A Turning Point on the Use of Non-Compete Agreements

I have a friend named Chris and a brother-in-law named Mike.

Both are great salesmen. They are likable, great with clients, and work either in a personal services or technology business. They have moved jobs, though, fairly frequently over the time I've known them. They're in demand, rightfully so. They're smart and good at what they do.

And both steadfastly refuse, ever, to sign a non-compete agreement. It hasn't hurt them a damn bit.

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Why do I bring this up? Well, first, many people I work with are just like Mike and Chris. Yet only a fraction take the approach my friends do. Just because an employer or prospective employer asks you to sign a non-compete doesn't mean you should. People aren't sheep, and we're not fungible commodities. Many people are afraid of confrontation. However, employers do not have all the leverage, even if it might appear that way. Though some may claim to need a non-compete of some kind, there's always room to negotiate and often times room to refuse to sign altogether. If the agreement's non-negotiable, then maybe you're better off finding a job elsewhere. Who'd want to work for that company?

Those are entirely reasonable approaches, and a great many employees have the ability to pick and choose among good and bad employers. People like Chris and Mike.

But not all do. Some people don't have marketable skills, are just entering the workforce, or face a shortage in the potential firms able to offer a decent job at a decent salary. And in those circumstances, bargaining power goes down. Dramatically. An employee may subjectively know she shouldn't sign a non-compete, but truth be told, she needs the f*cking job.

There are probably more people like that than there are workers like Chris and Mike. When it comes to non-competes, they live and work in the shadows.

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It is these shadow employees that leads us, in my opinion, to a pivotal moment in how firms use non-competes, let alone enforce them. There's a move afoot by state attorneys general to police the overuse of non-compete agreements, as we've seen with the Jimmy John's fiasco and Eric Schneidermann's efforts in New York to stop the anti-competitive madness. There may even be a path for individual "private attorneys general" to do the same sort of thing under state deceptive trade practices law - with the prospect of fee recovery there for the taking.

Throughout my time writing this blog, I've advocated for reform. But the complex nature of non-compete law means that incremental reform is how the ball must get rolling. In Illinois, the General Assembly and Governor Bruce Rauner passed common-sense legislation that banned non-compete agreements for low-wage workers. This is the ideal sort of starting point to clear out some of the underbrush.

The White House added a new substantive layer to the reform discussion this week by urging state lawmakers to adopt meaningful changes to non-compete law. This initiative is somewhat remarkable, because there's really no suggestion that federal legislation is on the way. (The proposed MOVE Act, which is limited in scope, has gone nowhere. My post from last year discussing the legislation, a direct response to the Jimmy John's imbroglio, is available here.) Instead, the federal government is calling on state lawmakers to act and implement best practices with regard to non-compete law.

Those best practices cover three basic areas:

1. Ban non-competes for certain classes of employees. According to the White House, classes would include "low-wage" workers, those who work in occupations that "promote public health and safety," those without access to trade secrets, and those who are laid off or terminated without cause.
2. Improve transparency. This approach would advocate for upfront disclosure about non-competes before the start of the employment relationship and to require some tangible consideration (such as garden-leave or a signing bonus) beyond the mere continuation of employment. Some states now - New Hampshire and Oregon - have implemented advance notice laws that help mitigate the adhesive nature of non-compete agreements and, in theory, enable workers to evaluate competing job offers before having a non-compete sprung on them when they start work. 
3. Incentivize fair drafting. The White House has promoted the "red pencil" doctrine, which would void an entire agreement if certain provisions are unenforceable. This approach would prevent an employer from stepping back into a reasonable contract it could have drafted but chose not to. As my prior posts illustrate, state law is all over the map with regard to partial enforcement of overbroad non-competes.

In my opinion, these reforms are spot on. My advice to state lawmakers would be to prioritize the areas the White House has identified, with an immediate focus on banning non-competes for low-wage workers, similar to what Illinois has accomplished, and those terminated without "cause," as defined consistent with other employment provisions in state law (e.g., eligibility for unemployment compensation). Once we've made progress in those areas, states can turn their attention to implementing more nuanced reforms - such as requiring garden-leave clauses, limiting the ability of judges to "equitably reform" overbroad contracts, and outlawing non-competes for certain types of industries.

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For further information, please read Russell Beck's comprehensive post (with great links) at Fair Competition Law. The White House's Policymakers' Guide to State Policies is very well-done, readable, and hits all the major discussion points.

Changes on the Horizon: Venue and Choice-of-Law Provisions in California Contracts

One of the most vexing procedural issues in recent years has been what to do with out-of-state litigation against a California employee. The contractual framework usually goes something like this:

1. California resident has a non-compete covenant in an employment contract.
2. California resident leaves to compete.
3. The contract contains a choice-of law and choice-of-venue provision that applies some other state's law.
4. That other state's law is more employer-friendly than California.
5. Litigation commences in the contractually selected state.
6. And sometimes, the employee files satellite litigation in California to get around the contractual framework.

Unfortunately, courts have not resolved these questions in a consistent manner. Some states, like Illinois and Delaware, appear to give primacy to California's overarching public policy interest embodied in its long-standing statutory prohibition on non-competes. Other states are more willing to enforce the venue and choice-of-law provisions despite that well-known California policy.

The question may get easier to resolve next year, when Section 925 of the California Labor Code goes into effect.That law will bar the procedural hurdles California employees sometimes face and give him or her the option to void contractually agreed-to venue and law provisions. An aggrieved employee also may recover fees arising out of this procedural dispute and may obtain an injunction in California against parallel litigation in another state.

Section 925 contains a potentially broad exception, stating that it "shall not apply to an employee who is individually represented by legal counsel in negotiating the terms of an agreement to waive any legal right, penalty, remedy, forum, or procedure for a violation of this code." In other words, if an employee engages counsel and waives Section 925 (and presumably gets some payment for that waiver), then the employee cannot undo the change after the fact.

By its plain language, the Section 925(i) exception does not apply to any individually negotiated agreement - only those where the actual agreement results in an express waiver of a challenge to foreign venue and choice-of-law rights.

Section 925 represents a legislative solution to a potentially serious problem of interstate comity involving California residents. In fact, it's exactly what I advocated for in a post nearly four years ago - which you can find here. I choose to be positive and will assume that the fine legislators in California relied on my blog post in crafting Section 925.

Non-Competes Gone Wrong: The Unneeded Belt-and-Suspenders Approach

When you have reviewed as many non-competes as I have, it doesn't take long to spot major red flags. They often times arise in the context of at-will employment contracts for regular, average, run-of-the mill employees who do not serve in an executive capacity. Indeed, the oddity is that this group of contracts for people who pose the lowest threat tends to be the most oppressive and poorly drafted.

Here are the 7 most common red flags associated with unreasonable non-compete contracts:

1. A broad non-compete clause that prohibits work in an entire industry, with no limiting condition narrowing the covenant to a specified group of jobs.
2. A vague definition of a "competitive business," which is sometimes nominally used to define the scope of the non-compete restriction.
3. A broad geographic scope that may be commensurate with the employer's line of business, but not with where the employee has developed her sphere of influence.
4. A non-solicitation covenant that contains a broad, untethered definition of "customer."
5. A non-solicitation covenant that extends to prospective customers who never developed a relationship with the employer.
6. A confidentiality clause with no time limit.
7. A confidentiality clause that contains an overbroad definition of "confidential information," suggesting it can be a backdoor non-compete clause that extends in perpetuity.

These covenants - particularly when applied to mid-tier employees - are frequently not litigated because the cost of doing so is prohibitively high for the employee. To be sure, most employees will make a rational economic choice to incur those costs only if (a) the new employer is willing to subsidize the effort (rare), or (b) the potential long-term gain from invalidating the agreement exceeds the sum of (i) litigation costs and (ii) discounted risk of a non-indemnifiable damages judgment (more rare). Frankly, the economics often just don't work.

When these agreements do make their way into court, judges will notice the seven red flags I identified above. My experience is that they're willing to overlook one or two as the work product of an overzealous attorney. However, when several (or sometimes) all of these factors are present, courts are inclined to strike the agreement and view it as a blatant overreach on the employer's part.

Sometimes this occurs at the earliest stages of litigation before the expensive discovery process begins. This is what occurred in Seneca One Finance, Inc. v. Bloshuk, No. 16-cv-1848, 2016 U.S. Dist. LEXIS 138866 (D. Md. Oct. 6, 2016), a case in which 6 of the 7 red flags were present in an employee's non-compete agreement. The Maryland court had little trouble tossing the case after the employee sought an early dismissal.

One of the structural impediments to non-compete litigation is the relative unwillingness of many judges (the Maryland court being an exception) to dismiss cases early. I have been an advocate of "quick-look" proceedings in non-compete litigation as a means to tease out facially overbroad agreements and those where consideration is sorely lacking. This process cuts against the design of our adversarial system where, for better or worse, the civil discovery process weeds out cases through sheer attrition.

The problem, in my mind, is that discovery attrition can work in cases where the parties are on a level playing field to litigate (many patent cases), or where the party with a relative lack of resources has the ability to recover monetary damages (discrimination or personal injury cases). In a non-compete dispute, neither of those fact patterns is usually present. And if we're to maintain a system where the freedom to compete and the freedom to contract stand in equipoise, then a quick-look system may be the only route to achieve that.

No Good Deed Goes Unpunished

The high-frequency trading business is nothing if not opaque. Noted author Michael Lewis shone light on it in the wonderful book Flash Boys. And the industry gave us Sergey Aleynikov, who has managed to contribute mightily to the area of trade secrets and corporate indemnification law over the past decade.

The HFT world, when it comes to non-competes, is predictably ahead of the curve. Having represented many quants and traders, something of an industry standard has developed. And I'm not sure it has been replicated elsewhere.

HFT non-competes often work like this. Employee signs an employment agreement that contains salary, bonus eligibility, and non-compete restrictions, along with the panoply of confidentiality clauses and invention assignment provisions you would expect in a business that thrives on opacity.

For starters, HFT firms don't really need customer-based clauses because they have no customers. So the non-compete is a true industry-wide restriction, justified largely on the basis that the firm's business model is proprietary and the employees are privy to a wide range of non-public trading strategies and confidential information.

The non-compete, though, shifts. It does so based on the company's election, at the time of termination, as to how long it will last. Typically, the HFT firm agrees to pay the employee his or her salary (or some percentage of total income) during the selected period. In my experience, the period can last 0, 3, 6, 9, or 12 months. And, according to a typical HFT contract, the company decides and notifies the employee of the non-compete term, paying the employee what amounts to garden-leave during that period of time.

This seems relatively uncontroversial (some might even say it's fair). But as shown by Reed v. Getco, LLC, a Chicago HFT firm, Getco, deviated from this model. Its contract contained a six-month non-compete clause, with consideration of $1 million payable to the employee during the term. When Reed quit, Getco advised him that his non-compete term was "zero months and/or is waived. You will not receive any noncompete payments."

Reed then sat out and did not compete for more than six months, seemingly abiding in full with his contractual covenant. He then sued for the noncompete payment. The appellate court found he was entitled to it. The court did not allow Getco to rely on boilerplate contract provisions concerning "waiver" and "modification," finding apparently that Reed had a contractual right to the $1 million - which he earned by complying with a non-compete Getco told him it was not going to enforce.

What is not clear from this opinion is whether Getco's agreement incorporated the industry standard non-compete that shifts, based on the employer's election. It appears that Reed negotiated something separate than that. So at first blush, I am not sure the Reed decision does much to upend the HFT business model for enforcing non-competes.

To that end, HFT firms still may be able to get away with their shifting non-compete term, provided that the contract makes it clear the payment is optional and dependent on the firm selecting an appropriate non-compete period. Getco may have been thinking that it would treat Reed like other employees - and simply forgot that his contract was much more custom.