?Noncompete agreements are becoming less common throughout the country, partly due to state legislative and court action. Most recently, Colorado has taken steps to significantly limit the use of noncompete and nonsolicitation agreements, which are contracts that stop employees from competing with the company or soliciting a company’s customers for a certain period of time after they leave the company.
California; North Dakota; Oklahoma; and Washington, D.C., ban noncompete agreements with a few narrow exceptions. Colorado, Illinois, Maine, Maryland, New Hampshire, Oregon, Rhode Island, Virginia and Washington state prohibit noncompete agreements unless the worker earns above a certain threshold. Multistate employers need to be aware of the changing legal obligations. “Whereas many state legislatures do not want to go so far as to outright ban all restrictive covenants, many also want to protect lower-income employees from being hamstrung by noncompetes and nonsolicits,” said Eric Barton, an attorney with Seyfarth in Atlanta. “By enacting salary thresholds, legislatures are attempting to balance employers’ wishes with the mobility of lower-income workers.”
Beyond the state legislatures, court cases are setting legal precedent, as well. In February, the Hawaii Supreme Court ruled that a real estate brokerage could not enforce a noncompete agreement that prohibited a real estate broker from establishing her own company in Hawaii for one year after leaving the employer. The court concluded that employers in Hawaii can’t enforce noncompete agreements unless there’s a legitimate business purpose for doing so, such as protecting trade secrets, confidential information or special customer relationships.
Most of these new state restrictions took effect within the last two or three years during the COVID-19 pandemic, which tightened the labor market in many industries, especially restaurants, hotels, transportation, utilities, professional services, retail, and arts and entertainment.
Who Is Bound by Noncompetes?
Approximately 18 percent of American workers are bound by noncompete agreements, with 38 percent saying they agreed to at least one in the past, according to a study published in the Journal of Law and Economics in 2021. Only 10 percent of employees negotiate over their noncompete agreements, and about one-third of employees are presented with noncompete agreements after having already accepted a job offer. Wages are lower where noncompete agreements are easier to enforce, compared with other locations, the study found.
Among workers earning $20 per hour or less, 12 percent reported having a noncompete contract in their current or most recent job, compared with 18 percent of workers earning more than $20 per hour, according to research released by the Federal Reserve Bank of Minneapolis in October 2021.
The most common reasons for using noncompete contracts are to protect the employer’s proprietary information and increase the employer’s incentive to provide training to workers. The threat of enforcement can limit workers’ negotiating power and career opportunities, even in states that do not heavily enforce the contracts, the report noted.
Colorado’s Law
Colorado has one of the newest and strictest laws regarding noncompete and nonsolicitation clauses, which took effect on Aug. 10.
It says those contracts are not enforceable unless they are:
- Noncompete agreements accompanying a sale of business.
- Noncompete agreements signed by highly compensated employees who earn more than $101,250 per year.
- Nonsolicitation agreements signed by workers earning more than $60,750 per year.
Colorado employers must notify job applicants about any noncompete agreements and ask them to review the agreements before they accept the job. For current employees, employers must provide written notice at least 14 days before the agreement takes effect. The law makes it clear that reasonable confidentiality agreements are still permissible.
“In general, noncompetition and nonsolicitation agreements must be for the protection of trade secrets,” said Mary Will, an attorney with Faegre Drinker in Denver. “Trade secrets are specifically defined under state law. Companies cannot deem information or documents a trade secret without compliance with specific trade secret laws.”
The consequences for noncompliance are big. Colorado employers that don’t meet the new statutory requirements could face penalties of $5,000 per worker, as well as possible criminal prosecution as a class 2 misdemeanor, punishable by up to 120 days imprisonment and a $750 fine.
“While a few other states have enacted laws that also include monetary and criminal penalties, the vast majority of states have not, so the new Colorado law is definitely in the minority,” Barton said. “Because the new Colorado law appears to allow substantial latitude for judges when it comes to enforcing the monetary fine and misdemeanor penalty, only time will tell how these particular provisions are actually implemented.”
“We think we may see an uptick in penalties assessed under the noncompete statute going forward and would anticipate such penalties hitting companies with multiple violations the hardest,” Will said.
What are the practical steps employers should take?
“HR professionals in Colorado need to be trained on the intricacies of the law, such as who it applies to, who it does not, what language it must contain,” Barton said. “If they have not done so in the last 12 months, I would strongly encourage all Colorado employers to conduct a restrictive covenant audit to ensure their noncompete and nonsolicitation agreements are enforceable and are being presented to the proper employees in the proper way to comply with the new law.”