With reports indicating somewhere between ¼ and ½ of private-sector workers are bound by non-compete agreements, post-employment restrictive covenants and their enforceability are key considerations of employers, particularly during the COVID-19 pandemic. Indeed, some employers have elected to waive the protections of their non-competes. The pandemic has created heightened scrutiny regarding the ability to restrict an individual’s right to work and ushered in uncertainty regarding the judicial process – as well as a general reluctance to incur litigation costs – resulting in a dramatic decline in non-compete litigation. At the same time, the Biden administration has reintroduced a push for federal reform of non-compete law, leaving the question: What can employers to do to protect their trade secrets and confidential information in a post-pandemic world?
A. Non-Competes 101
Post-employment restrictions, including non-compete agreements, are popular tools for protecting business investments, confidential information, client, customer and employee relationships, and goodwill. While they come in many different flavors, a traditional non-compete prohibits an employee from working for a competitor of his or her current employer for a certain duration following termination.
Currently, the enforceability and permissible scope of non-compete restrictions is not governed by federal law, leaving each state to try to balance employers’ interests in protecting their business with employees’ interests in earning a living—and each employer to try to navigate a web of regulations based on their geographic footprint. In 2016, the federal government pushed for state policymakers to rein in the use of non-competes after concluding that restrictions reduced the welfare of workers and hampered the efficiency of the economy as a whole by depressing wages, limiting mobility, and inhibiting motivation. At least 16 jurisdictions have enacted new legislation restricting employers’ ability to impose post-employment restrictions since that time.
More legislation is expected. For example, earlier this year, lawmakers introduced legislation which would expand the Illinois Freedom to Work Act to provide that covenants not to compete are neither valid nor enforceable if the employee subject to the covenant was terminated or furloughed due to (i) the COVID-19 pandemic or (ii) circumstances that are similar to the COVID-19 pandemic.
While statutory schemes vary, and some jurisdictions like California and, more recently, Washington, D.C., essentially have banned non-compete agreements in the employment context, recent legislation generally includes one or more the following benchmarks:
- Ban use of non-compete restrictions for categories of workers who traditionally are not deemed to pose a competitive threat, including employees age 18 or younger, employees who are not exempt under the FLSA, and low-wage employees (which, in some instances, means anyone making under $100,000 per year);
- Prohibit enforcement if the termination of employment is involuntary;
- Require employers to continue paying some or all of the employee’s salary during the post-employment restricted period (i.e., a statutory garden leave requirement);
- Limit the maximum duration of non-competes, for example to 12 or 18 months;
- Mandate that the non-compete agreement be governed by the laws of, and enforced in, the state in which the employee resides—and deeming any agreement that attempts to include another jurisdiction for either choice-of-law or choice-of-venue void;
- Apply limitations in new legislation retroactively to previously existing non-competition agreements; and
- Exclude from the limitations non-compete agreements executed in connection with the sale of business or dissolution of a partnership.
On February 25, 2021, federal legislators reintroduced the Workforce Mobility Act, a proposed bipartisan law aimed at limiting the use of non-compete agreements. As proposed, the bill would, among other things, narrow the use of non-compete agreements (even in instances of a dissolution of a partnership or the sale of a business), place the enforcement responsibility on the Federal Trade Commission and the Department of Labor, permit a private right of action, and require employers to ensure their employees are aware of the limitation on non-competes. Similar bills have been proposed in Congress for several years, but none of them passed.
B. COVID-19 pandemic impact on non-compete agreements
The current pandemic has added to an already-tangled web of legislative and judicial uncertainty for employers to navigate in seeking to enforce non-competition agreements across the country. The pandemic impacted courts’ willingness to enforce non-competition agreements, particularly whether to issue injunctive relief limiting an employee’s ability to earn a living. The economic uncertainty, coupled with the courts’ inability to hold in person hearings in most jurisdictions and docket backlogs, led to a decrease in employment-related non-compete litigation in 2020.
However, early statistics show that non-compete litigation is picking up in 2021, likely due to the stabilizing economy and increased mobility of upper-level employees. With new laws, lingering effects of the pandemic, and increased scrutiny of non-competes, employers may feel like they are “walking into spiderwebs” as they navigate restrictive covenants. However, with protection of their most valuable assets at stake, employers are nonetheless strongly encouraged to act swiftly and deliberately to ensure protection of their trade secrets and goodwill.
1. Balance of harms analysis has shifted as a result of the pandemic
In determining whether to issue injunctive relief to enforce a non-compete agreement, courts generally seek to balance an employer’s legitimate interest in protecting its trade secrets and competitive advantage against an employee’s genuine interest in earning a living. In the midst of the pandemic, in certain circumstances, this balance has shifted in employees’ favor, particularly in situations where the termination was not the employee’s fault, such as through a layoff or furlough. In some states, courts will not enforce a non-compete restriction when an employee is laid off or furloughed; in other states, this factor may impact a court’s balance of harms analysis and sway its willingness to issue injunctive relief to enforce such agreements.
In mid-2020, a federal judge in Pennsylvania rejected an employer’s argument that employees on an open-ended furlough during the pandemic are still employees, even if the employer is paying for their health care. The judge also denied the employer’s request for a preliminary injunction to enforce the non-compete agreement, holding that the employees would suffer greater harm if the preliminary injunction was granted than the company would suffer if it was not. Although the Bureau of Labor Statistics announced on April 2, 2021 that the unemployment rate had fallen to 6.0% nationally, there are still 9.7 million people out of work, which is more than double the number of unemployed workers pre-pandemic in February 2020. In the current unstable economic environment, courts may continue to closely scrutinize non-compete agreements that are perceived to keep employees out of work.
In addition, courts across the country have seen an increase in departing employees acting preemptively by filing declaratory judgment actions to prevent their former employers from enforcing non-competition agreements against them. And, courts have been more likely than ever to rule in favor of the departing employees. For example, in February 2021, a departed employee sued his former employer in Harris County, Texas seeking declaratory and injunctive relief after the company’s “reminder of continuing obligations” letter caused the employee’s new employer to terminate his employment. The Texas court granted the employee’s request for a temporary restraining order, specifically finding that the noncompetition provision lacked the requisite exchange of consideration necessary to be enforceable and was unreasonable and greater than necessary to protect its legitimate goodwill expectations. The court also held that unless the former employer was restrained from contacting the employee’s future employers, the employee would likely be unable to find work in his area of expertise.
2. Protection of proprietary information is even more important with a remote workforce
The pandemic has not shifted all balancing factors in favor of departing employees. The nature of an increased remote workforce has put a spotlight on employers’ measures to safeguard their proprietary information and trade secrets. According to the Bureau of Labor Statistics, 21 percent of employed persons nationwide continued to telework in March 2021 as a result of the pandemic. Businesses may have a greater need to control proprietary information and prevent its misuse during the pandemic when employees are working from home with less oversight. It is critical for employers to monitor employees’ use of company equipment and proprietary information while working remotely and to take prompt action to ensure that departing employees do not continue to have access to sensitive company property or data after their termination. If employers can show that departing employees had access to truly sensitive and proprietary company information and that the non-compete it is seeking to enforce is narrowly tailored to protect such information, courts are more likely to weigh this factor in favor of employers, even in the midst of the pandemic.
3. Geographic restrictions may need to be analyzed and conceptualized differently in light of pandemic and increase in remote work
Many state laws allow employers to use restrictive covenants if they have a legitimate business interest that needs to be protected—such as trade secrets or customer lists—and such provisions are narrowly tailored to protect those interests. Indeed, most states require non-compete agreements to contain reasonable limitations in temporal and geographic scope. However, the pandemic has caused many employees to shift their worksites in ways that had not been contemplated. Consequently, remote work situations involving geographic-based non-compete agreements is likely to be an area of fertile ground for legal challenges to restrictive covenants in 2021. The ongoing COVID-19 pandemic and the reality that employees will continue to work remotely or in locations outside of their employer’s headquarters or corporate offices for the near future have created “blurred lines” between the “office at home” and the “office at work”. As such, employers are urged to re-visit their existing non-compete agreements to ensure that the geographic scope of the restrictive covenants make sense based on their current situation.
What Lies Ahead
As the impact of the pandemic begins to wane, non-compete litigation appears to be picking up in 2021, with an estimated 28 percent increase in state court cases relating to non-competition agreements. But how long this rise will last is unknown as the fate of non-competes remains in flux. Uniform federal legislation, if enacted, would ease the struggles associated with navigating the current multi-jurisdictional legislative landmine. However, based on preliminary information about the content of that legislation, it could also severely limit not only employers, but business acquirors, from relying on this age-old protection mechanism. Employers are encouraged to stay abreast of the legal landscape in these rapidly changing times.