After nearly a decade of debate, Massachusetts has passed comprehensive legislation limiting the use of noncompetition agreements. Last Friday, Gov. Charlie Baker officially signed “An Act Relative to the Enforcement of Noncompetition Agreements” (the Act) into law after the bill passed the Massachusetts Legislature last week.
The Act, which goes into effect on Oct. 1, 2018, comes after years of discussion surrounding the effects of non-compete agreements on employee mobility and competition in the Massachusetts labor market. Many advocates calling for non-compete reform often point to California, where non-compete agreements are not enforceable, to support the position that eliminating these restrictions will bring the Bay State closer to competing with Silicon Valley. Despite the failure of previous attempts to pass similar legislation, the Massachusetts Legislature finally drafted a compromise bill that satisfied both sides of the aisle.
The Act, which applies to both employees and independent contractors, will undoubtedly have a major impact on the use of non-compete agreements in Massachusetts. Although this article focuses on non-compete restrictions, it should be noted that the Act also changes the current Massachusetts law governing trade secrets and adopts the Uniform Trade Secrets Act (UTSA). Massachusetts now joins 48 other states that also use the UTSA to govern trade secrets at the state level. (Note – the federal law governing trade secrets is the Defense of Trade Secrets Act.)
Below is an analysis of the most significant provisions of the Act and key strategies employers can use to prepare for these upcoming changes.
Prohibition of Non-competes for Specific Categories of Employees
The Act specifically prohibits the enforcement of non-compete agreements against four categories of employees:
- Employees who are nonexempt under the Fair Labor Standards Act (FLSA).
- Undergraduate or graduate students in a short-term employment relationship.
- Employees laid off or terminated without cause as the term “cause” is defined in their employment agreement.
- Employees under the age of 18.
While courts tend to look skeptically at attempts to enforce non-compete restrictions against low-level employees, the categories identified in the Act crystalize this view into law. Notably, the prohibition of non-compete agreements against nonexempt workers will create an interesting parallel to the increasing number of class action lawsuits involving the misclassification of employees. Given that the majority of workers in the U.S., including in Massachusetts, are nonexempt, this prohibition may spur a surge of movement by employees across industries in the state.
Garden Leave Requirement
Perhaps the most interesting provision of the Act is the requirement that employers must now provide payment of “garden leave” or some “other mutually agreed upon consideration” during the restricted period. Although a relatively rare provision in the United States, garden leave is a well-established concept in the United Kingdom and Europe. Garden leave provisions require an employer to pay the former employee a portion of his or her salary during the restricted period of the non-compete agreement. These provisions have served as an effective compromise between forcing employers to limit their use of non-compete agreements and providing employees with an incentive to abide by such restrictions.
The Act sets the minimum amount of garden leave an employer can pay as “at least 50% of the employee’s highest annualized base salary within the 2 years preceding the employee’s termination” on a pro rata basis. However, because the Act alternatively allows for the payment of some other mutually agreed-upon consideration, employers will be able to contractually agree to pay an employee less than 50 percent of their highest base salary.
Regardless of the amount, this new requirement will necessitate that employers assess their willingness to pay an employee during the restricted period versus their eagerness to enforce the employee’s non-compete restrictions. The new costs associated with enforcing non-compete restrictions provide at least some disincentive to use non-competes where they are not necessary to protect a legitimate business interest.
Consideration for Non-compete Agreements
Consistent with the current law in Massachusetts, the Act states that new employment is sufficient consideration for having an employee sign a non-compete agreement at the start of his or her job.
The Act does, however, change the current law, which permits continued employment as sufficient consideration for a non-compete agreement signed after the start of employment. Instead, the Act now requires that a non-compete agreement signed after the commencement of employment be “supported by fair and reasonable consideration independent from the continuation of employment.” In other words, continued employment is no longer sufficient consideration for having a current employee sign a new or revised non-compete agreement.
Although this represents a clear shift from the current law, the Act does not define what constitutes fair and reasonable consideration, so it’s unclear whether this requirement will have a material financial impact on employers.
Requirements Regarding Scope of a Non-compete Restrictions
As has always been the case, non-compete agreements in Massachusetts must be reasonably tailored to protect a legitimate business interest. The Act provides guidance on this concept by setting out requirements for “reasonable” non-compete restrictions. Specifically, the Act mandates that non-compete restrictions cannot exceed one year in duration. However, if an employee is shown to have breached a fiduciary duty to the employer or to have unlawfully taken the employer’s property, the restricted period can be tolled for up to two years from the end of the employee’s employment.
With regard to geographic scope, the Act defines a reasonable geographic scope as the areas in which the employee “during any time within the last 2 years of employment, provided services or had a material presence or influence.” The Act doesn’t define material presence or influence, so employers will need to review the job duties of each affected employee to determine the appropriate reach of this restriction.
Preparing for the Oct. 1, 2018, Law
The upcoming changes mandated by the Act will change the way non-compete agreements are used and enforced in Massachusetts. Notably, the Act expressly does not apply to non-competes included in the sale of a business and in a separation agreement, as long as the employee is given seven days to rescind his or her acceptance. The Act also doesn’t affect other types of restrictive covenants, including nonsolicitation agreements, nondisclosure agreements and no-raid agreements.
As a result, employers should focus on reviewing their non-compete agreements in connection with the employment of current and future employees. In order to prepare for the upcoming changes, employers should take the following initial steps:
- Review the categories of all employees subject to a non-compete agreement:
- Employers should confirm that they do not have any non-compete agreements in place for the four categories prohibited by the Act. Because one of the prohibited categories is nonexempt employees, employers will also want to audit their classifications of employees (exempt versus nonexempt) to ensure they are properly classified under the FLSA. Given the complicated nature of classifying employees for purposes of the FLSA, employers may determine that certain employees bound by a non-compete restriction should actually be reclassified because of a change in the employees’ job duties and/or responsibilities.
- Review budget to account for payment of garden leave or other mutually agreed-upon consideration during the restricted period:
- Employers should review their overall budget to ensure they can meet the financial obligations imposed by the Act’s requirement of garden leave. Although employers can provide some other mutually agreed-upon consideration, this added financial cost of enforcing a non-compete is an opportunity to assess the business reason for each employee bound by these restrictions. Ultimately, employers may decide to be more selective about which employees they require to sign a non-compete agreement.
- Review scope of current non-compete agreements:
- Employers will also need to review all current non-compete agreements to make sure they are no longer than 12 months in duration and are reasonable in geographic scope, as defined by the Act. This will necessitate reviewing the specific areas in which each employee provides services or has a material presence or influence. Because the Act does not define “presence” or “influence,” employers will want to conduct a careful review to determine the extent to which each employee provides services.
The Bottom Line
Massachusetts employers will need to carefully review and revise their existing noncompetition agreements to ensure compliance with the new requirements of the Act. Employers should also use this as an opportunity to assess their use of non-compete agreements to evaluate whether they are using these restrictions effectively.
If you have any questions, please contact the BakerHostetler employment team for more information.