United States: Washington State Governor Signs Law Severely Limiting Non-Competes

Washington state has joined the ranks of an ever-growing number of states that impose significant restrictions on employee non-compete agreements. On May 9, 2019, Governor Jay Inslee signed House Bill 1450, titled "An Act Relating to restraints, including noncompetition covenants, on persons engaging in lawful professions, trades, or businesses," into law. The Act will go into effect on January 1, 2020. We reported on the bill in detail in March.

This change to Washington law is significant. Businesses with employees or independent contractors in the state should revisit their non-compete agreements and take the necessary steps to ensure compliance with the Act by the end of this year. Some key features:

• The Act defines "noncompetition covenant" as "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" and does not include, among others, non-competes arising out of the sale of a business, non-solicitation agreements, confidentiality agreements, and covenants prohibiting the use or disclosure of trade secrets. The express exclusion of non-solicitation agreements distinguishes the law from more restrictive states like California.
• Non-competes are unenforceable against employees earning $100,000 a year or less and independent contractors earning $250,000 a year or less from the company seeking enforcement. Moreover, this threshold is adjusted annually for inflation, resulting in a moving target for employers and employees alike. For example, an employee making $100,001 when the law goes into effect may be subject to a binding, enforceable non-compete—but if his or her compensation does not keep pace with the cost of inflation, it would be unenforceable. Then, if the employee got a raise that brought his or her compensation equal to or greater than the cost of inflation increase, the non-compete would again be enforceable.
• Adding to the confusion, the Act defines earnings as "the compensation reflected on box one of the employee's . . . form W-2 that is paid to an employee over the prior year, or portion thereof for which the employee was employed, annualized and calculated as of the earlier of the date enforcement of the noncompetition covenant is sought or the date of separation from employment" or, for independent contractors, payments reported on internal revenue service form 1099-MISC. The reference to box 1 of the employee's W-2 reveals that employers will need to determine an employee's wages after adjusting gross pay based on deductions for 401k, medical flexible spending accounts, and other relevant deductions. This could result in a bizarre scenario where an employee who maxes out his or her retirement account could be under the $100,000 threshold, resulting in unenforceability of the non-compete, whereas an employee with the same exact job and who makes the same exact base salary—but does not fully fund a retirement account—earns more than the threshold, and thus his or her agreement is enforceable.
• The Act contains a notice provision, whereby the employer must disclose the terms of the non-compete in writing to new employees "no later than the time of the acceptance of the offer of employments." It further provides that "if the agreement only becomes enforceable only at a later date due to changes in the employee's compensation," (say, if an employee was hired at a salary of $100,000 or less but later got a raise that increased his or her salary over the $100,000 benchmark), the employer must "specifically disclose[] that the agreement may be enforceable against the employee in the future." This provision appears to allow employers to require their employees making $100,000 or less to sign non-competes, provided that the agreements specify that the non-compete provision will not be enforceable unless and until the employee's compensation meets the threshold earnings. Needless to say, this is likely to result in confusion, especially with employees who don't believe their agreements will be enforced but who ultimately meet the $100,000 threshold at a later date. The law does not appear to require any advance notice to existing employees asked to sign a non-compete, nor does it include a notice provision for independent contractors.
• For existing employees who are asked to sign a non-compete, the employer must provide consideration above and beyond continued employment.
• Non-competes are not be enforceable against laid off employees, unless enforcement includes compensation for the entirety of the non-compete period; this compensation must be equivalent to the employee's base salary at the time of termination, less any compensation that the employee earns through subsequent employment during the period when the non-compete is in effect.
• The Act creates a rebuttable presumption that non-compete clauses binding employees for more than 18 months post-termination are "unreasonable and unenforceable." Employers seeking to rebut the presumption need to provide "clear and convincing evidence" that a restriction exceeding 18 months is necessary to protect its "business or goodwill." This presumption does not appear to apply to independent contractors. (Oddly specific, but notable for those in the performing arts: the maximum permissible duration for a non-compete between "a performer and a performance space, or a third party scheduling the performer for a performance space," is three calendar days.)
• Under the Act, Washington-based employees or independent contractors could not be required to litigate the non-compete provision outside of Washington, nor is it permissible for a clause to "deprive[] the employee or independent contractor of the protections or benefits of" the bill—including, presumably, if the agreement includes a choice of law that is less friendly to employees or independent contractors than the proposed Washington law. It is unclear whether an agreement that includes a choice of law provision designating a more employee-friendly law (such as California law) would be enforceable under this law. In any event, employers with a workforce in Washington would have to keep the limitations of the law in mind when rolling out non-competes to their Washington-based employees and contractors, even if there would otherwise be a good reason to use another state's law.
• The Act also provides that no franchisor may restrict, restrain, or prohibit a franchisee from soliciting or hiring any employee of a franchisee of the same franchisor, or any employee of the franchisor itself.
• Separate and apart from the provisions regarding non-competes, the Act prohibits employers from preventing employees who make less than twice minimum wage from having other employment unless the "specific [additional] services to be offered by the employee raise issues of safety for the employee, coworkers, or the public, or interfere with the reasonable and normal scheduling expectations of the employer."
• The Act provides a private right of action (in addition to enforcement by the attorney general), and permits recovery of the greater of actual damages or a $5,000 penalty, plus reasonable attorneys' fees and costs. Notably, these remedies are also available against a company attempting to enforce a non-compete where the court or arbitrator "reforms, rewrites, modifies, or only partially enforces any noncompetition covenant." Accordingly, employers will need to prudently draft their non-compete agreements and carefully consider litigation strategy if they intend to enforce a non-compete that a court may deem overly broad, as they may wind up facing counterclaims subjecting them to damages, attorneys' fees, and costs, even for good faith efforts to enforce agreements they believed to be reasonable and enforceable.
• The Act "displaces conflicting tort, restitutionary, contract, and other laws of this state pertaining to liability for competition by employees or independent contractors with their employers or principals, as appropriate" but does not displace or modify the Uniform Trade Secrets Act.

Notably, the Act contains a very murky retroactivity clause that will undoubtedly be challenged during the infancy of the law: "The act takes effect January 1, 2020, and applies to all proceedings commenced on or after the effective date, regardless of when the cause of action arose. Otherwise, the law applies prospectively." The Act also provides that an action may not be brought on a noncompetition covenant signed prior to January 1, 2020, unless the noncompetition covenant is being enforced. It is not clear what is meant by "being enforced." This appears to mean that while the while the law goes into effect on January 1, 2020, it potentially impacts agreements that were signed before the effective date. It is very likely that both of these provisions will be challenged under provisions of the U.S. Constitution that bar states from passing laws that impair the obligations of contracts.

We'll continue to monitor the Act as new law and provide updates as it becomes interpreted and applied.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.