Non-compete reform has come to Massachusetts, with wide-ranging legal and practical implications for any employers with workers in Massachusetts. Employers have just six weeks to consider and adopt a new approach to non-compete agreements for their workforces. The new law, which becomes effective on October 1, 2018, comes after many years of debate and dramatically shifts the restrictive covenant legal landscape in the Commonwealth.
While employers will still be able to utilize non-compete agreements for most workers, the law necessitates a new approach to drafting, implementing, and enforcing these agreements. This post summarizes the new law, identifies employer action items, and raises several issues that will emanate from this reform.
Brief Summary of the New Law:
The key takeaways of the law are as follows:
- Non-compete agreements will be more expensive to utilize. Employers must offer the employee paid “garden leave” for the length of the restricted period of at least 50% of the employee’s highest base salary during the prior two (2) years (or some “other mutually-agreed upon consideration,” which the agreement must specify);
- Employers cannot require all employees to sign non-compete agreements. The law prohibits employers from requiring certain categories of workers, including non-exempt employees, to enter into non-compete agreements;
- Non-compete agreements may be void depending on the reason for separation. Employers cannot enforce non-compete restrictions against employees who have been terminated without cause or laid off, except when included as part of a separation agreement;
- The new law only applies to agreements entered into on or after October 1, 2018. Older agreements are not voided, but employers should consider revisiting the current agreements in place. We address this issue further below;
- Continued employment is no longer sufficient consideration. Employers must provide fair and reasonable consideration to support non-compete agreements signed after employment has commenced;
- The non-compete agreement must be reasonably tailored. A non-compete agreement must: (i) be limited to a maximum one (1) year non-compete period (subject to a limited exception discussed further below); (ii) protect statutorily covered employer interests (i.e. trade secrets); and (iii) cover a geographical scope that is reasonable in relation to the employer’s protectable interests;
- The new law applies to employees and independent contractors alike. The new law specifically defines employee to include contractors and will also require employers to retool those agreements to the extent they include non-compete provisions; and
- The law does not apply to all agreements with restrictive covenants. The law does not cover non-solicitation agreements, non-disclosure agreements, and separation agreements (among others discussed below), which means that these agreements will continue to be analyzed under the common law, but now against the backdrop of the new public policy on non-compete restrictions.
Taken together, while many of the law’s provisions reflect best practices for enforceable non-compete agreements, several of the requirements – particularly around the requisite consideration supporting non-compete agreements – will now require employers to evaluate their overall non-compete strategy, update their non-compete agreements, and adjust their human resources processes to ensure compliance with the law.
Below we explore the law in greater detail and highlight the practical and legal implications for employers.
The Law Captures Only Certain Types of Agreements and Applies to Only Certain Types of Employees
The New Law Applies to Non-Compete Agreements, But Carves Out Many Other Types of Restrictive Covenants
The law applies to non-compete agreements, and defines a “noncompetition agreement” as:
[A]n agreement between an employer and an employee, or otherwise arising out of an existing or anticipated employment relationship, under which the employee or expected employee agrees that the employee will not engage in certain specified activities competitive with the employee’s employer after the employment relationship has ended[.]
Other kinds of restrictions are not considered “noncompetition agreements” and are expressly exempted from the scope of the law. These include:
- A covenant not to solicit or hire employees of the employer;
- A covenant not to solicit or transact business with customers, clients or vendors of the employer;
- An agreement made in connection with the sale of a business entity or substantially all of the operating assets of a business entity or partnership when the party restricted by the non-compete agreement is a “significant owner” of, or member or partner in, the business entity who will receive “significant consideration” or benefit from the sale;
- An agreement outside of the employment relationship;
- A forfeiture agreement, defined as an agreement that imposes adverse financial consequences on a former employee as a result of the termination of an employment relationship, regardless of whether the employee engages in competitive activities. This does not include forfeiture for non-compete agreements, which imposes adverse financial consequences on a former employee as a result of the termination of an employment relationship if the employee engages in competitive activities;
- A non-disclosure or confidentiality agreement;
- An invention assignment agreement;
- A garden leave clause unrelated to a non-compete agreement;
- An agreement made in connection with the cessation of or separation from employment if the employee is expressly given seven (7) days to rescind acceptance; or
- An agreement by which an employee agrees not to reapply for employment to the same employer after the employee’s termination.
However, employers must understand that while exempted, Massachusetts courts will continue to analyze these agreements’ enforceability under Massachusetts common law, and likely will look to the public policy behind the non-compete law in their analysis. For example, even though the law exempts restrictive covenants included in separation agreements, courts could ask why a covenant lasting more than one (1) year should be enforced.
Employers Can No Longer Require Non-Exempt (and Other) Employees to Sign Non-Compete Agreements and Voids Them For Certain Involuntary Separations
The law specifically prohibits enforcement of non-compete agreements against the following categories of workers:
- Non-exempt employees;
- Undergraduates or graduate students engaged in short-term employment; and
- Employees 18 years or younger.
The law also voids non-compete covenants where the employer terminates the employee without cause or includes them in a layoff. The law currently does not define the term “cause,” leaving an open question for employers as to whether an employer may enforce a non-compete agreement against an employee it terminates for poor performance or misconduct. For example, firing an employee for willful misconduct or gross negligence likely constitutes “cause,” but what about an employee terminated for a repeated failure to meet performance expectations or pursuant to a progressive discipline policy? Another unanswered question is whether employers can define “cause” in the non-compete agreement so there is certainty around this issue. The statutory definition of “cause” will likely be the subject of litigation as employers try to enforce non-compete agreements against employees who have been involuntarily terminated.
This cause/layoff carve-out is a significant and troubling development because an employer’s interest in protecting trade secret and confidential information and its goodwill is aimed at preventing unfair competition, and these are interests that an employer still needs to protect regardless of the reason for separation. Thus, to the extent not already utilized, employers should consider other ways in which to protect these interests, including through appropriately-tailored non-solicitation or severance agreements.
The New Law Applies to Independent Contractors As Well
The law defines “employee” to include independent contractors. So a non-compete agreement with an individual engaged as a so-called “1099 employee” or independent contractor will be subject to the same rules as an agreement with an employee. Even if compliant with the new law, however, employers should be very careful requiring non-compete agreements for independent contractors as doing so can undercut an employer’s argument that a worker is properly classified as an independent contractor. As such, other restrictive covenants are better suited to independent contractor relationships.
The Law Guides Employers on How to Create a Narrowly Tailored Non-Compete Agreement
Protectable Interests: The new law requires that non-compete agreements be “no broader than necessary to protect the legitimate business interests of the employer.” Legitimate business interests are defined as the employer’s trade secrets, the employer’s confidential information that otherwise would not qualify as a trade secret, or the employer’s goodwill. This requirement is generally consistent with the current state of the common law. The law also states that a non-compete agreement “may be presumed necessary where the legitimate business interest cannot be adequately protected through an alternative restrictive covenant, including but not limited to a non-solicitation agreement, a non-disclosure agreement or a confidentiality agreement,” but provides no clarity on this presumption.
Duration: The law limits post-employment non-compete periods to one (1) year. In two scenarios however, this period can be extended to up to two (2) years – where the employee has breached a fiduciary duty to the employer or has unlawfully taken property belonging to the employer (physically or electronically). This is potentially significant for employers as they are often faced with the all-too-familiar-scenario of an employee absconding with their documents and information. Further, while silent on tolling language in non-compete agreements, this provision implies that, absent a breach of fiduciary duty or theft, a tolling provision would not be enforceable.
Geographic Area: The agreement must be “reasonable” in relation to the interests protected. The new law provides some color on that requirement by stating that it will presume as reasonable those geographic restrictions limited to only the geographic areas in which the employee, during the last two (2) years of employment, provided services or had a “material presence or influence.” But just as quickly as the new law giveth; it taketh away, as it fails to define the phrase “material presence or influence” leaving it likely to be the subject of dispute. For example, if a sales director managed employees in certain territories, but did not provide services in those areas himself or herself, does that equate to “influence”?
Scope of Activities: The agreement must be “reasonable” in the scope of proscribed activities that are restricted. Again, the new law attempts to guide the employer in the right direction by presuming as reasonable an agreement that “protects a legitimate business interest and is limited to only the specific type of services provided by the employee at any time during the last two years of employment.”
Mandatory Paid Garden Leave or “Other Mutually Agreed Upon Consideration”
The new law requires employers to provide “garden leave pay” or other “mutually agreed upon consideration”. The garden leave pay must be least 50% of the employee’s highest base salary over the prior two (2) years, pro-rated over the restricted period.
The statute makes clear, however, that the garden leave pay requirement only runs (i) if the employer chooses to enforce the restrictions; (ii) so long as the employee is in compliance with the agreement; and (iii) up to a maximum of one (1) year, and would no longer apply if the period extends to two (2) years because of a fiduciary breach or theft of the employer’s property.
Alternatively, the restriction can be supported by “other mutually agreed upon consideration,” an undefined term, and therefore employers should consider whether to provide alternative consideration such as stock options, training, or a signing bonus at the time of the execution of the agreement. However, it is unclear whether these alternatives must have a value at least equivalent to the 50% garden leave pay rate and, without more guidance on this issue, employers will lack certainty around this alternative.
Notably, there is no exception to the mandatory garden leave requirement where an employee resigns or is terminated for cause. As such, even if an employee resigns his or her employment to go work for a direct competitor, the employer still needs to pay either garden leave pay (or some other agreed-upon consideration) to hold that employee to his or her post-employment non-compete obligation.
The Law Requires Employers to Satisfy Certain Procedural Requirements in Order to Enforce a Non-Compete Agreement
The law distinguishes between non-compete agreements entered into at the start of employment versus those entered into during employment.
At the Commencement of Employment
If a non-compete agreement is entered into at the beginning of employment, then the agreement must:
- be in writing and signed by the employer and employee;
- expressly state that the employee has the right to consult with counsel prior to signing; and
- be provided to the employee before a formal offer of employment is made, or ten (10) business days before the commencement of the employee’s employment, whichever comes first. The law is silent on whether the ten (10) day waiting period may be waived if both parties agree.
After the Commencement of Employment
If, however, an agreement is entered into after the employment relationship has started, but not in connection with the employee’s separation from employment, then the agreement must:
- be supported by fair and reasonable consideration independent of the continuation of employment;
- provide notice at least ten (10) days prior to the effective date of the agreement;
- be in writing;
- be signed by both the employer and the employee; and
- state that the employee has the right to consult with counsel prior to signing. The statute does not provide any guidance as to what will suffice as “fair and reasonable consideration” – yet another concept that will have to develop over time through court decisions.
Violations of the Law, Blue-Penciling and Venue Choices
If a non-compete agreement is found in violation of the new law, a court will be permitted to declare the entire agreement as null and void, or to reform or revise the agreement so as to render it valid and enforceable to the extent necessary to protect the applicable legitimate business interests. If a specific provision of the agreement is considered null and void, the remainder of the agreement can remain valid.
Further, if there is a dispute over the validity of the agreement, the dispute must be brought in the county where the employee resides or, if the parties mutually agree, in Suffolk County. If the dispute is brought in Suffolk County, then the Superior Court will have exclusive jurisdiction over the matter (raising the question of whether an action could be filed in or removed to federal court). There are no jurisdictional limitations noted if the case is filed in a different county. In addition, the law requires that Massachusetts law be applied to employees that reside in or are employed in Massachusetts at the time of the employee’s termination. In this regard, employers will be unable to utilize a choice of law provision to circumvent the requirements imposed under the law.
Action Items for Employers
Until this law, non-compete covenants were analyzed under Massachusetts common law, and courts would generally enforce them if they were narrowly tailored to protect an employer’s legitimate business interests. However, what a court would consider to be “narrowly tailored” or a “legitimate business interest” was not always easy to predict. This led to substantial uncertainty about the enforceability of a non-compete covenant in any given case. Although the common law principles will continue to apply in many respects, the statute brings added certainty to the analysis of the enforceability of non-compete agreements. At the same time, the law introduces new concepts that it does not specifically define or otherwise leaves open to interpretation, and it will require courts to further develop the body of non-compete common law to provide greater certainty.
Employers have just six weeks to ensure that their non-compete agreements, and their practices around implementing and enforcing such agreements, comply with specific statutory requirements. Given the significant changes brought about by the new law, employers should consider the following action items:
- Evaluate overall non-compete strategy: in light of the new restrictions, employers should rethink their approach to requiring employees to sign non-compete restrictions and decide what consideration they will offer to support non-compete agreements. For example, an employer may decide to reserve non-compete agreements for only key employees that would pose a significant risk if they went to work for competitors, and use strong non-disclosure/non-solicitation agreements for other employees. In light of the requirement of a garden leave pay provision or “other mutually-agreed upon consideration,” employers also need to consider the financial impact of binding employees to post-employment non-compete restrictions.
- Draft new non-compete agreements: for incoming employees after October 1, 2018, new agreements should be created that comply with the new statutory requirements, including provisions on the notice period, one (1) and potentially two (2) year non-compete period, the geographic scope reflecting the employee’s work area, the narrow scope of proscribed activities, the garden leave pay, choice of law, venue and other procedural-based provisions. Employers will also want to strengthen non-solicitation and confidentiality restrictions to ensure protection for confidential business information and customer and employee goodwill.
- Address existing non-compete agreements: even though the law applies to agreements entered into after October 1, 2018, consideration should be given to providing new agreements to current employees so that employers will have a better sense of the agreements’ enforceability in the future. Depending on many factors, including the form of non-competes currently in place, the make-up of the workforce, and the protectable interests at issue, employers will need to weigh the pros and cons of signing existing employees up to new non-compete restrictions. Key issues related to this decision include:
- Keep in mind that because continued employment is no longer sufficient consideration to support a non-compete agreement, employers will need to provide specific consideration with the roll-out of new agreements.
- Consider if non-compete agreements with current non-exempt employees should be revised given the strong public policy arguments against enforcement of such restrictions even if they pre-date the new law.
- Determine whether new non-compete agreements should be provided to employees promoted after October 1, 2018 given existing case law favoring new non-compete agreements being entered into upon a material change in the terms and conditions of employment.
- Be mindful of anticipated litigation over the application of the law to both existing and new non-compete agreements. For example, since the law will apply only to agreements entered into on or after October 1, 2018, there is a notable tension between the terms of non-compete agreements for current employees and those that start after October 1, 2018 – particularly the equitable considerations of enjoining employees from working for competitors under agreements that now conflict with the public policy of the Commonwealth. How this gap will be addressed from a public policy standpoint remains to be seen.
- Update human resources processes and template documents: employers’ onboarding process and documents (such as offer letters) should be revised to ensure that non-compete agreements are validly entered into at the beginning of employment, including building in the requisite ten (10) day notice period (or providing the non-compete agreement before the formal offer). Likewise, the process and documents used for departing employees should be updated given the law’s varied requirement based on the nature of the separation. In addition, human resources employees, recruiters, and hiring managers would benefit from training on the law’s requirements.
We recommend consulting with counsel to ensure compliance with the new law and to limit the potential legal and financial risks of having your non-compete agreement declared void.