Two States Join Non-Compete Prohibition Party

The permissibility of using non-compete agreements continues to be a hot topic with both state legislators and federal regulators.

The primary concern is the perceived abuses of the growing use of such agreements for hourly and other lower-income wage earners.

Insurance agencies and brokerage firms are not the target of any such lower-income wage earner abuse concerns. The use of non-compete clauses negotiated between a buyer and seller(s) of a business is, however, critical for protecting the value of the acquired entity or asset. The insurance brokerage industry offers a unique example of how integral and necessary non-compete clauses can be in the acquisition of a company. Rather than tangible products, the key assets in such purchases are the firm’s client base and goodwill. As a practical matter, the only way to preserve those assets when a firm is sold is by ensuring that the sellers of those assets cannot set up shop across the street. If such restrictions cannot be legally imposed, then the value of those assets plummets.

Fifteen states and the District of Columbia have enacted laws banning the use of non-compete agreements. The District of Columbia and 11 states—Colorado, Illinois, Maine, Maryland, Massachusetts, Nevada, New Hampshire, Oregon, Rhode Island, Virginia and Washington—now generally ban the use of non-compete restrictions for hourly and/or other employees who make less than a specified amount per year. As a practical matter, these restrictions appear to have minimal if any impact on the general employment practices of insurance agency and brokerage firms.

Three other states—California, North Dakota and Oklahoma—have had long-standing bans on the use of non-compete agreements, but each of those states expressly allows the use of non-compete agreements in conjunction with the sale of a business:

• California: “Any person who sells the goodwill of a business, or any owner of a business entity selling or otherwise disposing of all of his or her ownership interest in the business entity…may agree with the buyer to refrain from carrying on a similar business within a specified geographic area in which the business so sold.”
• North Dakota: “A person that sells the goodwill of a business and the person’s partners, members, or shareholders may agree with the
  buyer to refrain from carrying on a similar business within a reasonable geographic area and for a reasonable length of time[.]”
• Oklahoma: Prohibits non-compete contracts except those written to protect the sale of the goodwill of a business or dissolution of a partnership.

In May, Minnesota became the most recent state to enact a general ban on the use of non-compete agreements, but, like California, North Dakota and Oklahoma before it, the Minnesota law expressly states that “a covenant not to compete is valid and enforceable” if it “is agreed upon during the sale of a business.”

In June, the New York legislature sent a bill to the governor’s desk that also would impose a blanket ban on the use of non-compete agreements in the state. That bill, however, includes no business sale exemption. If the governor signs the bill into law, New York would become the first state in the nation to bar the use of non-compete agreements in conjunction with the sale of a business.

The New York legislation is not, in my view, a model of statutory clarity. Perhaps in part for that reason, some are maintaining that the law would not bar the use of non-compete agreements in conjunction with the sale of a business, because it is meant to apply only to agreements between employers and employees.

The legislation, for example, defines a “non-compete agreement” as “any agreement…between an employer and a covered individual that prohibits or restricts such covered individual from obtaining employment, after the conclusion of employment with the employer included as a party to the agreement.”

And it defines “covered individual” as “any other person who, whether or not employed under a contract of employment, performs work or services for another person on such terms and conditions that are, in relation to that other person, in a position of economic dependence on, and under an obligation to perform duties for, that other person.”

Putting aside both the question of what exactly it means to be “in a position of economic dependence” and the fact that “owners” of insurance agencies or brokerages that are sold usually become “employees” of the acquiring firm post-sale, the legislation does include this rather emphatic declaration: “Every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”

Because the legislation includes a private right of action, any attempt to impose a non-compete restriction as part of the sale of a business could become fodder for litigation. There are potential end runs around that of course. You could, for example, include a poison pill provision which requires forfeiture of some or all of the transaction proceeds if the non-compete restriction were ever to be declared void, or you could hold some of those proceeds until the conclusion of the non-compete period.

There is some good news in New York. First, the legislation expressly exempts non-disclosure and non-solicitation agreements from the scope of the non-compete agreement prohibition (only California extends its ban to non-solicitation agreements). Second, unlike the Federal Trade Commission’s proposed ban, the New York legislation would apply only prospectively to agreements executed after the law’s effective date (30 days after it is signed into law, if it is signed into law).

If the New York legislation concerns you, you should urge the governor to veto it to enable the legislature to make it right. Visit ciab.com for more information.