New Jersey's Restrictive Covenant Bill: A Crude Proposal for a Noble Goal
Have you reviewed your employment agreement lately? Do you know if it contains a restrictive covenant? Over the past forty years, courts in New Jersey have established guidelines to determine whether such agreements are enforceable. Those guidelines are applied on a case-by-case basis: sometimes the agreements are enforceable; others they are not.
In late 2017, and again in January 2018, the New Jersey Senate and Assembly proposed bills that would eliminate some of the uncertainty in the common law of restrictive covenants. One way the bills would accomplish this is by outlawing restrictive covenants involving certain types of employees. But should something as varied as the employment relationship be the subject of such categorical regulation?
The prototypical restrictive covenant is a non-compete agreement. In its most basic form, a non-compete agreement prohibits an employee from competing with a former employer within a defined geographic area for a fixed time. For instance, a non-compete agreement may prohibit an employee from working for any of the employer’s competitors within a 50-mile radius for one year after the employment ends.
The proposed legislation aims to curb perceived abuses with these agreements. Those perceived abuses are best understood in their full historical context. At common law, non-compete agreements were per se unenforceable because they were contrary to public policy. This principle stemmed from the belief that non-compete agreements constitute anticompetitive restraints on trade. To an extent, this is true: a non-compete agreement temporarily limits the productive purposes for which a worker can use his or her skills. Similarly, courts historically viewed non-compete agreements as products of unequal bargaining power between employers and workers. And to an extent, this is also true: many non-compete agreements are offered to workers as a condition of employment on a “take-it-or-leave-it” basis.
But in a pair of cases decided in the early 1970s, the New Jersey Supreme Court established the modern standard for determining the enforceability of restrictive covenants in New Jersey. Under that standard, the touchstone inquiry is whether the non-compete agreement is “reasonable.” A reasonable non-compete agreement is enforceable; an unreasonable non-compete agreement, as the label implies, is not. See generally Solari Industries, Inc. v. Malady
, 55 N.J. 571 (1970); Whitmyer Bros. Inc. v. Doyle
, 58 N.J. 25 (1971).
To determine if a non-compete agreement is reasonable, a court in New Jersey will evaluate three factors: (1) the “fit” between the scope of the restriction and the employer’s interest; (2) whether the restriction causes undue hardship to the employee; and (3) whether the restriction harms the public at large. As relevant here, an employer has a legitimate interest in protecting its customer relationships, trade secrets, and other proprietary information. An undue hardship might include a situation where an employee must move across the country to find non-infringing new employment. And the public may be harmed, for example, where the restriction would virtually bar a consumer from choosing a fiduciary or highly-specialized professional of his or her choice.
In rough outline, this is the law as it stands today. Understandably, since New Jersey courts recognized that reasonable non-compete agreements are enforceable, the number of non-compete agreements in New Jersey has proliferated. The trend does not stop at the New Jersey border, either. A 2016 report from the United States Treasury Department estimated that 18% of workers – roughly 30 million people – are subject to a non-compete agreement. And because workers remain with their employers for at least some time, the number of non-compete agreements will only continue to increase.
Given these trends, non-compete agreements have attracted the attention of legislators in several states across the country. In keeping with this legislative momentum, in late 2017, and again in January 2018, the New Jersey Senate and Assembly introduced bills with the stated purpose of limiting restrictive covenants.
The proposed New Jersey legislation raises the question: are the current issues with non-compete agreements better addressed through the common law process than through legislation? While some legislation may be appropriate, the proposed bills are not narrowly tailored to address the harms they are designed to prevent. The best way to address the perceived abuses with non-compete agreements is through more nuanced legislation, with the primary engine of change coming through private litigation.
This comment focuses on one common element of both bills, which would make non-compete agreements completely unenforceable against certain types of employees. This proposal arises from a concern that employers are providing non-compete agreements to employees without any legitimate business purpose for doing so. By binding an employee to a non-compete agreement without any business reason, the argument goes, the non-compete agreement is a bald restraint on trade with no salutary benefit to the employer or the public. But while some categories of employee are appropriate for bright-line treatment, others are not.
Under the bills, for example, an employer cannot impose a non-compete agreement on a seasonal or temporary employee. This makes sense. A temporary employee, by definition, will leave the employment, has little bargaining power, and often does menial tasks. But is this bright-line treatment even necessary? Even under the current reasonableness standard, it strains the imagination to think of a situation where a post-employment restriction on a temporary employee would be reasonable.
On the other hand, the bills include some types of employees for which a categorical ban does not make sense. For example, under the bills an employee cannot impose a non-compete agreement on an employee classified as non-exempt. The universe of non-exempt employees, however, defies any simple explanation. Indeed, non-exempt employees can be – and often are – integral to the operation of a business, have significant contact with customers, and acquire trade secrets or other proprietary information during their employment. By prohibiting non-compete agreements involving non-exempt employees, an employer would be unable to protect itself from a non-exempt employee working for a competitor and using the knowledge he or she acquired during employment for the competitor’s benefit. This outcome would be contrary to the long-recognized principle that employers have an interest in protecting their legitimate business interests.
This is only one of many overly-broad provisions in the proposed legislation. As the bills move through committee, I do hope there is a more nuanced approach to correcting the perceived imbalance in non-compete agreements, without destroying the ability of private parties and the courts to develop the contours of what is reasonable on a case-by-case basis.