Massachusetts governor Deval Patrick recently announced proposed legislation that would make noncompete provisions in employment contracts unenforceable, except under certain limited conditions.1 If Massachusetts adopts the legislation, it will join California as one of the few states to generally prohibit noncompete provisions in employment contracts.
Employers typically use noncompete agreements to protect their confidential information and their investments in employee development and customer good will. If adopted, employers should adjust to the legislation by both (i) utilizing contractual provisions (discussed below) that are expressly allowed by the law and that provide some of the benefits of traditional noncompete restrictions and (ii) taking steps to mitigate the risks if departing employees do choose to compete.
The General Prohibition and its Exceptions
The proposed law would make any noncompete agreement arising out of an employment or independent contractor relationship extending beyond the term of that relationship void and unenforceable. The proposed law does include certain important exceptions to the ban on noncompete agreements, some of which are not recognized under California’s similar law. Massachusetts’ exceptions to the general prohibition would include:
- Non-solicitation. The proposed legislation does not prohibit either: (i) covenants not to solicit or hire employees or contractors of the employer, or (ii) covenants not to solicit or transact business with customers of the employer.
- Non-disclosure agreements. The proposed legislation does not ban employers from binding employees to non-disclosure obligations.
- Mergers and Acquisitions. The proposed legislation does not ban noncompetition agreements made in connection with the sale of a business or substantially all of the assets of a business, when the party restricted by the noncompetition agreement is an owner of at least a 10% interest in the business who received significant consideration for the sale. This exception allows employers to bind certain employees to noncompete agreements in connection with the sale of a business. As a practical matter, the 10% ownership requirement will generally limit the application of this exception to founders of the acquired business.
- Forfeiture agreements. The proposed legislation does not block employers from entering into “forfeiture agreements” under which employers can provide employees with additional compensation in return for an agreement not to compete (which the employee would forfeit upon choosing to compete).
Options for Employers
If Massachusetts adopts the proposed legislation, employers will be limited in their ability to prevent departing employees from competing against them. Employers can, however, take advantage of the exceptions to the general prohibition on noncompete provisions. The steps below help employers mitigate the risks of departing employees:
- Ensure that employees are bound by well-defined non-solicitation agreements that include explicit covenants not to solicit or hire employees or contractors of the employer andcovenants not to solicit or transact business with customers of the employer. Private equity and venture capital funds should include provisions that specifically restrict employees from calling on the fund’s limited partners and portfolio companies in which the fund invests.
- Ensure that employees are bound by comprehensive non-disclosure agreements. Employers should consider revisiting and bolstering their forms of non-disclosure agreements if employees are free to join competitors.
- Separate noncompetition obligations from other restrictive covenants, such as the non-solicitation and non-disclosure provisions noted above, to position non-solicitation and non-disclosure provisions to survive if noncompete restrictions are made unenforceable by the proposed law.
- “Pay” for noncompete provisions with key employees in the form of forfeiture agreements. This practice cannot prevent employees from competing, but does provide a contractual disincentive that should avoid litigation.
- Assuming there exists an actual relationship between the parties and a state other than Massachusetts, consider drafting noncompete agreements with favorable and exclusive choice of law and venue provisions, specifying that the laws of a state where noncompete agreements are recognized will govern and that disputes will be litigated in the courts of that state. While by no means a bulletproof way of enforcing the noncompete, it may be helpful under certain circumstances.