As mentioned in an earlier article, Minnesota is now just one signature away from a complete ban on noncompete covenants between employers and their employees and independent contractors. The new law, Article 6 of the expansive Labor Omnibus Budget Bill (SF 3035), declares all employee and independent contractor noncompete provisions in nondisclosure, employment, consulting, and severance agreements void and unenforceable. Governor Walz has stated he will sign the bill into law. The ban will be effective on July 1, 2023.
Specifically, the law prohibits “an agreement between an employee and employer that restricts the employee, after termination of the employment, from performing: (1) work for another employer for a specified period of time; (2) work in a specified geographical area; or (3) work for another employer in a capacity that is similar to the employee’s work for the employer.”
The Scope of Minnesota’s Ban on Noncompete Agreements
The scope of the legislation covers the full range of employment relationships, from entry level employees up to CEOs. “Employees” are defined broadly as “individuals who perform services for an employer, including independent contractors.” “Independent contractor” is defined to include not only an individual but “any corporation, limited liability corporation, partnership, or other corporate entity when an employer requires an individual to form such an organization for purposes of entering into a contract for services as a condition of receiving compensation under an independent contractor agreement.”
Unlike similar legislation in other states such as California, this ban will not apply to customer/client non-solicitation clauses. Also, nothing will change regarding the enforceability of confidentiality and nondisclosure agreements, trade secret protections, restrictions on an ex-employee’s use of customer, client, or other contact lists, or employee anti-raiding provisions. It also does not affect an employer’s ability to discipline current employees for competing with the employer or otherwise breaching their common law duty of loyalty.
The legislation cites two exceptions to the ban on noncompete covenants:
(1) The covenant not to compete is agreed upon as a condition of the sale of a business. The person selling the business and the partners, members, or shareholders, and the buyer of the business may agree on a temporary and geographically restricted covenant not to compete that will prohibit the seller of the business from carrying on a similar business within a reasonable geographic area and for a reasonable length of time.
(2) The covenant not to compete is agreed upon in anticipation of the dissolution of a business. The partners, members, or shareholders, upon or in anticipation of a dissolution of a partnership, limited liability company, or corporation may agree that all or any number of the parties will not carry on a similar business within a reasonable geographic area where the business has been transacted.
The law also includes a fee-shifting provision that allows a court to award reasonable attorney’s fees to an employee enforcing the employee’s rights under statute.
Choice of Law and Venue Restrictions
The new law also prohibits employers from requiring, as a condition of employment, that employees who primarily reside and work in Minnesota agree to litigate a claim arising in Minnesota anywhere other than Minnesota.
It also prohibits requiring choice of law provisions that prevent the application of Minnesota employment law to a controversy arising in Minnesota. This provision is not binding on cases commenced in a state or federal court in another jurisdiction, but that court’s choice of law precedent may compel the court to defer to the Minnesota statute. Courts presiding over challenges to the enforceability of a similar California statute have generally deferred to California’s choice of law and forum selection requirements.
Significantly, this law does not mandate that all agreements containing covenants not to compete must have Minnesota choice of law and forum selection clauses. The statute’s venue and choice of law protections only apply “with respect to a controversy arising in Minnesota.”
What’s Next for Minnesota Employers with Noncompete Agreements in Place?
The good news is that if you currently have a noncompete agreement with employees, you are under no obligation to act. The law does not require that you rescind those agreements. It merely states that those agreements are unenforceable. (Compare this with the Federal Trade Commissions proposed rule banning noncompete agreements nationwide which, if ultimately adopted, would in fact require employers to expressly rescind noncompete covenants). Of course, this does not mean that employers can mislead employees regarding the enforceability of a noncompete covenant.
At a minimum, employers should do the following:
- Employers should review their standard employment, independent contractor, consulting, trade secret, intellectual property, confidential information, nondisclosure, independent contractor, and consulting agreements and should strip from those agreements any covenants not to compete that fit the statutory definition.
- Those agreements also should be reviewed and modified to ensure that what remains provides the business with its maximum desired protection from methods of unfair competition from former employees.
- If such agreements have choice of law and forum selection clauses requiring the application of the law of another state or that claims be litigated in another state, a determination should be made as to whether the employer wishes to keep them in and run the risk of a challenge in future litigation. If not, these boilerplate provisions can and should be modified to ensure that the only exception to their standard provisions is for “a controversy arising in Minnesota.”
- Employers must ensure that any changes to their agreements with current employees are properly supported by new consideration. If changes are made that go beyond merely striking provisions that the legislation has deemed unenforceable, striking the unenforceable provisions, without more, likely will not be enough to support the other changes.
The Non-Solicitation Covenant Option
The primary goal behind a covenant not to compete is to preserve customer relationships and goodwill. Employers with noncompete covenants currently in place still have a valuable tool to use in protecting their trade secrets, confidential information, and goodwill.
Most existing noncompete agreements also have non-solicitation provisions which are still enforceable. The key is to ensure that those customer non-solicitation covenants are well-thought out and properly drafted to ensure they maximize their reach and protection. Many non-solicitation agreements have unintended loopholes, particularly in the way terms are defined. Thus, they in fact provide far less protection than intended.
Do not assume that courts will give the term “solicit” an expansive meaning, because they won’t. A non-solicitation agreement, like a noncompete agreement, is an agreement in restraint of trade and will be narrowly construed. “Customers” or “clients” must be clearly defined. Many agreements define the terms more narrowly than necessary. Copycat form agreements are often deficient.
Also, there are protections available short of a complete ban on solicitation. An agreement that prevents an employee from taking a client with them runs the risk of an irritated client, who may leave anyway and go somewhere else. Financial planning and investment management companies often allow departing producers to take clients with them to a new venture but require them to pay the former employer a reasonable sum to compensate the employer for the loss of that business.
Additional Options for Minnesota Employers Adjusting to the Ban on Noncompete Agreements
- Bolster your Trade Secret/Confidential Information Agreements. Do not define your trade secrets and confidential information only with “standard,” off-the-shelf form agreements and definitions. Rather, include clearly defined descriptions of what information your company deems to be a trade secret and confidential information.
- Tighten Client List Protections. In order to legally secure the protections of trade secrets and confidential information, employers must demonstrate that they have taken measures to protect the secrecy of this information, beyond merely having a policy. Those steps include labeling client information as “proprietary and confidential,” limiting access to client information to those with a “need-to-know,” employing physical and digital security, e.g., stored in locked cabinets and password-protected.
- Take Advantage of Federal Legal Options. For the time being at least, federal law does not restrict noncompete agreements except in the rare circumstance where such agreements or arrangements rise to the level of antitrust violations. Under the supremacy clause of the U.S. Constitution, plans qualifying under the Employees Retirement Income Security Act (ERISA) are governed by federal law, not state law.Thus, a deferred compensation arrangement that falls under ERISA can include non-competition forfeiture provisions. However, the plan must truly qualify and be treated as an ERISA plan, meaning it is subject to ERISA’s minimum vesting requirements. An example is a “top-hat” plan, an unfunded, non-qualified ERISA plan that functions primarily as a vehicle for deferring compensation to a relatively small group of high-level employees.
- Determine if Forfeiture Provisions May Apply. Some companies have non-ERISA deferred compensation and equity participation agreements that have “bad leaver” provisions that do not prohibit work for a competitor but will result in a forfeiture of equity or deferred compensation if the ex-employee competes with the employer. What impact, if any, this new statute will have on those agreements remains to be seen.