After years of stalled efforts, Washington has joined the growing list of states imposing statutory restrictions on employers’ use of restrictive covenants. On May 8, 2019, Governor Inslee signed into law Engrossed Substitute House Bill 1450 (HB 1450), which governs the enforceability of certain types of non-competition and other similar agreements.
The new law will take effect on January 1, 2020, and will impact the enforceability of all non-compete agreements with Washington employees—even those entered into before 2020. As discussed at the end of this alert, employers—with the advice of counsel—should carefully review their existing agreements with Washington employees and ensure that any employment agreements entered into on a going-forward basis comply with the new law.
Key features of HB 1450 include:
Notice and consideration requirements. When entering into a non-compete with an employee at the start of employment, HB 1450 now mandates that the employer must disclose the terms of the non-compete no later than the employee’s acceptance of the offer of employment.
The new law also codifies the long-held common law concept that non-compete agreements must be supported by adequate consideration. This means that they must be entered at the start of employment in exchange for the initial offer of employment, or, if entered into after employment has already begun, must be supported by some additional consideration (which could include, depending on the circumstances, a pay raise, bonus, promotion, training, or perhaps access to confidential information). Adequacy of such additional consideration will still be governed by common law principles as applied by a court or arbitrator.
Compensation threshold. The new law bars enforcement of non-competition agreements for employees whose annualized cash compensation does not exceed $100,000 (non-cash compensation like stock options and other equity are not included in calculating this amount). The threshold amount will be adjusted for inflation each year beginning in 2021. Employers may still enter into non-competes with employees who do not at that time earn greater than the threshold, so long as the non-compete contains explicit language that it is not enforceable until the employee surpasses the earnings threshold.
The new law also sets a $250,000 earnings threshold for independent contractors. However, employers should carefully consider, with the advice of counsel, whether non-competition covenants should be used with such contractors. Restraining them from providing similar services to others could contribute to a finding of contractor misclassification under the multifactorial tests applied by state and federal courts and agencies.
- “Garden leave” to enforce non-competes against laid off employees. In order to enforce non-competes against employees terminated as a result of a layoff, the new law requires that employers continue to pay the equivalent of the employee’s salary during the non-compete period, reduced by any compensation the employee receives from new employment during that period. The law does not define what constitutes a “layoff,” but based on the legislative history, “layoffs” likely do not encompass all types of involuntary terminations, and are likely instead limited to terminations due to lack of work, expiration of a short-term or seasonal assignment, position elimination, reductions in force, cessation of the employer’s business, or other similar circumstances.
- Maximum restricted period. The new law creates a presumption that non-compete periods exceeding 18 months are unreasonable and unenforceable. Although this presumption can be rebutted by clear and convincing evidence that a longer non-compete is necessary, this is a high standard to meet, and Washington courts have historically expressed skepticism over the reasonableness of many non-competes lasting for significantly shorter periods of time than 18 months.
- Restrictions on non-moonlighting clauses. Under the new law, employees with earnings less than the equivalent of twice the Washington minimum wage cannot be restricted from having an additional job, supplementing their income by working for another employer, working as an independent contractor, or being self-employed. However, HB 1450 expressly permits such moonlighting restrictions to the extent they are necessary for safety and to avoid interference with reasonable and normal scheduling expectations. Additionally, the law recognizes that employees may still be subject to obligations not to breach any legal duties of loyalty owed to their employers or to refrain from engaging in activities that would constitute conflicts of interest under the law.
- Litigation venue in Washington State. HB 1450 prohibits employers from requiring adjudication of any non-compete outside of Washington State.
- Stiff penalties. The new law adds strong financial disincentives to discourage employers from entering into non-competition covenants that do not comply with the new law or are otherwise overbroad and unreasonable under existing common law standards, which are not supplanted by the new law. Starting January 1, 2020, if a court or arbitrator determines that a non-competition agreement violates the requirements of HB 1450, or if a court or arbitrator reforms, rewrites, modifies, or only partially enforces a non-competition agreement to meet the traditional common law reasonableness standards, then the employer will be required to pay the employee 1) the greater of his or her actual damages or a penalty of $5,000, plus 2) attorney’s fees, expenses, and costs. Especially because attorneys’ fees in non-compete litigation can balloon rapidly, these penalties and fee awards represent an important risk for employers to consider when entering into and enforcing non-competes that could be deemed to be unreasonably restrictive.
- Exemptions for certain types of agreements. Not all types of restrictive covenants are subject to HB 1450. The law purports only to regulate non-competition agreements, which are defined as agreements that restrain or prohibit employees or independent contractors from engaging in a lawful profession, trade, or business. HB 1450 explicitly states that confidentiality and non-disclosure agreements, as well as certain narrowly-drafted non-solicitation agreements, fall outside of the law’s reach. However, non-solicits that are drafted more broadly or restrict additional activities (such as hiring the employer’s employees, contacting the employer’s customers for a purpose other than taking away business from the employer, or soliciting contractors, vendors, and others) may still be subject to the requirements of HB 1450.
Additionally, non-compete agreements executed in connection with the sale of the goodwill or ownership interest of a business (as opposed to employment-based agreements) are not subject to HB 1450, nor does the law apply to non-compete agreements executed in connection with certain sales of franchises.
What Is an Employer To Do?
Beginning January 1, 2020, the new law will govern enforceability of all new and existing agreements, even if entered into before 2020. As soon as possible, then, employers should work with counsel to develop a strategy for complying with HB 1450, which may include the following:
- Determining if and when the use of non-competition agreements is appropriate.
- Developing policies and procedures related to which types of employees are required to enter into non-competes and the timing of disclosing the terms of non-competes to new employees.
- Revising form non-competition agreements that will be used on a going-forward basis, including to ensure compliance with the new law and to ensure that the substantive restrictions in the agreement are narrowly tailored to prohibit activity no more than is necessary to protect the company’s legitimate business interests.
- Reviewing whether agreements signed by existing employees comply with the new law.
- Drafting and distributing notices to employees, if appropriate, regarding the enforceability of their existing non-competes, or potentially revising or replacing existing non-compliant agreements (keeping in mind that amending existing agreements or entering into new agreements with existing employees may trigger the requirement to provide substantial additional consideration).
- Considering alternatives to the use of non-competition agreements.