Reshaping Noncompetes in Washington

September, 2019

Lawrence R. CockJack Lovejoy, and Benjamin Byers

This article originally appeared in the September issue of NWLawyer, published by the Washington State Bar Association (WSBA), and is reprinted with the permission of the WSBA.

With the passage of Engrossed Substitute House Bill 1450 (ESHB 1450), signed by Gov. Jay Inslee on May 8, 2019, the Washington Legislature dramatically reshaped the landscape of Washington’s noncompetition law. This article introduces ESHB 1450, identifies ways in which it will change the common law, and discusses its purposes and goals.

APPROACHING DEADLINE: JAN. 1, 2020

Although the new law will take effect on Jan. 1, 2020, parts of the law will apply to noncompete agreements signed before the effective date. ESHB 1450, Section 13. An employer whose current agreement does not satisfy the new standards applicable to noncompetition agreements must either persuade employees to sign new agreements, accompanied by new and independent consideration,[1] before Jan. 1, 2020, or risk possible litigation in which the covenant is declared void and the employer is ordered to pay a statutory penalty and attorney fees.

TOO MANY, TOO LONG, TOO BROAD

In the past few years, several state legislatures have addressed noncompetition and other restrictive covenants.[2]  Legislative interest has been sparked by studies and articles that point out there are too many noncompetes, they are too long, and they are frequently overbroad.[3] Many covenants are so broad that they prevent an employee from taking any position at a competitor, even one wholly unrelated to the scope of current employment (that is, they prohibit working in the industry, rather than restricting certain activities or focusing on a particular scope of prohibited activity).[4]

At a time when more workers are eager to exercise greater job mobility, noncompetition covenants have become increasingly widespread (affecting an estimated 30 million workers nationwide).[5] Often, workers appear unaware of what they’ve agreed to, and 37 percent of workers are presented with the agreement only after accepting the job.[6]

Washington’s legislative process had additional catalysts. Organized labor supported reform as a result of a “no-hire” provision in an asset purchase agreement between grocers Haggen and Safeway. Upon Haggen’s bankruptcy, the no-hire provision resulted in grocery store workers being both unemployed and unable to secure employment at any Safeway. Separately, Attorney General Bob Ferguson has taken action against fast food franchisors using “no-poach” clauses,[7] which prohibit a franchisee from hiring a person who works at a company store or another franchise store. The lobbying arm of the Washington Employment Lawyers Association also prioritized noncompete reform on its agenda.

Another catalyst was a slow but steady judicial trend in noncompete litigation away from relying on policies that prohibit restraints of trade and toward placing greater emphasis on contract law. Washington common law is well settled that noncompetition covenants should be evaluated differently from other contracts; courts should balance the employer’s need for protection against general societal interest in prohibiting restraints of trade. One early example is the 1911 case involving a piano teacher, Columbia College v. Tunberg.[8] The court ultimately decided that Tunberg could not be prohibited from giving piano lessons in Seattle, but should be restrained from soliciting Columbia College of Music pupils. The court’s restructured restraint was narrow.

Compare that result to Emerick v. Cardiac Study Center 100 years later,[9] which involved a physician’s noncompetition covenant. The contract duration was five years; the court revised it to four. The original geographic restriction was Pierce County or Federal Way; the court revised it to two miles from the original place of employment. There was no consideration of a lesser type of restraint, such as nonsolicitation or nonacceptance of business, which could have adequately protected the employer. Rather, the court rewrote and enforced a narrowed noncompetition covenant and then went on to award the former employer attorneys’ fees exceeding $200,000 under a contractual prevailing party attorney fee clause.[10]

The judiciary’s increasing emphasis on the law of contracts and lessening discussion of restraint of trade principles explains the Legislature’s findings in Section 1 of ESHB 1450: “The legislature finds that workforce mobility is important to economic growth and development. Further, the legislature finds that agreements limiting competition or hiring may be contracts of adhesion that may be unreasonable.”

What’s more, the Legislature announced that its reforms should not be walked back or minimized: “This chapter is an exercise of the state’s policy power and shall be construed liberally for the accomplishment of its purposes.” Section 12.

THE EXPANSIVELY DEFINED ‘NONCOMPETITION COVENANT’

“Noncompetition covenant” is defined in Section 2(4), which states that it “includes every written or oral covenant, agreement, or contract by which an employee or independent contractor is prohibited or restrained from engaging in a lawful profession, trade, or business of any kind.”

This definition is borrowed from California Bus. and Prof. Code § 16600, which provides extensive protection to employees: “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” The use of language from California’s statute, together with the liberal construction requirement in Section 12, demonstrates that the Washington Legislature intended to encompass more, rather than fewer, covenants and types of covenants.

The Legislature carved out five circumstances that are not “noncompetition covenants” even though each of them may restrain another person from engaging to some extent in a lawful profession, business, or trade:

  1. A nonsolicitation agreement (as defined in Section 2(5));
  2. A confidentiality agreement (not defined);
  3. A covenant prohibiting use or disclosure of trade secrets or inventions;
  4. A covenant entered into by a person purchasing or selling the goodwill of a business or otherwise acquiring or disposing of an ownership interest; and
  5. A covenant entered into by a franchisee when the franchise sale complies with RCW 19.100.020(1). (This provision must be read in conjunction with Section 7, which prohibits “no-poach” and “no-hire” clauses with respect to franchises.)

The new law defines these five circumstances narrowly, while the definition of “noncompetition covenant” is broad. Thus, the statute covers a range of covenants, not just those that have traditionally been considered “noncompetition” covenants.

NONCOMPETITION COVENANTS ARE VOID FOR WORKERS EARNING LESS THAN $100,000

The new law’s most substantial reform protects workers earning $100,000 or less annually. If a worker’s W-2 form, Box 1, earnings for the preceding calendar year are $100,000 or less and the worker signed a noncompetition covenant, the covenant is void and unenforceable. Section 3(b). W-2 form, Box 1, earnings are less than Medicare earnings (Box 3) and do not include traditional retirement deferrals (but do include Roth retirement contributions). The $100,000 will be adjusted for inflation each September and the new amount will take effect the following Jan. 1. Section 5.

A promise to pay a monetary benefit in the future might constitute consideration, but a noncompetition covenant will nevertheless be unenforceable if the previous year’s earnings did not exceed $100,000. Additionally, the $100,000 must be paid by the “party seeking enforcement,” which is defined in section 2(6): “‘Party seeking enforcement’ means the named plaintiff or claimant in a proceeding to enforce a noncompetition covenant or the defendant in an action for declaratory relief.”

Thus, an entity in a highly structured business (for example, one seeking to reduce or avoid taxation by establishing distinct operating and holding companies) will be unable to enforce a noncompetition covenant against an employee whose wages were paid by a separate, related entity.

The earnings threshold for independent contractors is $250,000. Section 4(1). An employer who might see tax or liability advantages in classifying a worker as an independent contractor will have to consider the disadvantage of this higher earnings threshold. Additionally, the new law does not restrict its application to natural persons. In other words, the earning threshold applies equally to a noncompetition covenant signed by an entity.

Importantly, the new law does not provide a safe harbor for noncompetition covenants when the earnings threshold is met. (In fact, the law does not expressly authorize or approve any restrictive covenant.) All noncompetition covenants must satisfy the other standards enunciated in the statute. Covenants must also pass muster under the common law, which may continue to change. The new statute provides: “Except as provided in this chapter, this chapter does not revoke, modify, or impede the development of the common law.”[11] Section 10(2). [Emphasis added.] The Legislature thus invites the judiciary to reshape restrictive covenant law while providing the judiciary with two new, overarching principles as guidance: Workforce mobility is important to economic growth, and restrictive covenant agreements may be contracts of adhesion and unenforceable. Section 1.

PROTECTIONS APPLICABLE REGARDLESS OF EARNINGS THRESHOLD

Not all aspects of the new law differ based on income. Many provisions apply equally to any worker, regardless of salary. Some of these are discussed below.

  • Advance notice.An employer must notify a prospective employee in writing about “the terms of the covenant … no later than the time of the acceptance of the offer of employment.” A separate notice requirement applies when the worker makes less than the threshold at the time of signing, but the employer nevertheless has him/her sign a noncompetition covenant because the worker might ultimately exceed the threshold. Under that circumstance, the employer must “specifically disclose that the agreement may be enforceable against the employee in the future.” Section 3(1)(a)(i).
  • Midstream covenants must have independent consideration.As under common law, a midstream noncompetition covenant must be supported by independent consideration. Section 3(1)(a)(ii).
  • Eighteen-month cap on duration.Rejecting existing common law holdings,[12] the new law establishes a presumption that noncompetition covenants exceeding 18 months are unreasonable. Section 3(2). This provision should void contractual tolling clauses and eliminate equitable tolling.[13] Still, the law allows an employer to rebut the durational presumption with clear and convincing evidence proving that a longer duration is necessary to protect the ex-employer’s business or goodwill. The new law also includes a specific provision protecting performers from covenants lasting longer than three days. Section 4(2).
  • A noncompetition agreement is unenforceable against an employee if that employee “is terminated as the result of a layoff, unless enforcement of the noncompetition covenant includes compensation equivalent to the employee’s base salary at the time of termination for the period of enforcement minus compensation earned through subsequent employment during the period of enforcement.” Section 3(1)(c).

THE RESHAPED RULE OF REASONABLENESS

In Wood v. May, the Washington Supreme Court adopted the rule of reasonableness, described as “a new and different rule that a contract in restraint of trade will be enforced to the extent it is reasonable and lawful.”[14] Still, the well-recognized problem with the rule of reasonableness is that “even to the well-meaning draftsman, there is less need to be careful.”[15]

A comment to Restatement (Second) of Contracts § 184 (1981) states that courts:

will not aid a party who has taken advantage of his dominant bargaining power to extract from the other party a promise that is clearly so broad as to offend public policy by redrafting the agreement so as to make a part of the promise enforceable. The fact that the term is contained in a standard form supplied by the dominant party argues against aiding him in this request.[16]

But no Washington court has cited the comment, and only a few other courts have.[17] One federal court, applying Washington law, declined to rewrite an overly broad covenant, finding “it would result in an injustice” to the ex-employee.[18] Still, lawyers frequently drafted broader and broader covenants and courts rewrote and rewrote them to make them reasonable, rather than striking them.

ESHB 1450 substantially reshapes the rule of reasonableness, but not by curtailing judicial power to rewrite covenants or by simply declaring some covenants to be void. Rather, the Legislature imposed a $5,000 statutory penalty and required ex-employers to pay the ex-employee’s attorney fees under two circumstances. First, the penalty and attorney fee provision applies if the court or an arbitrator determines that the noncompetition covenant violates the new law. Section 9(2). Second, if the court or arbitrator reforms, rewrites, modifies, or only partially enforces any noncompetition covenant, the ex-employee is entitled to the statutory penalty and attorney fees. Section 9(3).

The message to drafters is unmistakable: draft covenants with limited durations, confined geography, and a narrow scope of prohibited activity, or your client may be on the hook for a penalty and an attorney fee award. These provisions legislatively overrule the attorney fee holding in Emerick.[19] Given Section 9(2)-(3), the judiciary may take another look at comment b of the Restatement (Second of Contracts § 184 and consider applying it to all restrictive covenants. It is settled Washington law that the employer has the burden of proving that the covenant is reasonable and that “the equities are in his or her favor.”[20] Judicial adoption of comment b to section 184 seems like a logical next step.

THREE OTHER PROVISIONS GIVE THE NEW LAW MAXIMUM EFFECT

  • Retroactivity. The Legislature decided to apply the new law to all legal proceedings initiated after the effective date, Jan. 1, 2020. Section 11. While limiting the application of the new statutory framework to actions commenced after the effective date, the new limitations on noncompete agreements are effective to all challenged agreements going forward— regardless of when such an agreement was entered—which is why the Legislature stated it was exercising the police power.[21] The sole exception to retroactivity is Section 9(4), which does not allow an ex-employee to bring a cause of action for a noncompetition covenant that was signed before Jan. 1, 2020 if it “is not being enforced.”
  • Venue and choice of law protections.The Legislature protected “Washington-based” workers from noncompetition covenants that require adjudication outside of Washington or deprive a person of the new law’s “protections or benefits.” Section 6. The phrase “Washington-based” comes from Bostain v. Food Express, Inc.[22] Other state legislatures have enacted similar protections for residents or workers in their states.[23] Employers must heed the choice of law directives imposed by the Legislature.[24]
  • Displacement of conflicting legal principles.The Legislature wanted clarity and fewer legal disputes between ex-employers and ex-employees. Thus, it included a provision that displaces conflicting legal theories: “this chapter displaces conflicting tort, restitutionary, contract, and others laws of this state pertaining to liability for competition by employees or independent contractors with their employers or principals, as appropriate.” Section 10. This language is reminiscent of the Trade Secrets Act’s displacement provision contained in RCW 19.108.900, but it is broader. The new law displaces conflicting contract principles, but claims under the Trade Secrets Act are unaffected by the new law. Section 10(1)(b).

PROTECTION FOR WORKERS WITH SECOND JOBS

ESHB 1450 also offers a new protection for workers earning less than twice the applicable state minimum wage. Employers are prohibited from restricting, restraining or prohibiting such workers from “having an additional job, supplementing their income by working for another employer, working as an independent contractor, or being self-employed.” Section 8(1). Section 8(2) limits this protection to some degree if the employee’s position raises “issues of safety” or the second job interferes “with the reasonable and normal scheduling expectations of the employer.” Section 8(2)(b) further limits the protection by stating that Section 8 does not alter the common law duty of loyalty or laws preventing conflicts of interest.

CONCLUSION

The Washington Legislature’s dramatic reshaping of noncompetition covenant law may become a wellspring of inspiration for Washington’s judiciary. The new law represents a fundamental reversal of common law and noisy rejection of restraints on worker mobility. The Legislature’s mandate is a warning to covenant drafters that the formerly free redrafting services by the judiciary now carry a hefty price tag. More changes are likely to come, as the Legislature has invited the judiciary to revisit and further reform restrictive covenant common law.

Editor’s Note: One of the authors advocated for and helped draft the legislation addressed in this article.


 

[1] Section 3(1)(a)(ii). The common law requires other midstream agreements not covered by the new law to be supported by new consideration (for example, a midstream nonsolicitation agreement). Labriola v. Pollard Group, Inc., 152 Wn.2d 828, 100 P.3d 791 (2004).

[2] See Ala. Code § 8-1-190 (effective 1/1/2016); Utah Code § 34-51-201 (effective 5/10/2016); Illinois 820 Ill. Comp. Stat. Ann. 90/10 (effective 2017); and Mass. Gen. Laws Ann. ch. 149, § 24L (effective 10/5/2018). In 2005, Washington’s Legislature addressed noncompetition agreements for broadcasting industry employees (but not those in sales or management). RCW 49.44.190.

[3] See, e.g., “Non-compete Contracts: Economic Effects and Policy Implications,” Office of Economic Policy (U.S. Dept. of the Treasury) (March 2016); “Non-Compete Agreements: Analysis of the Usage, Potential Issues, and State Responses,” (The White House) (May 2016); and M. Marx, “Reforming Non-Competes to Support Workers,” The Hamilton Project (February 2018).

[4] Washington does not yet have a published opinion enunciating the “janitor” rule of overbreadth. Examples from other jurisdictions include Mutual Service Cas. Ins. Co. v. Brass, 242 Wis.2d 733, 625 N.W.2d 648, 654-55 (2001) (clause that would prohibit ex-employee from working as a claim adjuster or “even a janitor” held overbroad), Telxon Corp. v. Hoffman, 720 F. Supp. 657, 665 n.7 (N.D. Ill. 1989) (“agreements which restrict the signer’s ability to work for a competitor without regard to capacity have repeatedly been declared contrary to law”), and Weber Aircraft L.L.C. v. Krishnamurthy, 2014 U.S. Dist. LEXIS 104041 ∗28 (E.D. Texas 2014) (restrictive covenant must bear “some relation to the activities of the employee”).

[5] https://www.treasury.gov/resource-center/economic-policy/Documents/UST%20Non-competes%20Report.pdf

[6] Id.The defendants in Knight, Vale & Gregory v. McDaniel, 37 Wn. App 366, 367, 680 P.2d 448 (1984), for example, were presented with a restrictive covenant on their first day, well after negotiating employment. “They signed the agreement, nevertheless, because they had changed their positions substantially in reliance on the offer of employment without such a stricture.”

[7] The Legislature authorized the Attorney General to bring an action for “any violation of this chapter.” Section 9.

[8] Columbia Coll. of Music & Sch. of Dramatic Art v. Tunberg, 64 Wash. 19, 116 P. 280 (1911).

[9] See Emerick v. Cardiac Study Center, Inc., P.S., 170 Wn. App. 248, 286 P.3d 689 (2012), and Emerick v. Cardiac Study Center, Inc., P.S., 189 Wn. App. 711, 357 P.3d 696 (2015).

[10] Despite the general trend toward greater enforcement of noncompetition covenants, there was an occasional judicial opinion favorable to ex-employees. SeeCopier Specialists, Inc. v. Gillen, 76 Wn. App. 771, 774, 887 P.2d 919, 920 (1995) (declining to enforce a noncompetition covenant because “skills acquired by an employee during his or her employment do not warrant enforcement of a covenant not to compete”).

[11] This feature of Washington’s new law is consistent with Oregon’s recent statute on noncompetition covenants. See Nike, Inc. v. McCarthy, 379 F.3d 576, 580-584 (9th Cir. 2004).

[12] Washington common law has many examples of restrictive covenants with long durations. See, e.g., Copier Specialists, Inc. v. Gillen, 76 Wn. App. 771, 887 P.2d 919 (1995) (three-year, 50-mile noncompete); Labriola v. Pollard Group, Inc., 152 Wn.2d 828, 100 P.3d 791 (2004) (threeyear, 75-mile noncompete); and Knight, Vale & Gregory v. McDaniel, 37 Wn. App 366, 680 P.2d 448 (1984) (three-year nonsolicitation and nonacceptance of business).

[13] CompareWillman v. Beheler, 499 S.W.2d 770 (Mo. 1973), abrogated on other grounds by State ex rel. Leonardi v. Sherry, 137 S.W.3d 462 (Mo. 2004) (refusing to extend covenant beyond duration in the contract despite protracted litigation), with Ocean Beauty Seafoods, LLC v. Pac. Seafood Grp. Acquisition Co., 2016 U.S. App. LEXIS 6983 (9th Cir. 2016) (a court sitting in equity may devise a remedy that extends a prior agreement).

[14] 73 Wn.2d 307, 438 P.2d 587 (1968).

[15] “Partial Enforcement of Post-Employment estrictive Covenants,” 15 Columbia Journal of Law and Social Problems 181, 192 (1979)

[16] Restatement (Second) of Contracts§ 184, comm. b.

[17] Smith, Batchelder & Rugg v. Foster, 119 N.H. 679, 406 A.2d 1310, 1314 (N.H. 1979) (ex-employer not entitled to reformation because it failed to sustain its burden of proving good faith); Data Management v. Greene, 757 P.2d 62 (Alaska 1988) (remanding for determination of whether employer acted in good faith).

[18] Genex Coop, Inc. v. Contreras, 2014 U.S. Dist. LEXIS 141417 ∗17 (E.D. Wash. 2014).

[19] Emerick, supran. 9.

[20] Sheppard v. Blackstock Lumber Co., 85 Wn.2d 929, 934, 540 P.2d 1373 (1975)

[21]  Section 12; see Optimer Int’l, Inc. v. RP Bellevue, LLC, 151 Wn. App. 954, 969, 214 P.3d 954, 961 (2009), aff’d, 170 Wn.2d 768, 246 P.3d 785 (2011) (retroactive legislation affecting existing contract upheld due to “rational connection between the purpose of the statute and the method the statute uses to accomplish that purpose”)

[22] 159 Wn.2d 700, 153 P.3d 846 (2007). Without defining the phrase, the Bostaincourt held that an interstate truck driver, based out of a Vancouver, Washington terminal, driving with a Washington license, and living in Clark County, was Washington-based despite spending 63 percent of his time driving out of state.

[23] See, e.g., California Labor Code § 925 and Mass. General Law 149 § 24L(e).

[24]  Restatement (Second) of Conflict of Laws§ 6(1).

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