Work Where, and For Whom, You Want: Are Covenants not to Compete Becoming Obsolete?

Tue, Mar 5th, 2024 | by Miles Mediation and Arbitration | Article | Social Share

By Kelly K. James

Covenants not to compete (also called restrictive covenants) are a hot topic in employment law today. A number of states now have, or are considering, laws invalidating these employment contract provisions. And the Federal Trade Commission (FTC) recently issued a proposed rule banning most non-competes.

What should employers consider when drafting these kinds of provisions? And what should attorneys consider when representing clients in these kinds of cases? We spoke with three labor and employment mediators and arbitrators — Steve Dunn, Tanya Tate, and Donna V. Smith — about this timely subject. Read on for a closer look at these issues.

What’s Driving this Trend?

Covenants not to compete are designed to protect businesses, but reasons exist to consider invalidating them. “Critics of covenants not to compete believe they hinder job mobility, infringe on workplace rights, suppress wages, and stifle competition and innovation,” said Tanya Tate, an Atlanta-based employment mediator and arbitrator. “Further, many states are seeing the writing on the walls with the issuance by the FTC of a proposed rule prohibiting employers from entering into and enforcing non-compete clauses with workers, including independent contractors. Anticipating the possible passage of the FTC Rule by the FTC Commissioners in April 2024, many states are getting ahead of the issue and already considering laws that would invalidate covenants not to compete.”

“The sweeping FTC proposal to essentially ban non-competes is because ‘the freedom to change jobs is core to economic liberty and to a competitive, thriving economy’,” said Florida-based mediator Donna V. Smith, quoting the FTC. “If, as the FTC states, nearly one in five workers in the U.S. is bound by a form of a non-compete clause … perhaps the premise upon which sweeping ‘reform’ is necessary to promote labor mobility and innovation.

“Notably, numerous states already restrict or effectively ban non-competes, and that number is growing. Of particular interest are those states which do not directly ban use of restrictive covenants but impose compensation thresholds and/or notice requirements,” added Smith. “The trend there seems to be to make sure workers know what they are signing and to limit the restrictions to those jobs which more likely implicate the training, actual competition, and other investments of time on both sides which merit heightened protection.”

Before Drafting Covenants not to Compete

So, what should employers consider when drafting such provisions? “The best practice is to make the restrictions as narrow as possible to adequately protect the business’ interests,” said Steve Dunn, a labor and employment mediator based in Charlotte, North Carolina. “For example, if 90 percent of the customers are located within 5 miles, don’t draft a non-compete with a radius of 20 miles. The more narrowly tailored the restrictions, the more likely they are to be enforced.

“It’s also a good idea to include provisions regarding confidentiality of business information and non-solicitation of the company’s customers,” Dunn added. “The overall goal is to protect the business against unfair competition. Doing this from different angles creates the best chance at least one of them will ‘stick’ in the event of a dispute.”

It’s also important to consider relevant state law, added Tate. “Employers should be aware of the laws in every state in which they require employees to sign non-compete agreements. All too often, corporations will use the same restrictive covenant agreement in every state in which they do business,” said Tate. “But, given the variation in laws from state to state, implementation of this ‘one-size-fits-all mentality’ can be a significant mistake.

“For instance, California, Colorado, Minnesota, North Dakota, and Oklahoma have all passed laws voiding non-compete agreements, with narrow exceptions. Washington, D.C. banned non-compete agreements for workers earning less than $150,000 annually,” said Tate. “Other states are addressing exclusions for lower-wage workers and certain occupations. If employers do not know the specific laws in each state in which they require employees to sign non-competes, they can be left holding a plainly unenforceable agreement.”

Employers should also consider what is and what is not considered a non-compete. “Limitations on a non-compete may not impact other post-employment restrictions such as garden leave, non-solicitation clauses, no-poach clauses, confidentiality and trade secret protection and related intellectual property protections,” said Smith. “As has always been the case, the more narrowly drawn to address a specific and identifiable business interest, the more likely the non-compete will survive legal scrutiny. Very particular special circumstances should be carefully considered and detailed if a non-compete in some form is required to address those circumstances.”

The Option of Alternative Dispute Resolution  

If issues arise over the enforcement and/or validity of a covenant not to compete, an alternative dispute resolution (ADR) option like mediation or arbitration can be a wise choice.

“Every business is different, but the remedies available in court are all the same. In mediation, we can tailor an agreement that fits the parties’ individual needs,” said Dunn. “This often includes an agreement to stay away from a certain set of customers, or to ‘buy out’ another set of customers or adjust any of the other parameters in the contract. Everything is negotiable!”

The time and cost of litigation can also be avoided with ADR, said Smith. “No one wins in non-compete litigation except the lawyers. The ramp-up for injunctive relief is costly. The impact on all parties is direct and substantial, and that includes third parties (such as the new employer or prospective employer) who may be dragged into this. Damages rack up quickly and there is little either side can do to contain those damages … with mediation, one side does not have to fail for the other to win.”

Issues of enforceability, which are typically questions of law, can be addressed in arbitration instead of litigation, said Tate. “When litigating issues of breach of non-compete and non-solicitation provisions, mediation is the perfect solution as it allows discussion and resolution without the parties having to involve valued clients in the dispute in an effort to prove (or disprove) breach allegations,” explained Tate. “For obvious business reasons, most notably the possibility of jeopardizing valued customer relationships, most companies do not want to involve their clients in these types of litigation matters.

“Mediation is ideal in this situation as it allows for a confidential discussion and hopeful subsequent resolution of the dispute before either side feels compelled to have to involve clients and customers in the matter,” said Tate. “Mediation allows the parties to work together to craft an enforceable non-compete provision, as opposed to leaving this decision in the hands of a judge who likely will not know as much as the parties about the industry and business concerns.”

So, What’s Next?

While it’s clear that non-competes are falling out of favor, that doesn’t mean they’re gone for good. “The winds of change are clearly blowing against the enforcement of non-competes,” said Dunn. However, “lawyers are extremely creative, and businesses love to restrain competition. Whatever regulations come out to ban non-competes, I look forward to seeing how lawyers try to get around them,” he added. “I expect there to be lots of inventive legal theories that will have to be tested in the courts, creating plenty of uncertainty and risk for the parties. In other words, great reasons to settle cases!”

** Originally published in the Daily Report and reprinted with permission.

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