September 16, 2014 Articles

To Compete or Not to Compete: Is That the Question?

Businesses today are keen to insert such clauses in employment contracts of all shapes and sizes.

By Sye T. Hickey

A recent New York Times article highlighted an increasing trend in the areas of antitrust, competition, and employment law: the enforcement of covenants not to compete in decidedly atypical fields. Steven Greenhouse, “Noncompete Clauses Increasingly Pop Up in Array of Jobs,” N.Y. Times, June 8, 2014. For years, covenants not to compete have been used to protect the legitimate business interests of big business and in the areas of science and technology, but the past few years have seen an expansion from these traditional uses to use in employment contracts in everyday jobs, such as the work of hairdressers and camp counselors.

The Varied Enforceability from State to State Most states treat non-competes differently, making it difficult to determine how standard form language may be viewed in multiple jurisdictions. A few states, including California and North Dakota, have statutes that restrict courts to enforcing non-compete clauses only in very limited circumstances. See Cal. Bus. & Prof. Code §§ 16600–16607 (with limited exceptions, “every contract by which anyone is restrained from engaging in a lawful possession, trade, or business of any kind is to that extent void”); N.D. Cent. Code § 9-08-06 (West 2014). On the opposite end of the spectrum, courts in states like Texas are more liberal in their enforcement of non-compete clauses, after a determination that such clauses are reasonable. See Tex. Bus. & Comm. Code § 15.50(a); Guy Carpenter & Co. v. Provenzale, 334 F.3d 459, 465 (5th Cir. 2003) (a covenant not to compete is enforceable if it is “ancillary to or part of an otherwise enforceable agreement at the time the agreement is made to the extent that it contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable”).

Despite the stark difference in treatment of non-competes between Texas and California or North Dakota, the majority of states’ policies favor enforcement. Courts in these states will typically inquire into the degree of reasonableness of the language of the non-compete clause, although there is much variety in the states’ respective language and factors determining enforceability.

For example, New York courts will enforce non-compete agreements if the contract (1) is no greater than is required for the legitimate interest of the employer, (2) does not impose undue hardship on the employee, and (3) is not injurious to the public. See BDO Seidman v. Hirshberg, 712 N.E.2d 1220, 1223 (N.Y. 1999). Pennsylvania courts, on the other hand, will enforce covenants not to compete if (1) they are incident to an employment relationship between the parties, (2) the restrictions imposed by the covenant are reasonably necessary for the protection of the employer, and (3) the restrictions imposed are reasonably limited in duration and geographic extent. See Missett v. Hub Intern. Penn., LLC, 6 A.3d 530, 538 (Pa. Super. Ct. 2010).

Unenforceable Restrictive Covenants States are split in their respective handlings of clauses deemed unreasonable. Courts in most states take a “reformation” or “blue pencil” approach to non-compete covenants and will rewrite unreasonable or impermissible clauses. For example, Florida has a statutory provision requiring courts to “modify the restraint and grant only the relief reasonably necessary to protect [legitimate] business interests.” See Fla. Stat. § 542.335(1)(c). When a provision of a restrictive covenant is deemed unreasonable in Indiana, the blue pencil doctrine “permits courts to strike that provision from those which are unreasonable if the unreasonable restrictions are divisible from the rest.” See Coates v. Heat Wagons, Inc., 942 N.E.2d 905, 914–15 (Ind. Ct. App. 2011). However, these restrictive covenants are not always severable, and courts have struck down provisions in their entirety because they were patently unreasonable. See Clark’s Sales & Serv., Inc. v. Smith, 4 N.E.3d 772, 783–87 (Ind. Ct. App. 2014).

Other states, like North Carolina, will not reform unreasonable covenants not to compete: “North Carolina’s ‘blue pencil’ rule severely limits what the court may do to alter the covenant. A court at most may choose not to enforce a distinctly separable part of a covenant in order to render the provision reasonable. It may not otherwise revise or rewrite the covenant.” Hartman v. W.H. Odell & Assocs., Inc., 117 N.C. App. 307, 317, 450 S.E.2d 912, 920 (N.C. Ct. App. 1994). Similarly, courts in Virginia make little effort to reform unenforceable non-compete agreements and are not hesitant to strike down “overbroad” provisions. See Omniplex World Servs. Corp. v. U.S. Investigation Servs., Inc., 618 S.E.2d 340, 342–43 (Va. 2005).

Confused yet? Don’t worry; you are not alone. In fact, the variety in enforceability of non-compete agreements has led to inconsistent enforcement of such contracts in different states. In sum, a few states have statutes that require courts to reject attempts by employers to enforce covenants not to compete. These states essentially have zero tolerance policies for restrictive covenants. On the other hand, most states enforce non-compete covenants so long as they are reasonable. For clauses deemed to be unreasonable, most states courts will rewrite the clause to permit the enforcement of what the court deems to be reasonable. A few states enforce reasonable restrictive covenants but reject unreasonable covenants.

Recent Expansion in Usage of Covenants Not to Compete Because many states have fluid standards for the reasonableness and enforceability of covenants not to compete, businesses have been increasingly keen to insert such clauses in employment contracts of all shapes and sizes, including those in the technologyfood preparationbrewing, and dog-walking industries, among many others. These clauses have put everyday workers in difficult positions in deciding whether to accept a job or not, simply because of the non-compete clauses in their employment contracts. The businesses, as highlighted in the New York Times article, counter by noting that their investments in training and methodology are legitimate business interests, making it more likely that a court would find a non-compete reasonable.

These businesses have not only inserted restrictive covenants into employment contracts but have also gone to great lengths to enforce them. In the fall of 2012, Invidia, LLC, a hair salon and spa in Massachusetts, filed suit to enforce an employment agreement with one of its former employees, Maren DiFonzo. Invidia, LLC v. DiFonzo, No. 2012-3798-H, 2012 WL 5576406 (Mass. Super. Ct. Oct. 22, 2012). Specifically, Invidia asked the court for a preliminary injunction to enforce the non-compete clause in the agreement, which restricted DiFonzo from working for another hair salon within 10 miles of Invidia for a period of 2 years. Id. at *1. At the hearing, DiFonzo attacked the clause on the grounds that it was not intended to protect Invidia’s “legitimate business interests” but was instead inserted to deprive DiFonzo of her ability to capitalize on goodwill she built with her clients. Id. at *4. The court ultimately punted, hiding behind the preliminary injunction standard, but the message regarding Invidia’s intent to enforce its employment contracts had already been conveyed. Id. at *6–7.

Recent State Legislation Restricting the Use of Non-Competes As a countermeasure to the perceived restraint on trade, some state legislatures have considered codifying a ban, and some have sought to limit the enforcement of non-competes. Adam Vaccaro, “Noncompete Limits Look More Likely Than Ban,” Boston Globe, July 2, 2014. For instance, state legislatures in Minnesota, New Jersey, and Massachusetts have all recently explored the idea of passing legislation on non-competes, effectively overruling the standards set by courts in their respective states.

In February 2013, Minnesota legislators Joe Atkins and Alice Hausman introduced a billintended to restrict the use of non-competes in the Land of 10,000 Lakes. The Minnesota bill sought to ban the overwhelming use of restrictive covenants limiting a profession, trade, or business, with the exceptions of the sale of businesses and the dissolutions of partnerships and limited liability companies. The Minnesota proposed legislation looks to mirror the regulations in California. See Cal. Bus. & Prof. Code § 16600 et seq. The bill, however, was sent to committee in 2013 and has been stalled there ever since.

Members of the New Jersey Legislature introduced legislation in April 2013, taking a drastic stance in the war against non-competes. Betty Graumlich, “New Jersey Joins Wave of States Considering Limitations on Noncompete Agreements,” Forbes, Apr. 16, 2013. The New Jersey bill, if passed, would eliminate any non-compete clauses in an employment contract under which the employee is eligible for unemployment compensation. This is a drastic change from New Jersey common law, which holds that non-compete agreements will generally be found reasonable where they “simply protect[] the legitimate interests of the employer, impose[] no undue hardship on the employee, and [are] not injurious to the public.” Laidlaw, Inc v. Student Transp. of Am., Inc., 20 F. Supp. 2d 727, 754 (D.N.J. 1998). However, like the Minnesota bill, the New Jersey bill has not progressed since its introduction.

In April 2014, Massachusetts Governor Deval Patrick announced his intention to introduce legislation abolishing the enforcement of non-compete covenants, with few limited exceptions. This announcement came as the result of many years of debate regarding the economic consequences of enforcement of such covenants in Massachusetts. Scott Kirsner, “Some Common Sense on Noncompete Clauses,” Boston Globe, July 3, 2011. As Massachusetts law currently stands, non-compete covenants are enforceable if they are “(1) necessary to protect a legitimate business interest; (2) reasonably limited in time and space; and (3) are consonant with public interest.” Re/Max of New England, Inc v. Prestige Real Estate, Inc., No. 14-12121-GAO, 2014 WL 3058295 (D. Mass. July 7, 2014).

Proponents of Governor Patrick’s efforts argue that the current enforcement of restrictive covenants in Massachusetts stunts the growth of the economy by discouraging entrepreneurs from starting their own companies. Bijan Sabet, “Getting Rid of the Non-Compete Clause Everywhere,” bijansabet.com, Dec. 1, 2007. Some in Massachusetts even believe that they are losing businesses in the technology sector, especially start-ups, to California because of Massachusetts courts’ enforcement of non-competes. One study concludes that productivity and work quality increase in the absence of non-compete agreements. On Amir & Orly Lobel, “How Noncompetes Stifle Performance,” Harvard Business Review, Jan.–Feb. 2014.

Initially aiming to restrict non-compete agreements in the same fashion as California courts, Governor Patrick’s bill received significant pushback from the Massachusetts legislature. Callum Borchers & Michael B. Farrell, “Patrick Looks to Eliminate Tech Noncompete Agreements,” Boston Globe, Apr. 10, 2014. The Massachusetts Senate’s version of the governor’s bill passed on July 1, 2014, and modified a number of provisions in the original bill.  Julie Cox, “Uncertain Fate of Non-Competes in Massachusetts: Senate Passes Compromise,” Nat’l L. Rev., July 2, 2014. Specifically, the Senate version limits the durational period of non-compete covenants to six months or less, requires the proposed covenant to be presented to the employee five days in advance of hire, and prohibits the use of such covenants with hourly employees. The bill maintains the “reasonableness” standard on geographic scope that is currently used by Massachusetts courts. On the other hand, the Massachusetts House of Representatives’ corresponding bill does not address restrictive covenants. Adam Vaccaro, “Proposed Noncompete Compromise Not Retroactive,” Boston Globe,  July 8, 2014. The two bodies of the legislature are currently working to find a medium for the final version of the bill.

California: The Promised Land? A cursory glance at states’ recent trends would seem to indicate that California’s practice of outlawing the vast majority of non-compete covenants is the preferred method. But is this accurate? If so, why haven’t more states limited the use of restrictive covenants?

Proponents of the use of non-compete agreements point to California’s “one size fits all” strict application of the law. They agree that, while California’s law may weed out the use of restrictive covenants for everyday employees like taxi drivers and meteorologists, it also eliminates the use of restrictive covenants for chief executive officers and highly specialized professionals. Andy Johnston, “Q&A on the News,” Atlanta Const. J., July 13, 2014. Restrictive covenant proponents also point to California’s high unemployment rates, high taxes, and businesses departing the state. Finally, these proponents argue that non-compete covenants effectively protect businesses’ legitimate interests, including intellectual property divulged in training and methodology.

Conclusion Is California’s restriction on non-compete covenants the gold standard that will eventually be followed by most other states? California’s unique economy, infrastructure, population, size, and demographics make it difficult to say. Clearly, the restrictions have allowed start-ups in the technological industries in Silicon Valley to thrive. Moreover, they have prevented the implementation of non-compete clauses in unskilled workers’ contracts. However, it is difficult to quantify the extent to which businesses have been burned by California’s lack of protection for intellectual property and small business owners.

This brings us back to Massachusetts and its legislation in the making. How the Bay State crafts its final version of legislation on non-compete covenants is certainly worthy of the attention of attorneys practicing in the areas of unfair competition and business torts law. While lawmakers in Massachusetts have been largely unsuccessful in enacting legislation similar to that of California, any modest changes those legislatures make may set the stage for other states, such as Minnesota and New Jersey, to follow.

Keywords: litigation, business torts, contracts, restrictive covenants, employment agreements, non-compete clauses, competition, legislation, blue pencil, reformation

Sye T. Hickey – September 16, 2014