Employers Beware: New Non-Compete Statute Takes Effect January 1, 2020

Washington recently joined other states by restricting the use of non-competition agreements for employees and independent contractors.  The new law, Chapter 49.62 RCW, takes effect on January 1, 2020 and affects both new non-competition agreements and existing agreements.

Overview of Statute:

The law defines a “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.”  The law does not, however, restrict the use of:

• a non-solicitation agreement
• a confidentiality agreement
• an agreement prohibiting use or disclosure of trade secrets or inventions
• a non-competition covenant in the sale of a business
• a non-competition covenant in a valid franchise agreement

Beginning on January 1, 2020, non-competes will be 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.  Employers need to be aware of a wrinkle in how earnings are defined for employees – it is the annualized “compensation reflected on box one of the employee’s . . . W-2 that is paid to an employee over the prior year.”  “Box one” reflects 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 the following scenario: the gross wages of two employees are identical and exceed $100,000.  The first employee maxes out his 401k and similar deductions, resulting in “Box 1” compensation below the $100,000 threshold.  The second employee takes no deductions, resulting in “Box 1” compensation above the threshold.  The non-competition agreement that both employees signed would be enforceable only for the second employee.

A final word on the amounts: they are adjusted annually for inflation, so a non-competition agreement that meets the compensation threshold in 2020 may not in 2021.

Practice caution:  Employers must consider carefully the potential impact of length-of-service requirements before employees can participate in 401k and similar benefits programs.  Employee contributions may make a non-compete no longer enforceable against an employee who previously was covered.  Similarly, before adopting or expanding certain employee benefits programs that allow employees to reduce taxable wages, the potential impact on non-competition agreements should be reviewed.

In addition to the compensation thresholds, the new law (1) establishes a presumption that a non-compete that lasts longer than 18 months is unenforceable and (2) requires employers to disclose the terms of the non-compete before the employee accepts the job.  Companies should also take note that the new law does not define independent contractors – the independent contractor may be another company, and a non-competition agreement is only enforceable if the independent contractor earns more than the $250,000 threshold from the company seeking to enforce the agreement.

An employer seeking to enforce a non-compete that doesn’t comply with the new law after January 1, 2020 will be required to pay the greater of the employee’s actual damages or $5,000 plus attorneys’ fees and costs – even if the court partially enforces the non-compete.  There is no liability for existing non-competes that are unenforceable under the law as long as the employer doesn’t try to enforce them after December 31, 2019.  It’s not clear, however, whether the employer would be liable for the statutory penalty and fees under the following scenario:

An employee earning $200,000 per year leaves ABC Corp. to work for its competitor XYZ Corp.  Although the non-compete has a three-year restriction, the employer only seeks to enforce the non-compete for 18 months.

How should employers respond?

• Review existing non-competition agreements for compliance with the new law. If they meet the compensation thresholds but not the time limit, we recommend new agreements to avoid the possibility of paying penalties when enforcing the non-competes.  Employers should note, however, that the new agreements require “independent consideration” (which does not include continued employment and may not include a reduction of the length of the non-compete).
• For employees earning less than the compensation thresholds, consider using a non-solicitation agreement. This is defined in the new law as “an agreement . . .  that prohibits solicitation by an employee, upon termination of employment: (a) of any employee of the employer to leave the employer; or (b) of any customer of the employer to cease or reduce the extent to which it is doing business with the employer.”
• Review agreements with employees and independent contractors to ensure that they contain adequate confidentiality and trade secret provisions; and review company procedures to ensure that confidential and trade secret information is protected and provided to employees and independent contractors only on a “need-to-know” basis.

About the Author:

Kevin Hansen provides clients with proactive advice through implementing best employment practices and developing employee handbooks and policies. He also provides counsel in response to specific matters concerning employment contracts, hiring and firing, wage and hour issues, trade secret protection, and discrimination.  Kevin regularly teaches continuing legal education courses for the WSBA and is an adjunct professor teaching business law at Northwest University.