Employers often rely on non-compete agreements and similar contracts to protect their interests when employees join or leave the company. However, the use of these agreements is becoming increasingly regulated at both the state and federal levels.
Employers need to understand how to use these agreements to protect their business without violating the law, as violations can lead to protracted legal battles, damages, and fines.
In this article, we will explore some common business agreements and best practices for using them to mitigate potential risks.
Common Employment Agreements and Contract Provisions
As an employer, there are various agreements and contract provisions (clauses) that can be used to protect your business interests. However, four of the most commonly used employer/employee agreements are:
- Non-compete agreements
- Non-solicitation agreements,
- Non-disclosure agreements, and
- Non-disparagement agreements.
In the legal world, these agreements or contract provisions are often referred to as restrictive covenants. While these agreements can be standalone documents, they can also be bundled together as clauses in a single employment contract or severance agreement.
Non-compete agreements restrict an employee from working for a competitor or starting a competing business for a specific period and within a defined geographical area after leaving your company. These agreements help protect your business by limiting the potential for former employees to share valuable knowledge, skills, or trade secrets with competitors.
Non-solicitation agreements prevent an employee from soliciting your clients, customers, or employees for a certain period after leaving your company. These agreements help protect your business relationships and investments in employee training by discouraging former employees from luring away your customers or staff members to join a competitor or start their own venture.
Non-disclosure agreements (NDAs), also known as confidentiality agreements, prohibit employees from disclosing sensitive information, such as trade secrets, proprietary information, or client data, during and after their employment. NDAs help protect your business by ensuring that valuable information remains confidential and does not fall into the hands of competitors or become public knowledge.
Non-disparagement agreements forbid employees from making negative or disparaging statements about your business or its management, both during and after their employment. These agreements help protect your company’s reputation by discouraging current and former employees from making harmful comments that could damage your business’s image or relationships with clients or other employees.
State and federal restrictions
The use of these types of agreements has come under scrutiny in recent years, with many states and federal entities imposing limitations or outright bans on their use. If your business runs afoul of these state and federal rules, you could face litigation and hefty government fines and penalties – leading to financial losses.
California has virtually banned all forms of non-compete agreements, while other states, like Washington and Massachusetts, have enacted laws that limit the enforceability of such agreements based on factors like duration, geographic scope, and the legitimate business interests of the employer.
Other jurisdictions that have enacted limitations on using non-competes include Colorado, Florida, Illinois, Maryland, Maine, Massachusetts, Nevada, New Hampshire, North Dakota, Oklahoma, Oregon, Rhode Island, Utah, Virginia, Washington, and Washington, D.C.
At the federal level, the Federal Trade Commission (FTC) has signaled its intention to scrutinize and potentially restrict the use of non-compete agreements, particularly for lower-wage workers. Although no federal laws limiting non-competes have been enacted to date, it’s worth keeping an eye out for future developments.
Non-solicitation clauses have also faced scrutiny in various states. For instance, California, which generally prohibits non-compete agreements, also extends its restrictions to non-solicitation agreements. In most cases, California employers cannot restrict employees from soliciting their clients or customers. However, clauses preventing the solicitation of fellow employees may still be enforceable in California, albeit with certain limitations.
Many other states also limit non-solicitation clauses, so it’s important to review your state’s rules to ensure compliance with local laws.
In recent years, there has been a growing concern about the misuse of NDAs to silence employees and prevent them from speaking out about harassment, discrimination, or other workplace misconduct. As a result, several states and federal entities have enacted limitations on NDAs, including Arizona, California, Hawaii, Illinois, Louisiana, Maine, Maryland, Massachusetts, Nevada, New Jersey, New Mexico, New York, Oregon, Tennessee, Vermont, Virginia, and Washington.
At the federal level, the Defend Trade Secrets Act (DTSA) includes a provision that protects whistleblowers who disclose trade secrets in confidence to government officials or attorneys to report or investigate suspected legal violations.
While non-disparagement clauses have not faced the same level of scrutiny as non-compete, non-solicitation, and NDAs, some states have enacted restrictions on their use in specific contexts.
For instance, Maryland passed a law restricting non-disparagement clauses if the clause limits employees from reporting potential violations of civil rights or criminal laws to government agencies.
At the federal level, the Consumer Review Fairness Act (CRFA) makes it illegal for businesses to include non-disparagement clauses in contracts with their consumers if it limits a consumer’s ability to share honest opinions about the business’s products or services. In other words, the CRFA says companies cannot restrict customers from leaving an honest review, even if the review is negative.
Additionally, the National Labor Relations Board (NLRB) has found that overly broad non-disparagement clauses in employment agreements can potentially violate employees’ rights to engage in protected concerted activities, such as discussing workplace conditions or organizing unions.
Severance agreements are contracts that outline the terms and conditions of an employee’s separation from a company. These agreements often include financial compensation, release of claims against the employer, and, in many cases, restrictive covenants.
The law surrounding severance agreements has also evolved in recent years, particularly with respect to the enforceability of restrictive covenants contained within these agreements. For example, in Massachusetts, non-competes must be supported by a “garden leave” clause that requires the employer to compensate the employee during the non-compete period or provide other mutually agreed consideration. This means that severance agreements that contain such clauses also must provide for payment (or other valuable consideration) for the length of any non-compete provisions.
Federally, the Securities and Exchange Commission (SEC) has taken the position that severance agreements cannot impede an employee’s ability to communicate with the SEC or other regulatory agencies about potential securities law violations. Additionally, a February 2023 ruling by the NLRB largely prohibits employers from requiring laid-off workers to sign broadly worded non-disclosure and non-disparagement agreements. The ruling found that broad non-disclosure and non-disparagement terms were unlawful because they would interfere with the worker’s rights to organize their workplace.
Best Practices to Protect Your Business
The employee agreements discussed in this article can offer many valuable protections to your company, but they can also open your company to liability if they are not drafted and exercised with care. To ensure your business gets the most out of these agreements (without the risks), here are a few general tips:
- Familiarize yourself with applicable state and federal laws. Consult with legal counsel to understand the specific requirements and limitations in your jurisdiction.
- Tailor the scope of your agreements. Limit the duration, geographic scope, and scope of activities to what is reasonably necessary to protect your legitimate business interests.
- Ensure the agreement is supported by adequate consideration. Some jurisdictions require additional consideration (e.g., financial compensation) for restrictive covenants to be enforceable, particularly when they are introduced after the commencement of employment.
- Educate your employees about their obligations. These agreements are most effective if your employees fully understand them, so it’s important to carefully review them with your employees to ensure they know their obligations and to reduce the risk of any misunderstanding.
- Periodically review and update agreements. Regularly review and update your contracts to ensure they remain compliant with evolving laws and regulations.
This article provides a brief overview of the benefits and risks surrounding the business use of restrictive covenants. It should not be construed as legal advice or individualized recommendations and is not a substitute for speaking with one of our expert advisors. We provide this information as a service for our business clients to help them protect their assets and mitigate risks. For more information, please contact our office.