EMPLOYERS BEWARE AND EMPLOYEES REJOICE: WASHINGTON STATE HAS CHANGED THE LAWS ON NON-COMPETITION AGREEMENTS
Copyright May 9, 2019 by Christopher C. Mason, Esq
Smyth & Mason, PLLC
Today, Washington State dramatically changed its laws on non-competition agreements. Governor Inslee has signed into law Engrossed Substitute House Bill 1450 (the “Act”) that limits the enforceability of non-competition covenants in this state. The Act goes into effect on January 1, 2020.
The Act limits the enforceability of noncompetition restrictions on employees and independent contractors. For example, restrictions on competition in a particular field or geographic area or work for a competitor are now prohibited except in limited circumstances involving high income individuals. But the Act also preserves the legality of important restrictions that employers and employees typically associate with non-competition agreements by excluding them from the definition of “Noncompetition Covenants”.
This summary is intended to help employers, employees and independent contractors understand the dramatic ways in which the Act i) changes non-competition laws in Washington State, but ii) also preserves the right to impose restrictions in certain contexts. Employers need to get ready, and employees and independent contractors need to understand their rights under the Act. For any employers who use non-competition agreements, the time to evaluate existing agreements and ensure compliance with the Act is now, before the new Act takes effect.
1. The Act Restricts Noncompetition Covenants, With 5 Exceptions
A “Noncompetition Covenant” is defined in the Act as “every” written or oral agreement “by which an employee or independent contractor is prohibited or restrained from engaging in a lawful profession, trade or business of any kind”, but five important exceptions to that definition apply. They are listed below and referred to hereafter as the “Five Exceptions”.
A. The Act Still Allows “Non-Solicitation Agreements” Between Employers and Employees
The Act does not restrict “Non-Solicitation Agreements” between Employers and Employees. A “Non-Solicitation Agreement” is defined to mean “an agreement between an employer and employee that prohibits solicitation by an employee, upon termination of employment a) of any employee of the employer to leave the employer; or b) of any customer of employer to cease or reduce the extent to which it is doing business with the employer”. For many employers, protecting clients through a non-solicitation agreement is enough, making this an important exception.
B. The Act Still Allows “Covenants Prohibiting Use or Disclosure of Trade Secrets and Inventions.”
This standard restriction continues to be allowed.
C. The Act Still Allows “Confidentiality Agreements.”
The Act allows “Confidentiality Agreements”. The term is not further defined. This suggests that contractual restrictions on use and disclosure of information may continue to be broadly defined to include more than trade secrets through contract definitions of “confidential information” or “proprietary information”.
D. The Act Still Allows Covenants Entered into in Conjunction with Purchasing or Selling an Ownership Interest or Goodwill.
The Act allows noncompetition restrictions in the context of purchase and sale agreements covering ownership interests or goodwill in a business. Because owners are often employees as well, this is an important exception as well.
E. The Act Still Allows Covenants by Franchisees in the Context of a Franchise Sale.
So long as a franchise sale complies with applicable law (RCW 19.100.020(1)) the Act allows broader non-competition restrictions in the context of franchise sales.
2. The Act Prohibits Additional Restrictions on Employees (Including Geographic Restrictions and Prohibitions on Competition in an Industry) Unless Income and Other Requirements Are Satisfied
The Act also establishes when “Noncompetition Covenants” (meaning non-competition covenants other than the Five Exceptions) will be allowed as to employees. For example, employer rights to obtain geographic restrictions on competition or prohibition on working for a competitor are now limited. In order for restrictions beyond the Five Exceptions to be allowed, the following requirements must be satisfied as to employees:
A. An Employer Must Disclose the Terms of the Noncompetition Covenant In Writing to the Prospective Employee No Later Than the Time of Employee’s Acceptance of an Offer of Employment
Most employers already disclose the need to sign a non-competition agreement in their offers. Now, they have to. Reference should also be made to the disclosure requirements explained below in the context of potentially fluctuating compensation.
B. If an Employer Enters Into the Noncompetition Covenant After Employment Begins, the Employer Must Provide Independent Consideration for the Covenant
This Washington common law requirement is now required by statute.
C. The Employee to be Restricted Must Make At Least $100,000 Per Year
This limitation is profound. No restrictions beyond the Five Exceptions are permissible under the Act except for high wage earners. If an employee does not make at least $100,000 per year, only the restrictions allowed through the Five Exceptions are permissible.
The mechanics for determination of the $100,000 threshold are set forth in the Act. Earnings are determined annually by looking at the total W-2 reported income paid the employee by the employer in the prior year. The amount is calculated as of the earlier of (i) the date of separation of employment and (ii) the date enforcement of the Noncompetition Covenant is sought.
Notably, the Act contemplates that agreements may be entered into which anticipate increases in pay and consequently broader restrictions if the $100,000 threshold is met. If an agreement becomes enforceable only at a later date due to changes in the employee’s compensation, the employer must specifically disclose to the employee at the beginning that broader restrictions are not currently in force but may be enforceable as to the employee in the future if income reaches the $100,000 threshold, as adjusted for inflation.
The Act provides that the $100,000 threshold in the Act will be adjusted annually for inflation, so it will go up.
D. If the Employee is Terminated Because of “Lay Off”, To Enforce the Noncompetition Covenant the Employer Must Pay the Employee “Base Salary” for the Period of Enforcement, Less Amounts Earned by the Employee Through Subsequent Employment
In the context of a layoff, enforcement of a non-competition covenant beyond the Five Exceptions will also require payment to the employee “Base Salary” for the period of enforcement, less amounts earned through new employment. This provision of the Act will have a chilling effect on employers. Many will be unlikely to want to pay a former employee such amounts to keep a noncompetition covenant in force. It will also likely be the source of confusion because “Layoff” is undefined. There will be argument over what a “layoff” means under the Act. Does a “layoff” require multiple terminations? Would a termination of one person other than for performance problems be a layoff? These issues have yet to be resolved.
3. The Act Limits Further Non-Competition Restrictions For Independent Contractors
The Act also establishes when “Noncompetition Covenants” (meaning non-competition covenants other than the Five Exceptions) will be allowed as to Independent Contractors. The right to obtain geographic or industry based restrictions on competition as a condition of hiring or continued employment of an independent contractor are now limited. In order for restrictions greater than the five exemptions to be allowed, the following requirements must be satisfied as to independent contractors:
A. The Independent Contractor to be Restricted Must Make At Least $250,000 Per Year
No restrictions on competition in a geographic area or industry are permissible under the Act unless the contractor makes at least $250,000 annually, as determined by 1099 income. If an independent contractor does not make at least $250,000 per year, only the five exemptions are permissible. The Act provides that the $250,000 number in the Act will be adjusted annually for inflation, so it will go up.
B. The Applicability of Additional Requirements for Employees to Independent Contractors is Uncertain.
The Act does not expressly state whether employee notice, layoff or other requirements for enforcement apply to Independent Contractors. Ambiguity on this point exists because the Act incorporates definitions of Employer and Employee as set forth in RCW 49.17.020. That section defines “Employer” to include entities and persons which “employs one or more employees or who contracts with one or more persons, the essence of which is the personal labor of such person or persons” and “Employee” to include a person “who is working under an independent contract the essence of which is his or her personal labor for an employer under this chapter whether by way of manual labor or otherwise.” Will employers be required to satisfy the additional requirements applicable to “employees” as to independent contractors as well because of these definitions? That remains to be seen, but in the context of independent contractors who are individuals, arguably yes.
4. The Act Establishes a New Presumption That Any Noncompetition Covenant Exceeding 18 Months After Termination of Employment is Unreasonable and Unenforceable
The Act requires courts and arbitrators to presume a Noncompetition Covenant exceeding 18 months is unreasonable and unenforceable. This does not apply to the five exceptions, but does apply to any other competitive restriction, like a geographic or industry wide restriction on competition. The presumption may be rebutted only by proving via clear and convincing evidence (the highest civil proof standard) that a duration longer than 18 months is necessary to protect the party’s business or goodwill.
This will make covenants longer than 18 months hard to justify and as a practical matter, make broader restrictions risky to enforce.
It is also possible that in practice, the 18 month limitation may also become a new de-facto standard for reasonableness by judges enforcing customer non-solicitation agreements under the Five Exceptions, even though the 18 month limitation does not expressly apply in that context under the Act.
5. The Act Forbids Provisions that Require any Washington Based Employee or Independent Contractor to Litigate a Noncompetition Covenant Dispute Out of State
Out of state employers need to take particular note of this provision. It is no longer permissible to require a Washington based employee or independent contract to litigate a noncompetition covenant out of state. Again, this does not apply in the context of the 5 Exceptions to the definition of Noncompetition Covenant in the Act.
6. An Employer Cannot Limit an Employee Earning Less than Twice the Applicable State Minimum Wage From Having An Additional Job, Being Self Employed or Working as an Independent Contractor, Except Under Limited Circumstances.
This restriction will impact employer policies on employees having second jobs, provided the employee makes less per hour than twice the minimum wage. However, the restriction is subject to important exceptions. First, if such additional employment “interferes with the reasonable and normal scheduling expectations of the employer” a restriction is permissible. Second, if the additional employment would violate the common law duty of loyalty and laws preventing conflicts of interest, a restriction is permissible. Third, if the services to be offered by the employee raises issues of safety for the employee, coworkers or the public, a restriction is permissible
7. Other Important Restrictions in the Act.
A. The Act Limits Non-Competition Restrictions on Independent Contractor Performers to 3 Calendar Days
The Act contains an important new restriction on the ability to limit competition of performers. While the Five Exceptions apply, further restrictions must now not exceed three days in two contexts.
First, the Act provides that the duration of a non-competition covenant between a performer and a performance space cannot exceed three days.
Second, the duration of a non-competition covenant between a performer and a third party scheduling the performer for a performance space cannot exceed three days.
B. Restriction on Franchisee Solicitations of Employees
In the franchise context, the Act prohibits any restriction or restraint on the ability of Franchisees to hire employees of the Franchisor or employees of other Franchisees of a Franchisor.
C. Provisions that Violate the Act Are Inherently Void and Unenforceable.
The Act provides that that any provision denying employees or independent contractors the benefits of the Act is void.
8. The Act Provides Significant Remedies for Employees and Independent Contractors if the Act is Violated.
The enforcement provisions of the Act are substantial. They include the following:
A. If the Noncompetition Covenant Violates the Act, the Employee Can Recover Statutory or Actual Damages, Whichever is Higher.
If a court or arbitrator concludes a Noncompetition Covenant violates the Act, the employee or independent contractor is entitled to payment of statutory damages of $5,000 or actual damages, whichever is higher.
B. The Act Provides For Recovery of Attorneys Fees and Costs by Employees or Contractors Only
If a court or arbitrator concludes a Noncompetition Covenant violates the Act, the employee or independent contractor is entitled to payment of reasonable expenses, attorney’s fees and costs. There is no provision for recovery of such fees and costs by statute if the Employer prevails.
9. The Act Appears to Apply to Agreements Signed Before the Act Takes Effect
A clause in the Act suggests that the Act may be used to challenge Noncompetition Covenants (but not the five exceptions) that employees or independent contractors signed before January 1, 2020, if the Employer attempts to enforce clauses prohibited by the Act after January 1, 2020. The Act states: “(A) cause of action may not be brought regarding a non-competition covenant signed prior to the effective date of this section if the non-competition covenant is not being enforced.”
This language strongly suggests that conversely, a cause of action may be brought under the Act to challenge a previously signed noncompetition covenant if the Employer tries to enforce it after January 1, 2020.
The Act also states that it applies “to all proceedings commenced on or after the effective date of this section, regardless of when the cause of action arose. To this extent, this chapter applies retroactively, but in all other respects it applies prospectively.” What this means will need to be determined by the courts.
10. The Act Preempts Other Conflicting Laws.
Notably, the Act states that with the exception of our State Trade Secrets Act (RCW 19.108), “this chapter displaces conflicting tort, restitutionary, contract, and other laws of this state pertaining to liability for competition by employees or independent contractors with their employers or principals, as appropriate”. Which of such laws conflict will be determined by the courts, but suffice it to say the preemption clause makes it clear it is the Act that now determines if competition is allowed or prohibited as to employees who terminate employment.
11. What You Need to Do Next
Any Employer who uses restrictive covenants in Washington, whether titled a non-competition agreement, a non-solicitation agreement, a non-disclosure agreement or otherwise, needs to review its existing non-competition agreements with counsel for compliance with the Act. Those Agreements will need to be revised to the extent they are non-compliant with the Act.
Before initiating any effort to enforce a noncompetition agreement or replace a non-competition agreement, advice from counsel should be sought on strategy given the imminent effective date of the Act.
Employees should seek advice from counsel on their agreements as well, particularly if they are approached by their employer on potential revision or replacement of existing agreements or are contemplating departure from their current employer.
Smyth & Mason, PLLC welcomes the opportunity to assist clients with respect to the Act and its changes to Washington law. You may contact us on our website www.smythlaw.com or call or e-mail Mr. Mason. This Document is informational only, and is not intended as legal advice for a particular contract or dispute. Thank you.