A Non-Compete Law Roadmap for Tech Start-Ups in Key Jurisdictions

 Topic

Post-employment non-compete agreements are unlawful except in the context of a sale of a business. See Cal. Bus & Prof. Code § 16601.

Worth noting, however, is NuVasive, Inc. v. Patrick Miles, 2018 WL 4677607 (Del. Ch. Sept. 28, 2018), which supports that a workaround to California’s rule against non-competes may exist. Specifically, despite Section 925, an employer may be able to enforce non-California choice of law and venue provisions in pre-2017 non-competes if the employee was represented by counsel. However, the California courts and legislature have not yet spoken on this issue.

To be valid and enforceable, a non-compete agreement must:

-be in writing and signed by both the employer and employee;

-expressly state that the employee may consult with an attorney before signing;

-be provided, if made before employment begins, to the employee by the earlier of either: (a) formal offer of employment; or (b) at least 10 business days before employment begins;

-be supported, if made after employment begins but not in connection with termination of employment, by fair and reasonable consideration independent from continued employment; and provided to the employee at least 10 business before agreement is effective;

-be no broader than necessary to protect the following legitimate interests of the employer: (a) trade secrets; (b) confidential information that is not a trade secret; or (c) the employer’s goodwill.

New York common law disfavors non-compete agreements as an unreasonable restraint of trade. Reed, Roberts Assocs., Inc. v. Strauman, 386 N.Y.S.2d 677, 679 (1976).

Courts may enforce a non-compete if the restriction is reasonable. Although courts evaluate non-competes on a case-by-case basis, a non-compete can be enforced only if it:

-is no greater than required to protect an employer’s legitimate protectable interests;

-does not impose undue hardship on the employee;

-does not cause injury to the public;

-is reasonable in: duration; and geographic scope.

BDO Seidman v. Hirshberg, 690 N.Y.S.2d. 854, 856-57 (1999); Reed, Roberts Assocs., Inc., 386 N.Y.S.2d at 679; Genessee Valley Trust Co. v. Waterford Grp., 14 N.Y.S.3d. 605, 608-9 (4th Dep’t 2015); Scott, Stackrow & Co., C.P.A.’s, P.C. v. Skavina, 780 N.Y.S.2d. 675 (3d Dep’t 2004).

New York courts have recognized the following protectable interests that may be sufficient to support a reasonable non-compete:

-employer’s trade secrets or confidential information;

-employer’s goodwill;

-employer’s interest in preventing loss to a competitor of an employee whose services are special, unique, or extraordinary.

Ticor Title Ins. Co. v. Cohen, 173 F.3d. 63, 70 (2d Cir. 1999); BDO Seidman, 690 N.Y.S.2d. at 858-59.

To be enforceable under Texas law, a non-compete must:

-be ancillary to or part of an otherwise enforceable agreement when the agreement is made;

-be reasonable concerning time, geographical area, and scope of activity to be restrained;

-impose no greater restraint than necessary to protect the employer’s (or promisee’s) goodwill or other business interest.

Tex. Bus. & Com. Code Ann. § 15.50(a).

Party seeking enforcement of the non-compete (typically, the employer) has the burden of proof.

Brown & Brown, Inc. v Johnson, 25 N.Y.3d 364, 369-370 (2015).

Employers may not enforce non-compete agreements entered into on or after Oct. 1, 2018, against employees who have been:

-terminated without cause;

-laid off.

M.G.L. c. 149, § 24L(c).

While NY courts are not entirely in agreement regarding whether non-compete agreements are enforceable against employees who have been terminated by the employer without cause, an increasing number of cases seem to find that they are not enforceable under those circumstances. See, e.g., Buchanan Capital Mkts., LLC v DeLucca, 41 N.Y.S.3d 229 (1st Dep’t 2016) (“covenants [not to compete] are not enforceable if the employer (plaintiff) does not demonstrate ‘continued willingness to employ the party covenanting not to compete’”); see also Greystone Funding Corp. v Kutner, 137 A.D.3d 427 (1st Dep’t 2016) (“Assuming, arguendo, that Post v Merrill Lynch, Pierce, Fenner & Smith (48 NY2d 84, 397 NE2d 358, 421 NYS2d 847 [1979]) mandates the invalidation of all restrictive covenants in an employment agreement upon the termination of the employee without cause…”). It should be noted that in May 2017, New York Attorney General Eric Schneiderman arranged for legislation to be proposed in the New York legislature which would render non-competes unenforceable upon a termination without cause. This legislation has not passed yet.

However, if the termination constitutes a breach of contract by an employer, any post-employment non-compete in that agreement cannot be enforced by the breaching employer.

Cornell v. T.V. Dev. Corp., 268 N.Y.S.2d 29, 34 (1966).

NY courts may blue pencil a non-compete if it is overbroad. BDO Seidman, 690 N.Y.S.2d at 860.

However, courts are not required to blue pencil overbroad non-compete agreements. Courts may simply refuse to enforce an overbroad agreement. See Scott, Stackrow & Co., C.P.A.’s, P.C. v. Skavina, 780 N.Y.S.2d 675, 677-78 (3d Dep’t 2004).

A Texas court must reform an overbroad non-compete if it is part of an otherwise enforceable agreement.

Tex. Bus. & Com. Code Ann. § 15.51(c).

Texas judges must blue pencil unreasonable time, geographic, and scope of activity limitations to make them reasonable and to prevent a greater restraint than is necessary to protect the goodwill or other business interest of the promisee.

Choice-of-law provisions are not honored by California courts if the outcome would violate California’s public policy against non-compete agreements. This is the case particularly when California-based employees are involved. See Application Group, Inc. v. Hunter Group, Inc., 61 Cal.App.4th 881, 895-96 (1998).

For all contracts entered into, modified, or extended on or after Jan. 1, 2017, involving any person who primarily resides or works in California, choice-of-law and choice-of-venue contract provisions are prohibited if they apply another state’s law or require adjudication in another state as a condition of employment. Cal. Lab. Code, § 925.

For non-compete agreements entered into on or after Oct. 1, 2018, courts will not enforce any choice-of-law provision if both:

-the provision has the effect of avoiding the requirements under the act;

-the employee is or has been for at least 30 days prior to the termination: a resident of Massachusetts; or employed in Massachusetts.

M.G.L. c. 149, § 24L.

New York courts enforce choice-of-law provisions if both:

-selected forum has substantial relationship to: the parties; or the transaction; and

-application of the selected forum’s law does not run contrary to a fundamental policy of a state with materially greater interest than the forum state. U.S. Merch., Inc. v. L&R Distribs., Inc., 996 N.Y.S.2d 83, 84 (2d Dep’t 2014); Marine Midland Bank, N.A. v. United Missouri Bank, N.A., 643 N.Y.S.2d 528, 530 (1st Dep’t 1996).

Generally, contractual choice-of-law provisions are enforced in Texas, unless either:

-provision violates a fundamental public policy of Texas; or

-contract bears no reasonable relation to the chosen state.

Tex. Bus. & Com Code Ann. § 1.301; Transperfect Translations, Inc. v. Leslie, 594 F. Supp. 2d. 742, 749 (S.D. Tex. 2009).

Massachusetts courts have determined that the employment relationship itself is sufficient consideration for a non-compete agreement signed at the beginning of the employment relationship. Stone Legal Res. Group, Inc. v. Glebus, 2003 WL 914994, at * 5 (Mass. Super. Ct. 2002).

For agreements signed after hire, continued employment is not sufficient consideration as required under the Massachusetts Noncompetition Agreement Act. M.G.L. c. 149, § 24L(b)(ii).

Initial employment, and under certain circumstances, continued employment, suffices. Gazzola-Kraenzlin v. Westchester Med. Group, P.C., 10 A.D.3d 700, 702 (2d Dep’t 2004); Zellner v. Stephen D. Conrad, M.D., P.C., 589 N.Y.S.2d 903, 907 (2d Dep’t 1992) (Continued employment sufficient consideration “where discharge was the alternative or where the employee remained with the employer for substantial time after covenant signed.”).

Payments to the employee. Lenel Sys. Int’l, Inc. v. Smith, 966 N.Y.S.2d 618, 621 (4th Dep’t 2013).

Intangibles, including the employee’s receipt of increased:

-knowledge;

-skill; or

-professional status.

Arthur Young & Co., v. Galasso, 538 N.Y.S.2d 424, 427 (Sup. Ct. New York Co. 1989).

Massachusetts Noncompetition Agreement Act prohibits a restricted period of longer than one year from the date the employment ends. A restricted period may extend to a maximum of two years only if the employee:

-breached her fiduciary duty to the employer; or

-has unlawfully taken the employer’s property, either physically or electronically

Courts have repeatedly held that six months or less is reasonable. Ticor Title Ins. Co. v. Cohen, 173 F.3d 63, 70 (2d Cir. 1999); Natsource LLC v. Paribello, 151 F.Supp.2d. 465, 470-71 (S.D.N.Y. 2001). 

Courts have found longer restrictions to be either reasonable or unreasonable depending on facts of particular case. See, e.g., Good Energy, L.P. v. Kosachuk, 49 A.D.3d 331, 332 (1st Dep’t 2008) (“The covenant not to compete is reasonable in terms of duration, five years, but unreasonable in terms of geographic area, the entire United States, since Good Energy operates in only eight states.”).

Under the Massachusetts Noncompetition Agreement Act, a geographic restriction is presumed reasonable when the reach is limited to regions where, for the last two years of employment, the employee:

-provided services;

-had a material presence of influence.

M.G.L. c. 149, § 24L(b)(v).

Limitations based on the former employee’s territory during employment are valid. Goodin v. Jolliff, 257 S.W.3d. 341, 352 (Tex. App. Fort Worth 2008, no pet.).

Another approach, applicable in some circumstances, is to limit the geographic restriction to the area of the employer’s operations.

The doctrine of inevitable disclosure was specifically rejected in California because it creates an after-the-fact covenant not to compete restricting employee mobility. Whyte v. Schlage Lock Co., 101 Cal. App. 4th 1443, 1449 (2002).

Massachusetts courts have not recognized the inevitable disclosure rule. A Massachusetts federal court declined to apply a broad interpretation of inevitable disclosure in a preliminary injunction ruling, finding the doctrine:

-may be used to establish irreparable harm after a party seeking an injunction already proved a likelihood of success on the merits;

-is not a basis for future misappropriation of trade secrets.

U.S. Elec. Servs., Inc. v. Schmidt, 2012 WL 2317358, at *8-9 (D. Mass. June 19, 2012).

NY courts have recognized the inevitable disclosure doctrine.

However, courts rarely enforce a non-compete based on the inevitable disclosure of trade secrets when there is no evidence of actual misappropriation of trade secrets by the departing employee. See Marietta Corp. v. Fairhurst, 301 A.D.2d 734, 737 (3d Dept’s 2003).

“Mere knowledge of the intricacies of a business is simply not enough … factual allegations must be enough to raise a right to relief above the speculative level.” Janus et Cie v. Kahnke, 2013 WL 5405543, at * 4 (S.D.N.Y. Aug. 29, 2013).

Agreements not to solicit customers are not per se unlawful in California. However, they must be very narrowly drawn and are not enforced if they are so broad in effect as to amount to a non-compete. Kolani, 64 Cal.App.4th at 407.

Generally, regardless of how narrowly a non-solicitation agreement is drafted, California courts will not enforce agreements not to solicit customers unless either:

-client is protectable as trade secret; or

-enforcement is otherwise necessary to protect the trade secrets belonging to the employer.

Thompson v. Impaxx, Inc., 113 Cal.App. 4th 1425, 1429, 1432 (2003).

Confidentiality (in the form of a non-disclosure provision) is another form of protection available to employers in NY. It prevents only the use or disclosure of trade secret and confidential business information the employee acquired during employment.

Because non-disclosure agreements are less likely to be a restraint of trade, they are treated more deferentially than non-competes under New York law. U.S. Re Cos., Inc., v. Scheerer, 838 N.Y.S.2d. 37 (1st Dep’t 2007).

Non-solicitation agreements are analyzed by Texas courts as a covenant not to compete because of their similar purpose and effect. Shoreline Gas, Inc. v. McGaughey, 2008 WL 1747624, at * 10 (Tex. App. – Corpus Christi, April 17, 2008, no pet.)

Purpose of non-disclosure agreements differ from that of non-competes, because non-disclosure agreements prevent only the disclosure of trade secrets acquired by the former employee during employment. Thus, treated differently and more readily enforced because non-disclosure is not a restraint on trade. Shoreline Gas, 2008 WL 1747623, at *10-11.

Employee Choice Doctrine: NY courts recognize the employee choice doctrine, which provides that breach of a non-compete will result in forfeiture of certain specified benefits. Under this doctrine, courts analyze breach of a non-compete as a contract issue and will not inquire into the reasonableness of the non-compete provision, as it does not preclude post-termination competition. The employee choice doctrine applies to voluntary terminations by an employee where the employer conditions the employee’s receipt of post-employment benefits on the employee’s compliance with a restrictive covenant and the employee has a choice of either:

-working for a competitor and forfeiting the post-employment benefits; or

-accepting the benefits and not working for a competitor.

Morris v. Schroder Capital Mgmt. Int’l, 825 N.Y.S.2d 687, 700-01 (2006).

A restrictive covenant, including a non-compete, will be enforced without regard to its reasonableness when it satisfied the elements for application of the employee choice doctrine.

Under Texas law, the consideration that the employer gives in the non-compete agreement must have a “reasonable relationship” to the employer’s interest in restraining the employee from competing.

Interestingly, a monetary payment at termination will not suffice.

The holding in Exxon Mobil Corp. v. Drennen, 452 S.W.3d. 319 (Tex. 2014) set up another option, akin to the New York employee choice doctrine. The court held that the agreement did not prohibit the employee from competing, but created significant incentives for the employee to decide (on his own) not to compete. Specifically, if the employee engaged in certain competitive activities, he forfeited restricted stock awarded to him during employment. Texas Supreme Court did not view this arrangement as a non-compete agreement because the employee could choose to compete and forfeit stock.

Although there is no California case law addressing remedies available to employers that enforce post-employment non-competes, courts have explored remedies in cases involving post-employment unfair competition by a former employee. These cases typically arise after an employee has taken the employer’s alleged trade secrets and used them to compete against it for another employer or in the former employee’s own business. See Reeves v. Hanlon, 33 Cal. 4th 1140, 1155 (2004).

These cases support the availability of:

-Injunctive relief (Reeves, 33 Cal.4th at 1151; ReadyLink Healthcare v. Cotton, 126 Cal.App. 4th 1006, 1015-16 (2005));

-Actual damages for lost profits (Klamanth-Orleans Lumber v. Miller, 87 Cal.App.3d 458, 466 (1978));

-Damages based on unjust enrichment (Morlife, Inc. v. Perry, 56 Cal.App.4th 1514, 1519, 1528 (1997));

-Liquidated damages, if appropriate (Weber, Lipshie & Co., 52 Cal.App.4th at 649);

-Punitive damages (Cummings Medical Corp. v. Occupational Medical Corp., 10 Cal.App.4th 1291, 1294 (1992)).

If the employee breaches the non-compete, a court may award the employer:

-injunctive relief (Shipley Co. v. Clark, 728 F. Supp. 818, 827-28 (D. Mass. 1990); Packaging Indus. Grp., Inc. v. Cheney, 405 N.E.2d 106, 112 (Mass. 1980)).

-damages, including lost profits and out-of-pocket (Nat’l Merch. Corp. v. Leyden, 348 N.E.2d. 771, 774-75 (Mass. 1976); My Break Baking v. Jesi, 214 N.E.2d.53, 56 (Mass. 1966)).

Texas courts may award the employer damages or injunctive relief, or both, for an employee’s breach of a non-compete. Tex. Bus. & Com. Code Ann. § 15.51(a).

If reformation of the non-compete is required for enforcement, the court may award injunctive relief, but not damages for any breach before the reformation. Tex. Bus. & Com. Code Ann. § 15.51(c).

A Texas court may award the employee costs and reasonable attorney’s fees incurred in defending an action to enforce the non-compete if the court finds that the employee establishes that the employer knew at the time of the execution of the agreement that the non-compete did not contain reasonable limitations as to time, geography, and scope of activity; the limitations imposed a greater restraint than necessary to protect the employer’s goodwill or other business interest; and the employer sought to enforce the non-compete to a greater extent than was necessary. Tex. Bus. & Com. Code Ann. § 15.51(c).

Employers should be aware that employees and their new employers may seek to use the Texas Citizens Participation Act (TCPA) (Tex. Civ. Prac. & Rem. Code Ann. §§ 27.001-.011) to dismiss an employer’s non-compete-related claims such as tortious interference and non-solicitation early in the litigation. Employers should discuss the potential applicability of this recently amended statute with experienced counsel before initiating a lawsuit that includes these types of related claims.

However, in this regard, it should be noted that effective Sept. 1, 2019, the TCPA will no longer apply to cases that seek recovery for misappropriation of trade secrets or corporate opportunities; or seek to enforce a non-disparagement agreement or a covenant not to compete.

Not applicable, as non-competes are not enforceable in California and are void against public policy, unless narrow exception applies. Cal. Bus. & Prof. Code § 16600.

To get a preliminary injunction, the employer must prove:

-likelihood of success on the merits;

-irreparable harm if the injunction is denied;

-risk of irreparable harm to the employer.

Packaging Indus., 405 N.E.2d. at 111-12.

As a general rule, a breach of a non-compete agreement tied to trade secret concerns triggers a finding of irreparable harm. Aspect Software, Inc. v. Barnett, 787 F.Supp. 2d 118, 130 (D. Mass. 2011).

To obtain a PI in New York, a party must prove:

-likelihood of success on the merits;

-irreparable injury if the injunctive relief is not granted;

-balance of equities weighs in favor of the employer.

Doe v. Axelrod, 73 N.Y. 2d. 748, 750 (1988).

Texas courts have held that the Texas Covenants Not to Compete Act governs only final remedies and does not preempt the law that generally applies to preliminary relief. Cardinal Health Staffing Network, Inc. v. Bowen, 106 S.W.3d. 230, 235 (Tex. App. -Houston [1st Dist.] 2003, no pet.).

To obtain a PI, the applicant must prove:

-a cause of action against the defendant;

-a probable right to the relief sought;

-a probable, imminent, and irreparable injury in the interim.

Cardinal Health, 106 S.W. at 235.