Retroactivity Provision in Washington State’s New Law Limiting Non-Competes May Face Court Challenges

This is the third blog by our Trade Secrets , Computer Fraud & Non-Competes team dealing with Washington state’s House Bill 1450, which dramatically alters non-compete agreements within the state. This blog discusses retroactive application of the statute and potential challenges the statute may face as it rolls out in January 2020.

What’s The Law?

As our team previously detailed, Washington state’s new House Bill 1450, which goes into effect January 1, 2020, will eliminate non-compete agreements for employees earning less than $100,000 a year and independent contractors earning less than $250,000 a year. The law requires advance notice of non-competes “no later than the time of acceptance of the offer of employment” and “independent consideration” for non-competes entered into after employment.

In addition, among other changes, the new law:

  • Establishes a presumption that a non-compete lasting longer than 18 months after termination of employment is unreasonable;
  • Provides that employers must specifically disclose to employees that a non-compete agreement may be enforceable against employees in the future due to changes in their compensation, even if they don’t meet the compensation thresholds at the time they sign the agreement;
  • Provides that employers cannot enforce non-compete agreements employees terminated as the result of a layoff unless employees are provided with compensation equivalent to their base salary at the time of termination for the period of enforcement minus compensation earned through subsequent employment during the period of enforcement;
  • Provides that “[a] person aggrieved by a noncompetition covenant to which the person is a party may bring a cause of action to pursue any and all relief provided for” in the statute, including “actual damages or a statutory penalty of five thousand dollars, plus reasonable attorneys’ fees, expenses, and costs incurred in the proceeding; and
  • Eliminates choice-of-law provisions as well as choice-of-venue if the employee or independent contractor is “Washington-based” (a term which the law does not define).

Is the Statute Retroactive?

Although the new statute does not go into effect under January 1, 2020, the statutory language suggests that agreements entered into prior to the effective date of the statute could, nevertheless, become void and unenforceable by retroactive application of the statute.

Most restrictive covenant laws provide that the new law will apply to all agreements entered into on or after the effective date. Not so with the new Washington law. The new Washington law provides that:

This chapter applies to all proceedings commenced on or after the effective date of this section, regardless of when the cause of action arose. To this extent, this chapter applies retroactively, but in all other respects it applies prospectively.

Somewhat confusingly, the statute also provides that “[a] cause of action may not be brought regarding a noncompetition covenant signed prior to the effective date of this section if the noncompetition covenant is not being enforced.” It’s unclear from this language whether non-compete agreements are “being enforced” only if the employer actively files, or threatens to file, a lawsuit against the employee for violating the non-compete, or if they are “being enforced” simply by reminding employees of their contractual obligations following termination of employment. If the latter interpretation applies, employers likely will need to inform employees that they will not be enforcing a non-compete covenant against the employee if they are otherwise reminding employees of their continuing obligations.

Regardless, it appears that, under the new law, many non-compete agreements that were valid and enforceable when signed will become invalid by application of the new law, even if the agreement was signed years before the new law was enacted.

What About the Contracts Clause?

Given its retroactive application, Washington’s new law might run into a constitutional challenge under the Contracts Clause in Article I of the U.S. Constitution. As fans of the hit Broadway musical Hamiltonwill recall, ensuring the financial stability of the new American Republic was a major concern of the Founders. The country’s financial stability was undermined, however, by attempts of state governments to pass laws relieving people of their obligation to pay their debts. For this reason, when the Framers enacted the Constitution, they included a limitation on the power of states to alter contractual agreements. Specifically, in the words of the Contracts Clause, “[n]o state shall…pass any…Law impairing the Obligation of Contracts.”

While the constitutional language seems clear, the Supreme Court has (as recently as last year) repeatedly held that the Contracts Clause prohibition is not absolute. The Supreme Court has delineated a two-part test for determining if a state law runs afoul of the Contracts Clause. First, as a threshold inquiry, courts looks at whether the state law has acted as a “substantial impairment” to the contractual relationship. Second, if a substantial impairment is found, courts will look at whether the state has a “significant and legitimate purpose” for the regulation.

With House Bill 1450 poised to void many non-compete agreements in the state, it seems likely that the law meets the threshold inquiry of substantial impairment. If a constitutional challenge is made, the battle will be whether the state can meet the burden to show a significant and legitimate purpose. The legislation’s stated purpose is to ensure “workforce mobility” and to eliminate “unreasonable” non-compete agreements that function as “contracts of adhesion.” We will have to wait and see if courts agree that this is sufficient to satisfy the second prong.

We will also be watching to see if this challenge makes it to the Ninth Circuit. As we’ve detailed before on this blog, the Ninth Circuit has not hesitated to apply state law striking down restrictive covenants. However, the Ninth Circuit has also shown it will enforce the Contracts Clause when faced with state laws that substantially impair the obligations of contracts. In fact, it did so against a previous Washington law in Continental Illinois National Bank & Trust v. Washington, 696 F.2d 692, 699 (1983) (holding that when a state law modifies pre-existing contracts, the court must strike it down as a violation of the Contracts Clause).

The Washington Supreme Court has also previously struck down state legislation as violating the Contracts Clause. In Carlstrom v. State, a teachers’ union claimed the state violated the contracts clause by enacting legislation that would have cancelled their previously-agreed-upon salary increases. The court held that the legislation violated the contracts clause by unreasonably impairing the previous contractual agreements. Carlstrom v. State, 103 Wash.2d 391, 397 (1985).

Because the new law will not become effective until January 1 of next year, only time will tell if the new law is subjected to challenges and, if so, if the statute’s retroactivity provision will be upheld. In the meantime, employers should prepare now for the effective date of the new statute.

What This Means For You

While the Trade Secrets, Computer Fraud & Non-Competes team will continue to monitor potential challenges to the law, Washington employers should ensure that their restrictive covenants practices are consistent with the new law, including:

  1. Ensuring that employee non-compete agreements entered into with new employees comply with the new law;
  2. Updating non-compete agreements with current employees to ensure they comply with the law’s “independent consideration” and other requirements; and
  3. Reviewing procedures for reminding departing employees of their existing obligations to ensure that unenforceable non-competes are not deemed to “be enforced” after the effective date of the statute.