Business Owner Options in a Land Without Non-Competes
By Arthur Xanthos & Stuart Gartner
For more than a century, New York courts have enforced non-compete agreements, which typically prohibit former employees (or sellers of a business) from competing against the former employer (or buyer of the business) for a reasonable period of time within a limited geographic area. A bill currently awaiting Governor Hochul’s signature would make most non-compete agreements unlawful in New York State, forcing employers and sellers of businesses to consider other options in the new legal landscape. The Governor has previously expressed support for eliminating non-compete agreements for workers earning below the median wage in New York; but the bill in its current form applies to all workers in New York regardless of earnings.
Utility of Non-Competes
Non-compete clauses are found primarily in four different kinds of agreements: employment/severance agreements, shareholder agreements, independent contractor agreements, and sale of business agreements. Typical clauses read as follows:
In an employment agreement:
“As consideration for the Employment herein, Employee agrees during the term of the Employment and for a period of two (2) years thereafter, not to compete against the Employer, or engage in the Employer’s Industry (other than as part of the Employment herein) as an employee, owner, independent contractor, or otherwise, in the States of New York, New Jersey, Connecticut, or Pennsylvania.”
In a shareholders agreement:
“Each Shareholder agrees while he or she is a Shareholder in the Company, and thereafter during the period of any Stock Redemption (or if there be no Stock Redemption for a period of two (2) years after that Shareholder no longer owns any shares in the Company) not to compete against the Company, or engage in the Company’s Industry (other than as a Shareholder in the Company) as an employee, owner, independent contractor, or otherwise, in the States of New York, New Jersey, Connecticut, or Pennsylvania.”
In an independent contractor agreement:
“As consideration for the payments herein, Consultant agrees during the Term of this Agreement, and for a period of two (2) years after the Term lapses or is earlier terminated, not to compete against the Company or engage in the Company’s Industry (other than as part of the Consultant’s obligations under this Agreement) as an employee, owner, independent contractor, or otherwise, in the Sales Territory as defined herein.”
In a sale of business agreement:
“Assuming Buyer is not in breach of and has not breached this Agreement, Seller shall not for a period of two (2) years following the Closing compete against Buyer or the Company, or engage in the Company’s Industry (defined above), as an employee, owner, independent contractor, or otherwise, in the States of New York, New Jersey, Connecticut, or Pennsylvania.”
While the language of the non-compete clause differs slightly in each scenario, the purpose is the same – to protect the Company from the departing employee/shareholder/seller/consultant, who now with a new company could leverage an insider’s knowledge of the former Company to a crushing market advantage.[1]
What the Bill Does
The bill awaiting the Governor’s signature eliminates the use of non-competes (with very narrow exceptions). The bill also creates a private right to sue in the event of a violation.
Section 2 of the bill is a blanket prohibition against employers, as well as other entities who engage workers, requesting or entering into new non-compete agreements.[2] Non-compete agreements prohibited by this section encompass 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.”
While Section 2 concerns employment agreements only, Section 3 of the bill makes most non-compete agreements in any context unenforceable (i.e., void):
“Every contract by which anyoneis restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void. For all covered individuals, no employer or its agent, or the officer or agent of any corporation, partnership, limited liability company, or other entity shall seek, require, demand or accept a non-compete agreement from any covered individual.” Emphasis added.
While the language of this section is not a model of clarity, a plain reading of the first sentence makes clear that all non-compete agreements are void, whether in the employment context or not. Presumably, sale of business agreements and shareholder agreements fall within the ambit of this section.
Finally, Section 4 of the bill allows a covered individual to bring a lawsuit against any person alleged to have violated the bill’s prohibitions. The remedies provided under the bill include voiding the non-compete agreement and “all other appropriate relief”, including liquidated damages up to $10,000 and reasonable attorneys’ fees.[3]
What Can an Employer/Business Seller Do Now?
In anticipation of the bill’s passage into law, businesses should heed the following:
- The bill applies to non-compete agreements made or modified after the effective date, viz., 30 days following the Governor’s signature. Therefore, previously executed non-compete agreements remain enforceable, so long as they are reasonable in scope and are not modified.
- If an agreement containing a non-compete clause is currently being negotiated, speed is obviously a priority. If you have a key employee who is not currently subject to a non-compete, you may want to consider getting a non-compete agreement in place before the bill is enacted and becomes effective.
- If your company-wide employee handbook contains a non-compete obligation, any modification to the handbook will theoretically constitute a violation and give all covered employees a claim for damages.
- Other agreements (clauses) are still permissible under the bill and if drafted correctly could serve to protect the company from unfair competition by the former employee/shareholder/seller/consultant. These include non-solicitation clauses (of clients), non-disclosure clauses (or proprietary information), and even non-poaching clauses (of employees). Such clauses, while not prohibiting a departing employee from competing, will stanch some of the damage caused by that competition.
- Finally, in instances where a payout is being made by the company to the departing employee/shareholder/seller/consultant, consideration should be given to a periodic payout over an extended time period, or even a back-ended payout. In that way, if your agreement is declared void prior to the full payout being made, there will be less ‘loss’ to the company.
[1] The protection provided by non-competes is usually purchased with substantial consideration – employment, a consultancy contract, stock, cash, etc.
[2] A new non-compete agreement is one entered into after thirty (30) days following the New York Governor’s signature on the bill.
[3] Any such lawsuit would have a a two-year statute of limitations but the two-year period only starts to run from the latest of: (1) the date the non-compete agreement was executed; (2) when the employee learns of the non-compete agreement; (3) when the employment or contractual relationship is terminated; or (4) when the employer attempts to enforce the non-compete agreement.
By Arthur Xanthos & Stuart Gartner
For more than a century, New York courts have enforced non-compete agreements, which typically prohibit former employees (or sellers of a business) from competing against the former employer (or buyer of the business) for a reasonable period of time within a limited geographic area. A bill currently awaiting Governor Hochul’s signature would make most non-compete agreements unlawful in New York State, forcing employers and sellers of businesses to consider other options in the new legal landscape. The Governor has previously expressed support for eliminating non-compete agreements for workers earning below the median wage in New York; but the bill in its current form applies to all workers in New York regardless of earnings.
Utility of Non-Competes
Non-compete clauses are found primarily in four different kinds of agreements: employment/severance agreements, shareholder agreements, independent contractor agreements, and sale of business agreements. Typical clauses read as follows:
In an employment agreement:
“As consideration for the Employment herein, Employee agrees during the term of the Employment and for a period of two (2) years thereafter, not to compete against the Employer, or engage in the Employer’s Industry (other than as part of the Employment herein) as an employee, owner, independent contractor, or otherwise, in the States of New York, New Jersey, Connecticut, or Pennsylvania.”
In a shareholders agreement:
“Each Shareholder agrees while he or she is a Shareholder in the Company, and thereafter during the period of any Stock Redemption (or if there be no Stock Redemption for a period of two (2) years after that Shareholder no longer owns any shares in the Company) not to compete against the Company, or engage in the Company’s Industry (other than as a Shareholder in the Company) as an employee, owner, independent contractor, or otherwise, in the States of New York, New Jersey, Connecticut, or Pennsylvania.”
In an independent contractor agreement:
“As consideration for the payments herein, Consultant agrees during the Term of this Agreement, and for a period of two (2) years after the Term lapses or is earlier terminated, not to compete against the Company or engage in the Company’s Industry (other than as part of the Consultant’s obligations under this Agreement) as an employee, owner, independent contractor, or otherwise, in the Sales Territory as defined herein.”
In a sale of business agreement:
“Assuming Buyer is not in breach of and has not breached this Agreement, Seller shall not for a period of two (2) years following the Closing compete against Buyer or the Company, or engage in the Company’s Industry (defined above), as an employee, owner, independent contractor, or otherwise, in the States of New York, New Jersey, Connecticut, or Pennsylvania.”
While the language of the non-compete clause differs slightly in each scenario, the purpose is the same – to protect the Company from the departing employee/shareholder/seller/consultant, who now with a new company could leverage an insider’s knowledge of the former Company to a crushing market advantage.[1]
What the Bill Does
The bill awaiting the Governor’s signature eliminates the use of non-competes (with very narrow exceptions). The bill also creates a private right to sue in the event of a violation.
Section 2 of the bill is a blanket prohibition against employers, as well as other entities who engage workers, requesting or entering into new non-compete agreements.[2] Non-compete agreements prohibited by this section encompass 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.”
While Section 2 concerns employment agreements only, Section 3 of the bill makes most non-compete agreements in any context unenforceable (i.e., void):
“Every contract by which anyoneis restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void. For all covered individuals, no employer or its agent, or the officer or agent of any corporation, partnership, limited liability company, or other entity shall seek, require, demand or accept a non-compete agreement from any covered individual.” Emphasis added.
While the language of this section is not a model of clarity, a plain reading of the first sentence makes clear that all non-compete agreements are void, whether in the employment context or not. Presumably, sale of business agreements and shareholder agreements fall within the ambit of this section.
Finally, Section 4 of the bill allows a covered individual to bring a lawsuit against any person alleged to have violated the bill’s prohibitions. The remedies provided under the bill include voiding the non-compete agreement and “all other appropriate relief”, including liquidated damages up to $10,000 and reasonable attorneys’ fees.[3]
What Can an Employer/Business Seller Do Now?
In anticipation of the bill’s passage into law, businesses should heed the following:
- The bill applies to non-compete agreements made or modified after the effective date, viz., 30 days following the Governor’s signature. Therefore, previously executed non-compete agreements remain enforceable, so long as they are reasonable in scope and are not modified.
- If an agreement containing a non-compete clause is currently being negotiated, speed is obviously a priority. If you have a key employee who is not currently subject to a non-compete, you may want to consider getting a non-compete agreement in place before the bill is enacted and becomes effective.
- If your company-wide employee handbook contains a non-compete obligation, any modification to the handbook will theoretically constitute a violation and give all covered employees a claim for damages.
- Other agreements (clauses) are still permissible under the bill and if drafted correctly could serve to protect the company from unfair competition by the former employee/shareholder/seller/consultant. These include non-solicitation clauses (of clients), non-disclosure clauses (or proprietary information), and even non-poaching clauses (of employees). Such clauses, while not prohibiting a departing employee from competing, will stanch some of the damage caused by that competition.
- Finally, in instances where a payout is being made by the company to the departing employee/shareholder/seller/consultant, consideration should be given to a periodic payout over an extended time period, or even a back-ended payout. In that way, if your agreement is declared void prior to the full payout being made, there will be less ‘loss’ to the company.
[1] The protection provided by non-competes is usually purchased with substantial consideration – employment, a consultancy contract, stock, cash, etc.
[2] A new non-compete agreement is one entered into after thirty (30) days following the New York Governor’s signature on the bill.
[3] Any such lawsuit would have a a two-year statute of limitations but the two-year period only starts to run from the latest of: (1) the date the non-compete agreement was executed; (2) when the employee learns of the non-compete agreement; (3) when the employment or contractual relationship is terminated; or (4) when the employer attempts to enforce the non-compete agreement.