Business

Restricting Restrictive Covenants – New Jersey’s Current and Potential Future State of Law

Employers in New Jersey have long imposed post-employment restrictions on their employees and contractors through a variety of contractual provisions, including non-competition, non-solicitation (of customers, vendors, and/or employees), and non-disclosure (confidentiality).  The historical basis for permitting the use of restrictive covenants has been to protect the legitimate business interests of the employer, including protecting the employer’s investment in the employee (i.e. investment in training and advertising/promoting the employee), protecting the goodwill of the employer, ensuring the employee does not poach the employer’s business relationships, and to protect the confidential information of the employer. 

However, such provisions have recently drawn scrutiny nationally, and in New Jersey, particularly when same are applied to low-wage and lesser-skilled employees.  Critics argue in general that restrictive covenants limit market competition, prevent employee mobility, and suppress wages.  More specifically, with low-wage and lesser-skilled employees, critics allege that restrictive covenants are unnecessarily harsh, disproportionately threaten low-wage and lesser-skilled employees, and do not serve to protect the employer’s legitimate business interests.  See generally https://www.treasury.gov/resource-center/economic-policy/Documents/UST%20Non-competes%20Report.pdf.

For example, the New York attorney general accused a prominent sandwich restaurant chain of unlawful employment practices for utilizing a non-competition clause prohibiting employees from working for other businesses that sold certain hoagie/sub-style sandwiches within two (2) miles of any of its location in the entire United States for a period of two (2) years after the cessation of employment.  The attorney general argued that such provisions were unconscionable when applied to low-wage and lesser-skilled employees and did not further the employer’s legitimate business interests, and in announcing a settlement with the chain to refrain from utilizing or enforcing such provisions, stated, that restrictive covenants “limit mobility and opportunity for vulnerable workers and bully them into staying with the threat of being sued. Companies should stop using these agreements for minimum wage employees.” 

California (except for the shareholders in sales of entire businesses), Montana, Oklahoma, and North Dakota, have gone even further in largely abolishing non-competition provisions.  See e.g. Cal. Bus. & Prof. Code § 16600; N.D.C.C. § 9-08-06.  Other states have also passed legislation to curb, but not eliminate, restrictive covenants, including Massachusetts (which prohibits non-competition clauses for certain healthcare employees and the broadcast industry, as well as significantly limiting such clauses in general), Utah (limits duration of non-competition clauses to one year), and Hawaii (prohibits non-competition and non-solicitation clauses for employees of technology businesses). See e.g. https://www.mass.gov/info-details/massachusetts-law-about-noncompetition-agreements; HB1090 CD1.  Such provisions go well beyond limiting the use of restrictive covenants for low-wage employees, and are also being used to protect physicians, engineers, and highly skilled professionals.

Following the lead of other states, the New Jersey Legislature, in 2017, introduced Senate Bill 3518 (S-3518) / Assembly Bill 5261, which sought to substantially limited the enforceability and scope of restrictive covenants in New Jersey.  While S-3518 did not pass during the 2017-18 legislative session, a largely identical bill, Senate Bill 2872 (S-2872) / Assembly Bill 1769, has been introduced in the 2018-19 legislative session. See https://www.njleg.state.nj.us/2018/Bills/S3000/2872_I1.HTM.

Presently, New Jersey utilizes the so-called blue-pencil rule, which allows a court to limit, or modify, a restrictive covenant provision that is otherwise invalid (for example, the time period, scope of prohibition, or distance is too long, broad, or far), provided that the employer can demonstrate that such a restrictive covenant protects a legitimate business interest of the employer.  In all, New Jersey’s current system allows for the broad use of restrictive covenants, and blue penciling and/or the declaration of invalidity of restrictive covenants is fact-intensive and, as a practical matter, without a statutory structure in place that delineates specific instances where restrictive covenants are impermissible, often places the onus on the employee to prove that such a restriction is impermissible.

However, in the event of the passage of S-2872, the law would impose specific prohibitions from inclusion in restrictive covenant clauses, including, limiting non-competition to one (1) year, geographic limitations to where the employee had a material presence, allowing an employee to provide services to an employer’s customers/clients if the employee did not solicit said customer/client, and waiver of enforceability if the employee is not provided in writing shortly after the end of employment of the employer’s intent to enforce the restrictive covenant. 

Moreover, the law would prohibit restrictive covenants being enforced against nonexempt employees, temporary employees, employees terminated without a determination of misconduct, low-wage employees, independent contractors, and those employees employed for less than one (1) year, it would impose penalties for employers in violation of the law, as well as impose the requirement that the employer pay the former employee 100% of what she/he would have made if still employed, along with fringe benefits, for the restricted period (commonly known as garden leave/garden pay) so long as the employee was not terminated for good cause.

The proposed S-2872 stands in stark contrast with current New Jersey law.  While S-2872 remains in committee, momentum is building around the country to limit, if not outright eliminate, restrictive covenants, and employers, particularly those in industries with low-wage or temporary employees, industries with high employee turnover, and industries with specially-trained professionals, should become acquainted with the national trends surrounding limiting restrictive covenant enforcement, and how S-2872, and any future New Jersey iterations, may affect their business.

Wed Feb 6, 12:00am