Legal Alert: New Jersey Bill Would Limit Enforceability Of Post-Employment Covenants

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Executive Summary:  New Jersey legislators have proposed making a variety of post-employment restrictive covenants unenforceable where the employee is eligible for unemployment benefits.  Many high-level sales employees and employees with specialized technical knowledge are subject to such restrictions, which range from limiting competition with a former employer to prohibiting disclosure of trade secrets and confidential information learned during employment.

  • Bill Would Tie Enforceability of Covenants to Eligibility for Unemployment

The bill (A-3970) would make any agreement "not to compete, not to disclose or not to solicit" between an individual and an employer unenforceable when the individual is "eligible" for unemployment benefits.  (The bill applies only to such agreements entered into after passage of the law.)  However, the bill does not define "eligibility."  Under New Jersey's unemployment statutes, an individual is eligible for unemployment benefits if he or she has filed for benefits and is available to work.  Likewise, the state Department of Labor and Workforce Development's website advises that individuals are eligible for unemployment if they have worked 20 weeks in covered employment or earned $7,300.  It is unclear whether the legislation should have referred to whether an individual was "disqualified" for benefits, which occurs when the individual has left work voluntarily without good cause or when the individual was discharged for misconduct connected with the work.  As written, the bill would invalidate a post-employment covenant for any individual who was previously employed for a certain period of time or who earned a certain amount. 

  • Perverse Incentives Will Encourage More Use of Unemployment System

If what legislators meant was to release individuals from post-employment restrictive covenants when they involuntarily leave employment (see discussion of eligibility versus disqualification, above), the bill could incentivize employees to be discharged, rather than leave of their own accord, before pursuing other employment. 

For example, many high-level employees in sales functions are evaluated based on performance metrics, and are subject to automatic discharge where performance metrics fall below a pre-established level.  Rather than leave voluntarily and be subject to a non-solicitation agreement, an employee who plans to leave his employer has an incentive to simply stop performing and be involuntarily discharged, because he will then be free to contact his old accounts, a benefit to his new employer.  While the previous employer can argue that the employee purposefully took actions that resulted in his termination, the former employee can argue that forces outside of his control, such as tighter customer budgets or competition from another firm, affected his performance metrics. 

Likewise, more employees will argue that they were "constructively" discharged – meaning that the work environment was so unpleasant or difficult that a reasonable person would have felt compelled to resign.  These perverse incentives will not only create additional uncertainty in the labor market and decrease productivity, but will also spawn additional litigation over factual disputes as to the nature of the employee's termination. 

Impact Expected Among NJ's Largest Industries

New Jersey is home to several major players in the bio/pharmaceutical and financial services/insurance industries, where post-employment covenants are common among high-level employees.  By largely invalidating new non-solicitation, non-disclosure and non-compete agreements and providing perverse incentives for involuntary discharge, New Jersey is risking employers in these industries moving high-level employees out of New Jersey and into states friendlier to post-employment covenants.  

What Does this Mean for Employers?

If this bill is passed into law, it will invalidate many non-solicitation, non-disclosure, and non-compete agreements between employers and employees, and create perverse incentives to be discharged rather than voluntarily leave employment.  Employers in industries where such agreements are commonplace, particularly for high-level employees, will look for ways to move these employees to friendlier states.   

We will keep you informed of any developments regarding this legislation, which has been referred to the Assembly Labor Committee.  If you have any questions regarding this Alert or other labor or employment related issues, please contact the authors, Salvador Simao, ssimao@fordharrison.com, or Joanna Rich, jrich@fordharrison.com, both of whom are attorneys in our Berkley Heights, New Jersey office, or the FordHarrison attorney with whom you usually work.