WOULD PARTIAL GARDEN LEAVE REALLY CHANGE NONCOMPETE PRACTICES IN MASSACHUSETTS?

At the recent hearing on noncompete reform before the Joint Committee on Labor and Workforce Development in the Massachusetts Legislature, Bradley MacDougall, Vice-President of Government Affairs at Associated Industries of Massachusetts, surprised many by announcing AIM’s support for H.2371, a bill that provides employee noncompetes are unenforceable if they do not contain a partial “garden leave” provision requiring that the employer pay the employee a portion of his or her salary during the period the employee is restricted from competing. In the past, AIM opposed including garden leave in any noncompete reform bill. Still, it is not clear just how vigorously AIM will support H.2371 and whether the bill (or any other noncompete reform bill) has a chance of success.

However, it is worth asking, would partial garden leave have a substantial impact on how employers and employees approach employee noncompetes? The simple answer is: probably not.

H.2371 leaves much of current employee noncompete law intact. The bill, like current law, prohibits enforcement of employee noncompete agreements that are not (a) necessary to protect legitimate business interests (trade secrets, confidential information and good will), (b) reasonable in scope, duration and geographic reach, and (c) supported by consideration. The bill generally prohibits enforcement of noncompetes longer than one year, but permits judges to reform agreements that contain a longer restricted period. The bill creates presumptions about the geographic reach and scope of noncompetes that more or less mirror current practice.

H.2371 would make some changes. Like most of the other reform bills introduced this session, the bill would prohibit the enforcement of noncompetes against employees classified as nonexempt under the FLSA, undergraduate and graduate student interns or short-term employees, and employees under the age of 19. While most of the reform bills prohibit enforcement against employees who are terminated without cause or laid off, H.2371 permits enforcement of noncompetes against employees who are terminated without cause (as does current law) and only prohibits enforcement against laid off employees who are not eligible to receive from the employer half the employee’s salary for the restricted period.

Like most of the reform bills introduced this session, H.2371 would require that noncompetes include language stating the employee had the right to consult with counsel prior to signing. The bill would require that employers provide prospective employees with notice of a noncompete requirement either at the time of a “formal offer of employment” or ten (10) days before commencement of employment. H.2371 permits enforcement of employee noncompetes entered into after the commencement of employee, but only if supported by “fair and reasonable consideration independent from the continuation of employment.” Whether this change is truly significant would depend largely depend on how courts interpret “fair and reasonable consideration.”

The most substantive change in the law that would result from adoption of H.2371 is the following partial “garden leave” provision:

The noncompetition agreement shall be supported by a garden leave clause or other mutually-agreed upon consideration, which shall include training, that provides the employee, the opportunity to receive compensation during the post-employment restricted period. To constitute a garden leave clause or other mutually agreed-upon compensation within the meaning of this section, the agreement must (i) provide for the payment, consistent with the requirements for the payment of wages under section 148 of chapter 149 of the general laws, on a pro-rata basis during the entirety of the restricted period, of at least 50 percent of the employee’s highest annualized base salary paid by the employer within the 2 years preceding the employee’s termination; and (ii) except in the event of a breach by the employee, not permit an employer to unilaterally discontinue or otherwise fail to make the payments; provided, however, if the restricted period has been increased beyond 12 months as a result of the employee’s breach of a fiduciary duty to the employer or the employee has unlawfully taken, physically or electronically, property belonging to the employer, the employer shall not be required to provide payments to the employee during the extension of the restricted period.

This garden leave provision of the bill must be read in conjunction with the definition of “garden leave clause” that appears earlier in the bill:

“Garden leave clause”: a provision within a noncompetition agreement by which an employer agrees to pay the employee during the restricted period, provided that such provision shall become effective upon termination of employment unless the restriction[s] upon post-employment activities are waived by the employer or ineffective under section (c)(iii).

The combined effect of the partial garden leave provision and the definition of “garden leave clause” may be summarized as follows. First, under H.2371, an employee noncompete is enforceable only if the agreement contains a provision that requires the employer to make post-employment payments to the employee during the restrictive period equal to at least half the employee’s “highest annualized base salary” in the two year’s prior to termination. The bill does not define “base salary,” but presumably it excludes commissions, bonuses, and benefits. Second, the employer is not required to make the post-employment payments to an employee who breaches his or her covenant not to compete. Third, H.2371 permits an employer to avoid its contractual obligation to make post-employment payments by waiving its right to enforce the employee’s covenant not to compete.

H.2371 does not make clear how an employer waiver of an employee noncompete is effectuated. The language of the bill suggests that in the absence of an explicit waiver of the employee covenant not to compete, the employer’s failure to make post-employment payments to the employee required under a garden leave clause would constitute a breach of that clause. H.2371 provides that a noncompetition agreement is unenforceable if it is not supported by a garden leave clause or “other mutually agreed-upon compensation,” which, in turn, must provide for post-employment payments and which does “not permit an employer to unilaterally discontinue or otherwise fail or refuse to make the payments.” Accordingly, it seems clear enough that if an employer has not explicitly waived its right to enforce a covenant not to compete and fails to make post-employments payments to an employee who has not breached his or her covenant not to compete, the employer’s failure to make the post-employment payments constitutes a breach of the garden leave clause. Moreover, because the garden leave provision of H.2371 requires post-employment payments “consistent with the requirements for payment of wages under section 148 of chapter 149 of the general laws,” the failure to make those payments in the absence of a waiver of the noncompete likely is also a violation of the Massachusetts Wage Act, subjecting the employer to treble damages and the payment of the employee’s attorney’s fees in any lawsuit to recover those payments. In addition, the employer’s failure to make post-employment payments in the absence of a waiver would invalidate the covenant not to compete under the well-established doctrine that where an employer breaches an employment agreement by failing to make payments owed the employee, any noncompetition agreement between the employer and employee is invalid.

So how will noncompete practice (as opposed to noncompete law) change if H.2371 were to become law? Probably very little. Why? The system of incentives and disincentives governing employee and employer conduct would not be significantly impacted.

Consider, first, the employee who is contemplating resignation and accepting employment that may constitute a breach of his or her noncompete, which, of course, includes the mandatory garden leave clause. As is the case now, the employee still cannot be certain whether the new job would constitute a breach of the covenant not to compete, largely because the requirement that the noncompete be “necessary to protect legitimate business interests” is sufficiently vague as to give trial judges substantial discretion. Moreover, and again, as is the case now, the employee cannot be certain whether the employer will seek to enforce the covenant not to compete, which may include a provision requiring that the employee pay the employer’s attorney’s fees if the employer prevails in a suit against the employee for breach of the noncompete. So, even if H.2371 becomes law, the employee pondering changing jobs still has a difficult decision to make and under conditions where he or she cannot predict whether he or she will be sued for breach of the noncompete and, if so, whether he or she will prevail in that suit.

The employee considering a change of jobs would have an option if H.2371 became law that he or she does not have now. The employee could resign without immediately commencing new employment. The employee could then wait. If the employer explicitly waives the employee’s covenant not to compete, the employee would be free to take any job, including a job that otherwise would have breached the covenant not to compete. Similarly, if after a month or so, the employer has not explicitly waived the employee’s covenant not to compete but also has not made post-employment payments, the employee would again be free to accept any job and likely has a Wage Act claim against the employer for failing to make post-employment payments during the period the employee did not breach the covenant not to compete. But how many employees will or can even afford to elect the “quit and wait” option? True, the employer could waive the covenant not to compete right away and the wait would be short and painless. But more likely, the employer will wait and determine whether the employee has accepted or commenced employment with a competitor in breach of the covenant not to compete, at which time the employer will, as it does now, review its options. And in still other instances, fearing that a key employee has accepted or will accept a job that constitutes a breach of the covenant not to compete that could cause harm to the employer, the employer likely will make post-employment payments and the employee will have no job and receive only a portion of his or her prior salary, without benefits. Employees who are risk adverse, cannot afford even a month without full salary and benefits, or cannot afford to lose the gamble involved likely will avoid the “quit and wait” option.

On the employer side, there is no reason to think that employers will be less likely to require that their employees sign noncompete agreements. There is no disincentive to requiring that employees sign noncompetes. On the contrary, noncompetes are effective at discouraging employees from taking jobs with competitors, and employers should be expected to continue requiring that employees sign them, even if the employers do not intend to enforce the agreements or to make post-employment payments.

Also, there is no reason to think employers will sue less frequently to enforce noncompete agreements. Today, when an employee with a noncompete leaves to work for a competitor, the employer must decide whether to sue to enforce the covenant not to compete. The employer must make this decision without being certain whether the court will enforce the covenant. Moreover, there is a disincentive to litigation, namely the cost. Not surprisingly, compared to the number of employees who have noncompetes, the number of suits filed to enforce employee noncompetes is small. H.2371 changes none of that calculus. It could be argued that if it became law, H.2731 might offer another disincentive to filing suit. When an employer sues to enforce an employee noncompete, the employer typically files a motion for a preliminary injunction. The court must decide on a preliminary basis whether the employer is likely to succeed on its claim that the employee breached the covenant not to compete. If the court rules that the employer is not likely to succeed, the employee could assert a counterclaim for breach of the Wage Act if the employer has not made contractually required post-employment payments, but only if the suit is filed after post-employment payments came due. However, noncompete cases are often filed so soon after the employee begins working for the competitor that post-employment payments will not have come due. In this situation, the employer would have to decide whether to waive the employee noncompete and dismiss at least the claim for breach of the noncompete or to begin making post-employment payments. Employers generally will not choose the latter option, which would only make sense if the employer believed that despite the negative preliminary injunction ruling, it will eventually prevail on its noncompete claim in the litigation.

In short, despite what seems like a major reform of Massachusetts noncompete law, the impact of H.2371’s partial garden leave requirement on practice is not likely to be significant. Employers would still require employees to sign noncompetes and those employees would still have multiple disincentives not to risk accepting jobs with competitors, including the risk of being sued for breaching their noncompetes. While it is true that employers likely will explicitly waive their right to enforce covenants not to compete in most instances where a former employee has started working for a new employer, even a competitor, this is true today, as well, only the waiver takes a different form, namely a decision not to sue.