Non-compete agreements are gaining traction, but courts may step on the brake

The past few years have witnessed an ongoing legislative trend that seeks to narrow the scope of employee restrictive covenants, specifically non-compete agreements. Currently, California, North Dakota, Minnesota and Oklahoma almost exclusively ban the enforcement of non-compete agreements. While most states permit "reasonable" non-compete agreements, the standards for enforceable non-compete provisions vary throughout jurisdictions. The most common factors considered include wage thresholds, employment types, notice requirements, and limits on restriction periods. In most cases, California bans employers from enforcing restrictive covenants against their employees. California Business and Professions Code Section 16600 provides that "every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void. " Section 1600 reflects California's legislative inclination towards promoting "open competition and employee mobility" and protecting the right of all Californians to "engage in businesses and occupations of their choosing." Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 946 (2008). Silicon Valley's success is largely attributed to California's ban on non-compete agreements, which allowed for the growth of knowledge transmission and technological innovation.

California treats non-compete provisions as wholly void unless they fall into one of three narrow exceptions. California Business and Professions Code Section 16601 states in part that "any person who sells the goodwill of a business, or any owner of a business entity selling or otherwise disposing of all of his or her ownership interest in the business entity" may agree with the buyer to refrain from engaging in a business similar to the one sold, within a specified geographic area.

Similarly, Sections 16002 and 16602. 5, respectively allow partners and members of limited liability companies to agree not to compete "upon or in anticipation of a dissolution of, or the termination of his or her interest in" the partnership or limited liability company. Another relevant section is Labor Code Section 925, which governs contracts entered into after Jan. 1, 2017. The Section prohibits employers from requiring employees to agree to any provision that would (1) require the employee to adjudicate a claim outside of California that arose in California; or (2) deprive the employee of the substantive protection of California law with respect to a controversy arising in California. If exercised by the employee, the Section voids any such forum selection clause, thereby transferring the action to California. Section 925 only applies to employees who primarily reside and work in California and who were not represented by counsel in negotiating the forum-selection or choice-of-law provisions. In NuVasive v. Miles, Case (Del. Ch. Ct. Aug. 26, 2019), the court held in favor of the breaching party, concluding that California's public policy was "sufficiently strong that it must not be 'diluted by judicial fiat,'" and, therefore, outweighed Delaware's interest in freedom of contract. In 2022, several legislatures passed laws limiting employers' ability to enter into restrictive covenant agreements with their employees. Colorado, the District of Columbia, and Illinois were among the jurisdictions where laws narrowing the scope of non-compete agreements were enacted. On May 24, 2023, Minnesota Gov. Tim Walz signed a bill banning new non-compete agreements. In a similar vein, the New York Legislature passed a similar bill that, uponGov. Kathy Hochul's signature, will make New York the fifth state banning practically all non-compete agreements. Even Delaware, a notably contractarian state, is shifting away from broadly enforcing non-compete agreements. For example, in Kodiak Building Partners, LLC v. Philip D. Adams (Del. Ch. Ct. Oct. 6, 2022), the Delaware Court of Chancery struck down a non-competition provision in the context of a business sale agreement, finding that the covenant went beyond the buyer's "legitimate business interest" of protecting the goodwill it acquired in the sale.

Similarly, jurisdictions that allow out-of-state choice of law provisions are also becoming increasingly reluctant to uphold provisions where the application of the forum state's laws would be contrary to another state's public policies. In Cabela's v. Highby, 801 Fed. Appx. 48 (3rd Cir. 2020), the 3rd Circuit held that although the action was brought in Delaware due to the contractual choice of forum provision, Nebraska had a greater interest in the litigation and that Nebraska's more restrictive non-compete laws overrode the Delaware choice of law provision. The federal government is also implementing measures to restrict the use of employee non-compete agreements. On Jan. 6, 2023, the Federal Trade Commission proposed a new rule that, if enacted, would effectively impose a near-total ban on the use of non-compete agreements across all fifty states. See FTC Proposed Rule, 88 Fed. Reg. 3482 (Jan. 19, 2023).

Under the proposed rule, non-compete agreements involving owners engaged in the sale of a business would remain valid. The rule followed President Biden's 2021 Executive Order 14036, directing the FTC to "curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility. " The issuance of the rule is not expected until 2024, and the rule itself will likely face an uphill battle in court.