consideration . . . specified in the noncompetition agreement.”
“Garden leave” is a term used to describe when an employee leaving a job is required to stay away from work for a period of time while continuing to be paid. As I described in 2018 in describing the Massachusetts Noncompete Act, garden leave occurs when an employer is required “to continue paying the employee, during the restricted period on a pro rata basis, no less than 50% of the employee’s annualized base salary, thereby financially enabling the employee to putter around in her ‘garden’ during the restricted period.” In other words, a one year noncompete would require the employer to pay the employee 50% of her base salary during the year.
Garden leave can be expensive for employers. However, the law contains a loophole – it allows the employer and employee to avoid garden leave by agreeing on “other mutually-agreed upon consideration.”
What constitutes “other consideration”? Does it have to be reasonable? Could an employer buy its way out of garden leave if the employer and employee agreed that the consideration could be one dollar? Could they agree that the very job offer itself is the mutually-agreed upon consideration?
Now a decision by Judge Timothy Hillman in the Massachusetts federal district court is the first reported case to apply the Massachusetts Noncompete Law. Because it is the first case in three years, it has received a good deal of attention in the legal community – however, I see it as little more than a nothingburger, beyond being a warning to employers not to ignore the Act.
In the case – KPM Analytics Corp. v. Blue Sun Scientific, LLC – Philip Ossowski signed a noncompete with KPM in 2019, after the new law took effect. However, Ossowski’s agreement did not state that Ossowski had the right to consult with counsel prior to signing (one of the eight requirements). And, it did not contain a garden leave clause or an agreed-upon consideration that would have allowed the employer to avoid garden leave payments. Hence, the court concluded that the agreement was unenforceable by KPM.
What’s the takeaway from this case?
Well, for starters any other outcome would have been surprising. The noncompete agreement violated the “consult with counsel” requirement, and it made no mention of garden leave at all. Therefore it failed two of the eight requirements. It seems that some Massachusetts lawyers have read the decision as holding that employment alone may not provide consideration for garden leave, but to me that seems self-evident, since it would largely obliterate the garden leave requirement. In any event, Judge Hillman does not address this theory or discuss it in his opinion.
However, Massachusetts lawyers are starved for court guidance on this law – after all it’s been three years since the law took effect. The only other case to touch on garden leave in the last three years is Nuvasive, Inc. v. Day (D. Mass. May 29, 2019), which involved a noncompete that had been entered into before the effective date of the Act. The Act does not apply to noncompetes entered into prior to its enactment.
In Nuavsive Massachusetts federal district court Judge Caspar suggested that had the new law applied and garden leave required, “compensation … received from the Company (including for example monetary compensation, Company goodwill, confidential information, restricted stock units and/or specialized training)” might have satisfied the option for “other mutually-agreed upon consideration.” However, given that the law did not apply in that case this was little more than dicta. And, she provided no discussion or rationale for such a conclusion.
The bottom line is that after KPM Analytics and Nuvasive, and three years after the law took effect, we still have no guidance from the legislature or the state courts as to how an employer and employee can agree on consideration that will stand in lieu of garden leave, without the risk that the employee will argue that the consideration was inadequate and therefore the noncompete is unenforceable.
I ended my 2018 post with the comment that “lawyers will struggle to explain all of this to bewildered clients, both employers and employees, for years to come.” Three years later, nothing has changed.
The Massachusetts Legislature has attempted to pass legislation regulating noncompete agreements every year since 2009. This year, it finally succeeded. The new law, which Governor Baker signed on August 10, 2018 and which is effective October 1, 2018, makes important changes to the body of Massachusetts non-compete “common-law” that has evolved over decades in the courts.
Here are the highlights of the new law.
Not Retroactive. The law is not retroactive. Any noncompete entered into before October 1, 2018 (for convenience I refer to this as “2018”) is unaffected. This means that, as a practical matter, there will be two bodies of law: judges will apply the “old” court-made common law to pre-2018 agreements, and the new statute, along with the common law that is unaffected and therefore remains in place, to agreements entered into after 2018.
Formalities. For a non-compete to be enforceable the employer must follow certain procedural formalities. The most important of these is that a written noncompete agreement must be provided to the employee before a formal offer of employment is made, and at least 10 days before employment begins. This means that the new employee can’t be ambushed with a noncompete after accepting a new job. “Nice to meet you, can you start work tomorrow?” will become a thing of the past, at least where the employer wants a noncompete in place.
The law does not address how an employer/employee negotiation factors into this 10-day requirement – if an employer gives a prospective employee an agreement 10 days in advance of the start date but the agreement is negotiated and changed, must the start date be pushed back to accommodate the 10-day requirement? I would think not, since the purpose of the 10 day notice period is to give the employee time to consider the noncompete and not be ambushed at the last minute, but until a court rules on it, this is an open question.
Another formality is that the noncompete must be signed by both the employer and employee and state that the employee has the right to consult counsel prior to signing. This is not a big deal, since most employment and noncompete agreements already include “consult counsel” boilerplate and are commonly signed by both parties, as is true of every written contract.
The One Year Limitation. A noncompete agreement may not impose a “restricted period” (the law’s term for the post-employment period the noncompete is in effect) longer than one year. I don’t view this as a significant change since one year or less has become the de facto standard in Massachusetts in recent years.
However, there is an exception: the agreement may be as long as two years if the employee breaches a fiduciary duty to the employer or unlawfully takes physical or electronic property belonging to the employer. Since, as a practical matter, employers will only learn this after-the-fact (during or following employment), this means that agreements may include an “alternative” provision (what Boston attorney Russell Beck calls a “springing noncompete”) that will “spring” into effect only if an employee engages in one of these violations.
Employees Terminated Without Cause/Laid Off. A noncompete agreement may not be enforced against certain categories of employees. The most important group is employees terminated without cause or laid off. This means that noncompetes will only be enforceable against employees who voluntarily resign or who are terminated for “cause” – a term usually described in an employment agreement.
This is a significant change from the pre-2018 law. However, it comes with the risk that some employers may broaden the definition of “for cause” termination in employment agreements or unjustifiably terminate an employee for cause in order to make a noncompete enforceable. If this happens the burden will be on the employee to show that the for-cause termination was unjustified. Whether the courts will find some way to penalize an employer who makes a mistake on this issue or acts in bad faith remains to be seen.
Hourly Employees Exempt. The law does not permit enforcement of noncompete agreements against “non-exempt” employees (such as hourly employees eligible for overtime) and students.
Employers have been criticized for unfairly restricting the job opportunities of workers in these groups. However, despite the publicity around a few high-profile, patently unfair (and unenforeable) cases where college students and low-paid hourly workers were required to sign noncompetes, these situations have been rare.
Noncompetes and the Sale of a Business. Massachusetts common law has treated noncompete agreements tied to the sale of a business more liberally than employer/employee agreements. The new law does not change this – it does not regulate noncompetes entered into by business owners in connection with the sale of a business. Often, agreements in this category are quite lengthy – three to five years is not uncommon – and this will not change.
Non-Solicitation/No-Hire Agreements. The law does not affect agreements in which an employee agrees not to solicit or hire employees of the employer or not to solicit or transact business with customers of the employer (“non-solicitation”/“no-hire” agreements).
This is an important exception that employers will take advantage of – a prohibition on soliciting customers of the former employer can substitute for much of what a noncompete accomplished for the employer, particularly in the case of employees involved in sales. However, this is not a blank check to impose a lengthy non-solicitation restriction, since these agreements will still be subject to the reasonableness standard of Massachusetts common law. And, the law around what constitutes a “solicitation” is not entirely clear.
Garden Leave. The section of the law that has rightly received the most attention is the “garden leave” provision, which will be unique to Massachusetts. This requires the employer to continue paying the employee, during the restricted period on a pro rata basis, no less than 50% of the employee’s annualized base salary, thereby financially enabling the employee to putter around in her garden during the restricted period (we can thank the Brits for the expression “garden leave”). The provision providing for this payment must be included in the non-compete agreement.
However, the law contains what appears to be a major loophole: the employer and employee may agree on “other mutually-agreed upon consideration.” While the interpretation of this phrase is likely to be the subject of litigation, on its face there is nothing in the law requiring that the agreed upon consideration be “reasonable.” For example, in theory the parties may agree that the employee will receive garden leave payments in an amount significantly less than 50%. Or, the parties could agree that the employee will receive a small signing bonus in lieu of post-employment garden leave.
Whether there are any limits to how far below 50% of base salary an employer can go, or what other forms of alternative consideration will be acceptable, will have to be determined by the courts.
Noncompetes After the Employee Has Started Work. In cases where an employer fails to ask an employee to sign a noncompete when hired, employers sometimes will ask employees to enter into noncompetes after they have started working, sometimes months or even years later. Whether the employee’s continued employment is adequate consideration to the employee for such an agreement has been the subject of legal controversy: most cases, but not all, have held that continued employment is sufficient consideration for a noncompete.
The new law attempts to clear this up by requiring that in this situation the agreement be supported by “fair and reasonable consideration independent from the continuation of employment.” However, the law does not make clear whether this requires garden leave pay, mutually-agreed upon consideration or something else. It will be up to the courts to interpret and apply the meaning of this provision in the law.
Employers Outside Massachusetts. An out-of-state employer that has workers in Massachusetts may hope that it can avoid the Massachusetts noncompete law by having the noncompete stipulate that the parties are bound by the law of another state – one less restrictive of noncompetes than the new Massachusetts law.
However, the Massachusetts law is designed to prevent this. The law applies if the employee is, and has been for at least 30 days immediately preceding cessation of employment, a resident of or employed in Massachusetts at the time of termination of employment.
And treating the worker as an independent contractor will not avoid application of the law – the statute treats independent contractors the same as employees.
What To Do Now and Implications for the Future. Many companies have standard noncompete agreements that they have used for years, and that they rarely reviewed in the past. However, it’s safe to assume that as of October 1, 2018, any boilerplate non-compete agreement currently in use in Massachusetts will be obsolete and unenforceable. Any company that plans to use a noncompete agreement after that date should begin the process of revising its agreements in time to meet this deadline.
As far as the future goes, one consequence of the new law is that noncompetes will be more, not less, complex.
For example, employers and employees must now struggle to understand the various scenarios that will be standard in post-2018 noncompete agreements:
- if the employee resigns the noncompete is enforceable for up to one year;
- if the employee is terminated (not for cause) or laid off the noncompete is not enforceable;
- if the employee is terminated for cause the noncompete is enforceable for up to one year;
- if the employee engages in breach of fiduciary duty or theft (during or after employment) the noncompete is enforceable for up to two years.
All of this needs to be spelled out in the noncompete agreement before the employee starts work.
Intertwined with these scenarios are the choices inherent in the garden leave provision:
- will the employer and employee accept the statutory default of up to six months garden leave at one-half salary?
- will they negotiate an alternative arrangement?
- If they negotiate an alternative arrangement, what rules apply?
Lawyers will struggle to explain all of this to bewildered clients, both employers and employees, for years to come.
Laws are like sausages, it is better not to see them being made. Otto von Bismarck
Update: A new noncompete law was finally enacted in 2018. For a detailed discussion of the law see: A New Era In Massachusetts Noncompete Law
You could go to sleep for years, Rip van Winkle-like, and not miss much when it comes to keeping up with Massachusetts noncompetition legislation. Bills have been filed every year since 2009 and failed to be enacted into law. These bills have displayed all kinds of restrictions on non-competes, ranging from an outright ban (California-style), to a minimum salary requirement.
However, it’s worth taking an occasional peak at what the drafters of this legislation are up to, and the proposed 2016 law is worth waking up for, particularly since it passed the Massachusetts House and is headed for the Senate and possible delivery to Governor Baker for signature by the end of July.
Unsuprisingly, watching the sausage factory (the legislature) at work is not a pretty sight. At the same time, it’s difficult to avert your eyes.
The bill, now H. 4434, contains a lot of what you might expect based on past bills: a 12 month restriction on non-competes (expanded to two years if the employee has breached her fiduciary duty to the employer or unlawfully taken, physically or electronically, property belonging to the employer), and requirements that noncompete agreements be in writing and be provided to employees in advance of the commencement of employment.
However, the proposed law also contains a controversial so-called “garden leave” requirement. The expression “garden leave” — which is common in Britain but infrequently used in the U.S. — describes the situation where an employee leaving a job is told to stay away from work for a certain period, while remaining on payroll. The idea is that a few weeks or months hanging out in the “garden” (or pub!) will prevent the employee from learning confidential information she might take to a new employer.
The proposed Massachusetts law requires that noncompete agreements include a “garden leave clause,” although what this describes is a variation on the British version. It would require an employer to pay an employee subject to a non-compete, post-termination, “at least 50 percent of the employee’s highest annualized base salary” during the two years before the termination. This amount would be paid pro-rata over the duration of the noncompete period (presumably no more than 12 months).
An earlier version of the bill made garden leave mandatory with no loopholes. If the bill had remained in this form it would have greatly complicated employers’ decisions on whether or not to impose noncompetes, since the cost to employers if they chose to enforce a noncompete would have gone from free (today) to six months’ salary.
However, at the last minute the bill was amended to allow employers and employees to agree on, as an alternative to garden leave, some “other mutually-agreed upon consideration.” Translation: employer to employee – “if you want this job you need to agree to a two week garden leave provision. Take it or leave it.” This loophole has been described elsewhere as a “giant, EMC-sized hole“.
Whether the garden leave provision remains in its now-weakened form in the Senate, or whether it will be restored to its original, noncompete-disincentivizing form, remains a key consideration as to whether this bill will have a major impact on noncompete law in Massachusetts.
A few other aspects of this legislation are also worth mentioning. First, and most importantly, a noncompete would not be enforceable against an employee terminated without cause or laid off. This would be a significant limitation on noncompetes in Massachusetts. Employees are often aghast to discover that a noncompete may be enforced against them even though they were terminated from their employment. The bill would leave noncompetes enforceable only against employees terminated with cause (a relatively infrequent occurrence) and employees who terminate their employment voluntarily.
Second, noncompetes would not be enforceable against non-exempt (overtime eligible) employees, students and employees 18 years or younger.
Third, if the employee has been a resident of Massachusetts or employed in Massachusetts for 30 days before termination of employment the employer won’t be able to avoid complying with the law by designating the controlling law to be that of another (more noncompete-friendly) state.
Whether this bill will be passed into law and, if so, what form it will take is is anyone’s guess. However, one thing it clear: only if the garden leave provision is restored without the current loophole will the culture of noncompetes in Massachusetts truly be transformed.
Early this month the White House issued a report titled, Non-Compete Agreements: Analysis of the Usage, Potential Issues, and State Responses. The conclusion of this 16 page report is as follows:
In some cases, non-compete agreements can play an important role in protecting businesses and promoting innovation. They can also encourage employers to invest in training for their employees. However, as detailed in this report, non-competes can impose substantial costs on workers, consumers, and the economy more generally. This report informs future discussions and potential recommendations for reform by providing an overview of the research on the prevalence of noncompetes, evidence of their effects, and examples of actions states are taking to limit the use and enforcement of unnecessary non-competes. There is more work to be done. The Administration will identify key areas where implementation and enforcement of non-competes may present issues, examine promising practices in states, and identify the best approaches for policy reform. Researchers must continue to assess and identify promising policy reforms and the potential impact of those reforms including unintended consequences. Ultimately, most of the power is in the hands of State legislators and policymakers in their ability to adopt institutional reforms that promote the use and enforcement of non-competes in instances that appropriately weigh their costs and benefits and in ways that provide workers appropriate levels of transparency about their rights.
Among many interesting points made are the following:
- Almost 1/6 of of workers earning less than $40,000/year are bound by noncompetes.
- An estimated 37% of employees subject to noncompetes are asked to sign noncompete agreements only after accepting a job offer.
- There is a correlation between noncompetes and lower wages.
- Many workers who sign noncompetes do not understand the legal implications of these agreements.
. . . and much more. Read the full report here.
The White House report comes on the heels of a March 2016 report by the U.S. Treasury titled Non-compete Contracts: Economic Effects and Policy Implications. The Treasury report makes many of the same points, concluding:
Though non-compete contracts can have important social benefits, principally related to the protection of trade secrets, a growing body of evidence suggests that they are frequently used in ways that are inimical to the interests of workers and the broader economy. Enhancing the transparency of non-competes, better aligning them with legitimate social purposes like protection of trade secrets, and instituting minimal worker protections can all help to ensure that non-compete contracts contribute to economic growth without unduly burdening workers.
Legislation regulating noncompetes has been filed with the Massachusetts legislature every year since 2008, and is likely to be filed again this year. Hopefully, the state lawmakers will take the findings of these reports into consideration and, at the very least, take steps that will curb some of the more egregious abuses associated with noncompete agreements.
Download the pdf file
I’ve often written about how easy it can be for an employer to lose the ability to enforce an employee noncompete provision. In recent years the courts have come down hard on employers who materially change an employee’s job responsibilities but fail to require the employee to enter into a new contract, holding in many cases that a noncompete provision in the old contract does not survive the job change. (For example, see Rent-A-PC Fails to Enforce Restrictive Covenants Against Former Employees).
However, there is an even more fundamental mistake employers can make, as illustrated in the decision in Meschino v. Frazier Industrial Co. (D. Mass. November 18, 2015). In this case the employee entered into an agreement in 2005 which contained a covenant not to compete and a confidentiality provision. The employee then signed a new employment agreement in 2012, but the 2012 agreement did not include these terms or refer back to the 2005 agreement. As the court noted, the 2012 agreement “states on its face that it contains ‘the terms of [the employee’s] employment’ without any reservation or reference to any other document or agreement.”
That, so far as Massachusetts Federal District Court Judge Stearns was concerned, was the end of the matter. The employer may have intended to preserve the 2005 noncompete provision in the 2012 contract (as it claimed), but the 2012 agreement contained not even the hint of such an intention.
Employers and employees have a lot at stake when it comes to noncompete and confidentiality agreements, and failing to consult a qualified lawyer to make sure that these terms remain in effect (or, in the case of an employee, to know when they may not be enforceable) can be a costly mistake, as Frazier learned in this case.
Meschino v. Frazier Industrial Co. (D. Mass. November 18, 2015).
Now that the Massachusetts legislature has abandoned (at least until next session) a bill to make employer/employee noncompete agreements unenforceable (or more difficult to enforce) in Massachusetts, we’re back to business as usual in Massachusetts, and how the courts handle these cases remains of interest. And, since the preliminary injunction stage of these cases is so critical, how the courts handle preliminary injunction motions in noncompete cases is of particular interest.
Of course, noncompete law (sometimes statutory, sometimes “judge-made” case law) varies from state-to-state. A recent case highlights the extent to which even the procedure for handling these cases can differ from state-to-state.
In Massachusetts, the trial courts — federal or state — have no obligation to hold an evidentiary hearing when resolving a preliminary injunction motion. Affidavits are usually enough, and its rare to see a hearing with witnesses and cross-examination.
However, this is not the case in the 11th Circuit, which covers federal cases in Alabama, Florida and Georgia. The 11th Circuit recently held, in a noncompete case involving a preliminary injunction motion, that while an evidentiary hearing is not always required before issuance of a preliminary injunction, ““[w]here the injunction turns on the resolution of bitterly disputed facts … an evidentiary hearing is normally required to decide credibility issues. … where much depends upon the accurate presentation of numerous facts, the trial court erred in not holding an evidentiary hearing to resolve these hotly contested issues.”
The case was remanded to the trial court for a hearing.
Moral of the story: if you think an evidentiary hearing will improve your chances on a noncompete preliminary injunction motion, ask for one. Just maybe, you’ll get it. If the appealing party in this case had not asked for an evidentiary hearing, it would have had no basis for complaining, on appeal, about the failure of the court to grant one, and would not have obtained the reversal. While an Eleventh Circuit decision is only persuasive (not binding) on courts outside the Eleventh Circuit, a particular judge in another state could find it very persuasive, and an evidentiary hearing may make a difference in the outcome in the trial court. It also creates the basis for a good faith argument on appeal.
Moon v. Medical Technology Assoc. (11th Cir. Aug. 18, 2014)
In Corporate Technologies v. Harnett, decided by the First Circuit on August 23, 2013, the court upheld the Massachusetts U.S. District Court’s enforcement of a 12-month employee non-solicitation clause. The court rejected Harnett’s (the former employee) argument that he did not solicit Corporate Technologies’ customers, particularly given evidence that the new employer sent a “blast email” to a group that included many of Corporate Technologies’ customers.
The opinion contains an extensive discussion of the “metaphysical” distinction between “soliciting” and “merely accepting” business, an issue I discussed in another post this summer (Nudge, Nudge, Wink, Wink – Are You “Soliciting” in Violation of an Employee Non-Solicitation Agreement?).
The First Circuit rejected a “bright-line” rule in determining who made initial contact in a non-solicitation case (the former employee or a customer), stating that –
we believe that the better view holds that the identity of the party making initial contact is just one factor among many that the trial court should consider in drawing the line between solicitation and acceptance in a given case. This flexible formulation not only reflects sound policy but also comports with well-reasoned case law from other jurisdictions.
Of interest is the First Circuit’s rejection of Massachusetts Superior Court cases as precedent on this issue: “these trial court decisions have no precedential force … Where, as here, the highest court of a state has not spoken to a question of state law, our precedents teach that we should look, among other things, to ‘persuasive adjudications by courts of sister states’ and ‘public policy considerations.'”
This decision is bad news for employees who hope to do an end-run around a non-solicitation clause, since the absence of a bright-line test makes it more difficult to predict how a court will handle a particular set of facts.
Non-solicitation cases are infrequent visitors to the First Circuit. While federal court cases are not binding on the state courts, they are highly persuasive, and I expect this case to be an important precedent in the law of non-solicitation agreements in Massachusetts.
Corporate Technologies, Inc. v. Harnett (1st Cir., August 23, 2013)
Two note-worthy decisions have emerged from AMD v. Feldstein, a trade secret case pending in federal district court in Massachusetts. At the heart of the case is the conduct of several AMD employees who left to work for Nvidia Corporation. Inexplicably, they copied and took with them huge amounts of AMD data, actions which earned them a preliminary injunction in the first of two opinions, dated May 15, 2013.
However, in the May 15th decision Massachusetts federal district court judge Timothy Hillman also addressed the thorny issue of what constitutes a “solicitation” in violation of a non-solicitation agreement, and specifically solicitation of employees (as opposed to customers) of the former employer.
The employee non-solicitation provisions in this case were fairly standard. For example, Feldstein’s provided that:
during [Feldstein’s] employment with [AMD] and for a period of one year following the termination of [Feldstein’s] employment, whether voluntary or involuntary, [Feldstein would] not hire or attempt to hire an employee of [AMD], or directly or indirectly solicit, induce or encourage an employee of [AMD] to leave his or her employ to work for another employer, without first getting the written consent of an Officer of [AMD].
However, just what kinds of behavior violate such a provision, and which do not?
Clearly, expressly asking or encouraging an AMD employee to leave AMD would do so (“you should leave AMD and come to work for Nvidia with me – you can make much more money there, and they have chair massages every day!”). But what if Feldstein, on his last day of work at AMD, tells another employee “I’m moving to Nvidia” and winks? What if, after he’s at Nvidia, he has lunch with a former co-worker at AMD and raves about how much he likes his new job, nothing more? What if, once Feldstein is at Nvidia a former co-worker at AMD approaches him and asks him questions about salary and working conditions at Nvidia, and whether there are any more job openings, and he does nothing more than answer these questions? What if Feldstein encourages an AMD employee to move to Nvidia, but the employee was unhappy at AMD, and was planning to leave in any event? The permutations are almost endless.
These examples pose perplexing problems for employers and employees alike, who must try to navigate a thin line between legal and illegal behavior.*
*As the Massachusetts Appeals Court stated in a case involving the alleged solicitation of customers, “as a practical matter, the difference between accepting and receiving business, on the one hand, and indirectly soliciting on the other, may be more metaphysical than real.” (Alexander & Alexander, Inc. v. Danahy, 1986).
There is not a lot of law to help sort out these issues. As Judge Hillman points out, “much of the case law on solicitation in Massachusetts deals with former employees soliciting customers from their former employers,” not soliciting other employees. However, he noted that “colleagues can generally be expected to have even closer personal relationships than do employees and customers; and wherever closer working relationships are, courts must bear in the mind the fact that solicitation can be quite subtle.”
Needless to say, the parties in the case took opposing views. AMD argued for something close to a “wink test”– if Feldstein says he is leaving AMD to work at Nvidia and winks at another employee he has solicited. The former employees in the case argued that AMD should be required to prove that they took “active steps to persuade” an employee to leave, and even then they were not soliciting if the person were planning to leave anyway.
Rejecting these extreme positions Judge Hillman formulated the following tests:
I will define solicitation as follows. Direct solicitation is what might be seen as traditional solicitation, encompassing any active verbal or written encouragement to leave AMD, even if not intended to harm AMD. Due to the personal relationships that develop between colleagues, liability for indirect solicitation requires a more context-sensitive inquiry. …subtle hints and encouragements … can constitute indirect solicitation. However, to preserve the public’s interest in free personal communications, such solicitation should only be found where the finder-of-fact is satisfied that the solicitor actually intended to induce the solicitee to leave AMD.
Given the paucity of precedent on indirect solicitation in Massachusetts, this decision may be the best guide to the law of employee solicitation in Massachusetts at present.* However, the definition of “indirect solicitation” is problematic: given that a former employee accused of indirect solicitation is unlikely to admit illegal intent, it may be very difficult for the former employer to prove the requisite level of intent in court. Absent overt encouragement in the form of testimony or “smoking gun” emails, what chance does the employer have of proving the “actual intent” required by this test? Under this definition “nudge, nudge, wink, wink” may be safe for the former employee.
*A caveat: this decision was issued by a federal court, not a state court. The decision may carry relatively little weight with a state court judge, who is not bound by federal court decisions on Massachusetts law. The state courts are the final arbiters of state law.
An obvious conclusion to be drawn from this case is that non-solicitation clauses (at least as applied to employees), are weak tea. A potentially more effective way of preventing an ex-employee from luring employees away to a competitor (in most states, but not all) is indirectly, through a non-compete agreement. Although non-competes have their own set of enforcement problems (see, for example, this recent post), they have fewer problems than non-solicitations.
I’ll be writing about the second important issue to emerge out of this case in a separate post.
AMD v. Feldstein (D. Mass. May 15, 2013)
My late May post on Rent-A-PC, Inc. v. Robert March, et al. discussed a Massachusetts federal district court case in which Judge O’Toole refused to issue a preliminary injunction enforcing noncompete provisions against two former employees of Rent-A-PC because their job responsibilities had substantially changed since their non-compete agreements had been signed.
In a decision issued by a Massachusetts Superior Court Judge in May, the court refused to issue a preliminary injunction on the same grounds. In Intepros v. Athy one defendant, Paul Athy, had advanced from branch manager to regional vice president. Relying on the hoary case of F.A. Bartlett Tree Expert Co. v. Barrington (1968), as well as several more recent cases, the court held that this change in job title responsibilities, as well as changes in pay, constituted a material change rendering the noncompete agreement void and unenforceable.
A second defendant, Anne Marie Canty, had been hired and fired twice, and had signed a noncompete agreement on the first two hires. However, she was not asked to sign a noncompete agreement at the time of her third hire, a fact that left the employer without an enforceable noncompete agreement against her.
Ms. Canty’s case was open and shut: if you fire an employee don’t expect a noncompete provision from that employment to be enforceable if you rehire the employee and don’t get a new agreement.
Mr. Athy’s case is more difficult. Must an employer require an employee to sign a new noncompete agreement (or ratify an existing agreement) on the occasion of every promotion or change in salary? Not only is this an awkward condition to impose on the employer-employee relationship, but lets face it: many employers will forget. To make matters murkier, no court has provided a bright line as to how much an employment relationship must change before a new agreement becomes mandatory. In fact, one Massachusetts judge has ruled that the material change doctrine applies only when the change adversely affects the employee, such as in the case of a demotion or decrease in pay. (Sentient Jet LLC v. Mackenzie, Garsh, J. 2012).
Employers may attempt to use noncompete agreements that specifically anticipate job changes during the course of employment and provide that the non-compete clause will continue regardless of such changes, but no Massachusetts court has ruled on whether such a provision is enforceable.
Unfortunately, for now the material change doctrine seems to be an unavoidable stumbling block for Massachusetts employers.