Washington State Enacts Law Restricting Non-Compete Agreements
Washington State Enacts Law Restricting Non-Compete Agreements
Washington’s Engrossed Substitute House Bill 1450, which dramatically curtails non-compete agreements, was signed into law by Governor Inslee on May 8, 2019. Although the new law does not take effect until January 1, 2020, businesses will need to act quickly to evaluate both existing and future non-compete agreements in order to avoid costly litigation and significant penalties.
“The legislature finds that workforce mobility is important to economic growth and development. Further, the legislature finds that agreements limiting competition or hiring may be contracts of adhesion that may be unreasonable.”
Washington’s new law places significant restrictions on the use of non-compete covenants, rendering them “void and unenforceable” against: (1) employees earning less than $100,000 per year, annualized and adjusted for inflation, from the party seeking enforcement; (2) employees who are terminated as the result of a layoff, unless the employee is compensated at base salary at the time of termination for the period of enforcement, minus compensation earned through subsequent employment during the period of enforcement; and (3) independent contractors earning less than $250,000 per year, adjusted for inflation, from the party seeking enforcement.
Below are some of the key provisions and takeaways from the new law.
“Non-compete covenants” are defined as “every written or oral covenant, agreement, or contract by which an employee or independent contractor is prohibited or restrained from engaging in a lawful profession, trade, or business of any kind.” Explicitly excluded from this definition are non-solicitation agreements, confidentiality agreements, covenants prohibiting the use of trade secrets or inventions, covenants entered into by a person purchasing or selling the goodwill of a business or otherwise acquiring or disposing of an ownership interest, and covenants entered into by a franchisee when the franchise sale complies with applicable Washington law.
“Earnings” are defined as “the compensation reflected on box one of the employee’s United States internal revenue service form W-2 that is paid to an employee over the prior year, or portion thereof for which the employee was employed, annualized and calculated as of the earlier of the date enforcement of the noncompetition covenant is sought or the date of separation from employment.” For independent contractors, “earnings” means payments reported on Internal Revenue Service form 1099-MISC.
The law creates a rebuttable presumption that a non-compete covenant lasting longer than 18 months is unreasonable and unenforceable against an employee. A party seeking to rebut that presumption must prove by clear and convincing evidence that a duration longer than 18 months is necessary to protect the party’s business or goodwill—a significant burden to overcome.
The duration of a non-compete covenant between a performer and a performance space or a third party scheduling the performer for a performance space is expressly limited to three calendar days. Interestingly, the law places no express duration on a non-compete covenant enforceable against an independent contractor, effectively leaving that to traditional common law analyses.
The new law requires employers to disclose the terms of a non-compete covenant in writing to prospective employees no later than the time of the acceptance of the offer of employment. If the non-compete covenant becomes enforceable only at a future date because of changes in the employee’s compensation, the employer must specifically disclose that the agreement may be enforceable against the employee in the future. Non-compete covenants that are entered into after the commencement of employment must be supported by independent consideration.
Many employers choose to offer employees additional compensation in the form of stock. It is important for employers to recognize that stock may qualify as “earnings” under the new law under certain circumstances, rendering a non-compete covenant enforceable against an employee who would otherwise have earnings of less than $100,000 per year. For example, employee stock grants become earnings at the time of vesting. Non-qualified stock options become earnings when they are exercised. Employee stock purchase plans will generate earnings depending on whether they are qualified or non-qualified: the former when selling the shares and the latter when purchasing shares.
Choice of Law
The new law prevents employers from utilizing forum selection or choice-of-law provisions to circumvent application of Washington law. So long as the non-compete covenant is signed by an employee or independent contractor who is “Washington-based,” the provision is unenforceable if it requires the employee or independent contractor to adjudicate a non-compete covenant outside of Washington or if it “deprives the employee or independent contractor of the protections or benefits” of Washington law. The determination of whether an employee is “Washington-based” is often unclear and will likely be a complex and significant issue in non-compete litigation going forward.
Moonlighting and Franchisors
The new law prohibits employers from restricting, restraining, or prohibiting employees earning less than twice the state minimum hourly wage from having an additional job, supplementing their income by working for another employer, working as an independent contractor, or being self-employed. An exception is made for employers who can show that the outside employment raises safety issues or interferes with the reasonable and normal scheduling expectations of the employer. Additionally, the law does not alter the obligations of an employee to an employer under existing law, including the common law duty of loyalty and laws preventing conflicts of interest. This means that an employer’s ability to restrict employees from engaging in outside employment for a competitor has not changed.
Additionally, the law prohibits franchisors from restricting, restraining, or prohibiting franchisees from soliciting or hiring any employee of a franchisee of the same franchisor or from the franchisor directly.
Enforcement should be of particular concern to businesses utilizing non-compete covenants. The new law provides a cause of action for any person aggrieved by a non-compete covenant that may be pursued independently or by the attorney general on behalf of the aggrieved person. If a court or an arbitrator determines that a non-compete covenant violates the new law, the violator must pay the aggrieved person the greater of their actual damages or a statutory penalty of $5,000, plus reasonable attorneys’ fees, expenses, and costs. As explained further below, this applies to both new and existing non-compete covenants, so long as those covenants are being enforced.
Washington courts have long held the authority to modify non-compete covenants that are unreasonable or otherwise enforce only the reasonable portions of a non-compete covenant. Under the new law, a party seeking enforcement of a non-compete covenant is liable for an aggrieved party’s damages, including attorneys’ fees and costs, if a court or arbitrator reforms, rewrites, modifies, or only partially enforces the non-compete covenant. Thus, a party seeking enforcement of a non-compete will be liable for damages and both parties’ attorneys’ fees and costs unless the covenant is enforced as-written.
Although the new law becomes effective on January 1, 2020, it expressly applies to all proceedings commenced on or after that date, regardless of when the cause of action arose. This means that non-compete covenants that were entered into before the law becomes effective are subject to the law’s provisions, so long as those non-compete covenants are being enforced. Businesses that have existing non-compete covenants should carefully review those covenants for compliance with the new law and consider entering into new agreements with additional consideration if necessary.
Subject to Existing Law
The new law displaces conflicting tort, restitutionary, contract, and other laws pertaining to liability for competition by employees or independent contractors. Non-compete covenants are still subject to existing common law standards, however. Thus, a non-compete covenant that otherwise complies with the new law must still be reasonable in duration, scope, and geographic area to be enforceable.
Should employers take affirmative action to inform employees that existing non-competes will not be enforced?
The enforcement and retroactivity provisions of the new law pose a significant challenge for employers who have existing non-compete agreements with current or former employees. However, the new law explicitly prohibits a cause of action from being brought regarding a non-compete covenant signed before January 1, 2020 “if the noncompetition covenant is not being enforced.” This means that employers who have existing non-compete agreements should, in theory at least, have nothing to worry about so long as they are not attempting to enforce those agreements. The new law does not define the exact contours of what “enforcement” entails, but it does state that the “party seeking enforcement” means a “named plaintiff or claimant in a proceeding to enforce a noncompetition covenant or the defendant in an action for declaratory relief.”
What ambiguities exist in the law?
The new law leaves several questions unanswered.
First, the law renders non-compete covenants void and unenforceable against employees who have been terminated as the result of a layoff, unless the employer continues to compensate the employee “for the period of enforcement minus compensation earned through subsequent employment during the period of enforcement.” But it is not clear how an employer would know whether a former employee has found subsequent employment or how much that former employee is being compensated. The employer presumably must rely on the former employee’s representations regarding compensation—a difficult position considering the employee was laid off.
Second, tying the enforceability of non-compete covenants to an employee’s annual earnings could create confusion. By way of example, an employee making $90,000 in annual earnings would not be subject to a non-compete. If that employee received a $10,000 end-of-year bonus, the non-compete would become enforceable. If that employee did not receive a bonus the following year, however, the non-compete would again be rendered unenforceable. If that employee also receives stock options, the enforceability of the non-compete becomes even more complicated.
Are non-compete agreements still viable after the new law takes effect?
Non-compete agreements will continue to be a valuable tool for many employers. The biggest impact of the new law may be for smaller employers—particularly startups. Startups often compensate employees using company stock with the hope that the company’s value will grow in the coming years. Because the enforceability of non-compete covenants will now be tied to an employee’s annual earnings, non-compete agreements may no longer be a viable alternative for those companies.
A better alternative for many businesses may be company or role-specific confidentiality agreements. Covenants prohibiting the use or disclosure of trade secrets or inventions are not included in the new law and may be a more effective way for businesses to prevent many of the issues that could otherwise be addressed through a non-compete covenant.
Contact your Summit Team representative with any questions you may have on this issue.