Latest federal and state legal guidelines restrict using non-compete agreements by state contractors and different employers

The worker non-compete landscape continues to evolve rapidly, with several states introducing new restrictions on the use of non-compete agreements between employers and employees. Once a valuable tool for employers to protect their companies from unfair competition, loss of customers, or misuse of confidential company information, many states have increasingly restricted the enforceability of such agreements.

The federal government is now examining the sensible use of non-compete obligations between employers and employees. President Biden’s Executive Order of July 9, 2021 calls on the Federal Trade Commission (“FTC”) to limit such agreements, signaling a possible expansion of state regulation of employer-employee agreements. And a pending Senate bill would ban most non-compete agreements. In light of these developments, government contractors and other employers should evaluate whether their use of these agreements with workers is consistent with recent developments in the state and with the broader trend towards limiting the enforceability of these agreements.

The state judicial and legislative treatment of non-compete obligations

Non-compete obligations between employers and employees, typically found in employment or severance agreements, prohibit the employee from doing work that rivals his employer’s business. This prohibition usually begins with employment and lasts for a certain period of time after the employee no longer works for the employer. Non-compete obligations generally describe the duration of the non-compete clause, the geographic scope of the non-compete clause, and the types of work that the employee is not allowed to perform during the non-compete period.

Traditionally, enforceability of these agreements has been largely a matter of common law and is governed by the principles of state contract law, although some states, particularly California, long ago enacted laws to limit enforceability to very narrow circumstances. In the vast majority of states, courts have tended to use flexible multi-factor tests to assess restraints, and in some jurisdictions courts may exercise their discretion to partially enforce or even rewrite non-compete obligations that are too broad (known as blue-penciling) ). . In recent years, however, more and more states have introduced stricter legal regulations that specifically limit the non-competition clause.

This trend has continued over the past year. In May 2021, Oregon amended its non-compete clause to specifically provide that overly broad non-compete agreements are void and unenforceable, which can limit a court’s ability to enforce a stricter version of that non-compete clause. See Oregon Senate Bill 169 (changing relevant legal language from “void” to “void and unenforceable”). Also in May 2021, Nevada changed its laws to penalize employers who attempt to enforce unlawful non-compete agreements. See Nevada Assembly Bill 47 Section 22.5 (7) (requires courts to award attorney’s fees and costs when an employer improperly attempts to (i) enforce a pledge not to compete against an hourly employee, or (ii) prevent employees from cooperating former customers that the employee did not request).

Many states recently banned non-compete obligations for low-wage or hourly workers. Last year, Virginia banned most agreements not to compete for low-wage workers (Va. Code Ann. § 40.1-28.7: 8) less than two years after Maryland did the same (Md. Code Ann., Lab. & Empl § 3 -716). Nevada followed suit this year and, effective October 1, 2021, banned non-compete agreements for employees who are paid only on an hourly basis. See Nevada Assembly Bill 47 Section 22.5 (3). Some states have further restrictions on non-compete obligations. Later that year, the District of Columbia will join California, North Dakota, and Oklahoma as the only states to prohibit the use of non-compete agreements between employers and employees in most cases. See DC Act 23-563.

As the patchwork of restraints on non-compete agreements continues to grow, employers must keep an eye on relevant state and potential federal laws and regulations.

Federal efforts to limit non-compete obligations for employees

On July 9, 2021, President Biden signed the Executive Order to Promote Competition in the American Economy (“Order”). As Covington previously reported, the regulation covers a number of competition issues. Most relevant to non-compete agreements between employers and workers, the regulation encourages the FTC to use its regulatory powers “to restrict the unfair use of non-compete clauses and other clauses or agreements that may unfairly restrict worker mobility”. Implementing Regulation, Section 5 (g). Although the FTC has not yet published such rules, the regulation follows a workshop the FTC held in 2020 on non-compete agreements between employers and employees. It also comes shortly after the FTC announces a new rulemaking group and updated rulemaking procedures, which are intended to revitalize the “rulemaking authority” in accordance with 15 USC § 57a and to support “the planning, development and implementation of rulemaking – especially new rulings”[.]”

Independent of the Order, four US Senators recently introduced the Workforce Mobility Act of 2021 (“WMA”) with bipartisan support. If it were to become law, the WMA would (1) largely limit the application of non-compete agreements to agreements signed in the context of a business sale or dissolution or dissolution of a partnership, (2) dual enforcement for the FTC and the U.S. Department of Labor, and (3) Grant employees a private right to sue in the event of violations of the WMA.

These recent developments suggest that the federal government will restrict the use of non-compete obligations between employers and employees. While a general ban seems unlikely, the federal government can follow the state trend and prohibit non-compete agreements with low-wage employees or employees who have no access to the employer’s trade secrets. Contractors and other employers whose employees only have access to customer relationships and confidential (but not trade secrets) information may be particularly affected by such restrictions.

Statutory or regulatory restrictions on the enforceability of existing non-compete agreements with employees can also have adverse tax consequences for some employees. For example, limited inventory taxation is sometimes delayed after an employee leaves the company when the limited inventory is non-compete. In addition, the excise tax on golden parachute payments is sometimes reduced or abolished when a non-compete obligation is imposed after termination of employment in connection with a corporate transaction. A ban on enforcing these existing non-compete obligations could lead to an acceleration in taxes or an increase in excise duties for some workers.

Practical guidance for government contractors and other employers

In addition to monitoring developments at the federal and state level with regard to non-compete obligations for employees, employers should consider the existing enforcement parameters. In general, non-compete clauses must not be worded wider than is necessary to protect the employer’s legitimate business interests. Employers should not assume that a court will rewrite and partially enforce overly broad rules in blue feathers because a court may not have the power to do so or simply refuse to enforce an overly broad non-compete clause. To increase the likelihood that a written non-compete clause will be enforceable, the agreement should be tailored in terms of duration and geography, as well as the nature of the prohibited competitive activity. For example, a provision that prohibits a competitor from working in any capacity could be attacked.

A non-compete clause for workers should clearly aim to protect an employer’s trade secrets and other confidential business information from improper use or disclosure. Firms employing low wage earners should exercise additional caution in formulating non-compete agreements and assessing the need, if any, of such agreements.

Even with significant restrictions on the use of these agreements, employers can protect their assets in other ways. For example, tight non-solicitation clauses may be enforceable while broader non-compete clauses do not apply, and employee nondisclosure agreements are generally enforceable when tailored accordingly. Aside from contractual restrictions on competition or advertising, employers should maximize the protection of their trade secrets and other confidential information through practical safeguards such as improved data protection measures, employee training to protect company information, and rigorous enforcement of security and confidentiality guidelines.