Labor and Employment Update

The Disfavoring of Non-Compete Agreements For
Low-Income Wage Earners

By Kathleen Gatti & Deborah Brouwer

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Executive Summary

Millions of employees across the United States are covered by non-compete agreements. Due to the trend of subjecting low-income or low-skill workers to non-compete agreements, the federal government and many states have taken the position of restricting the validity of these agreements. Employers should be judicious in utilizing non-compete agreements, limiting their application only to those employees whose positions allow them access to sensitive company information.

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As demand for highly skilled and trained workers in certain professions becomes more competitive, employers increasingly seek to require newly hired employees to sign non-competition agreements (“non-competes”). These agreements typically limit the employee’s ability to work in the same industry, within a defined geographic area and for a defined period of time, after the employee is terminated (voluntarily or otherwise) from her current employment. Several rationales have been advanced for these agreements, including encouraging innovation by preventing employees who possess trade secrets from transferring that information to competitors, and encouraging employers to invest in worker training and skill development. Historically, non-competes were limited to high level managers, technical personnel and other key employees who could be expected to acquire proprietary information in the course of their employment. However, as the economy recovered from the Great Recession and employee turnover rose, employers turned to these agreements to gain a competitive edge. As a result, non-competes have spread to occupations viewed as “low-skilled,” in comparison to the executive management and technical positions to which these agreements traditionally were limited.

Today, 18 percent, or approximately 30 million employees, are covered by non-compete agreements. These employees are not limited to senior management and those highly compensated. For example, approximately 15 percent of employees without a college degree are subject to non-compete agreements, as are 14 percent of employees earning less than $40,000 per year. Recent media reports are beginning to raise public awareness of the spread of such agreements to employees such as fast-food workers, warehouse employees and even employees of a chain of doggy daycare centers. Perhaps the employer receiving the most public scrutiny over its use of non-compete agreements, however, is the franchised sandwich chain, Jimmy John’s.

Jimmy John’s and Non-Competes

In 2014, two Jimmy John’s sandwich makers filed suit in federal court in Illinois seeking a declaration that a non-compete agreement they signed was unenforceable. The agreement prohibited former employees of the company from working at any food service establishment within two miles of any Jimmy John’s store that derived more than 10% of its revenue from the sale of sandwiches, submarines or wraps, for two years after leaving the company. The agreements applied to employees whose main tasks were to take food orders, and make and deliver sandwiches. In support of its motion to dismiss, Jimmy John’s submitted affidavits declaring that it had no intention of enforcing the non-compete agreements in the future. Reasoning that there was no cognizable injury because there was no reasonable apprehension of litigation on the part of Jimmy John’s, the court dismissed the plaintiffs’ claims for injunctive and declaratory relief.

Jimmy John’s Non-Competes in New York

That same year, New York Attorney General Eric Schneiderman began an investigation into Jimmy John’s use of non-competes. Except in limited circumstances, such as the protection of trade secrets or employees with special skills, New York law prohibits such agreements. This investigation revealed that some, though not all, Jimmy John’s franchisees in the state used the non-competes that were distributed to them by franchisor Jimmy John’s. In June 2016, Jimmy John’s entered into a settlement with the New York Attorney General, resolving the inquiry. As part of the settlement, Jimmy John’s agreed that, as a franchisor, the chain would not support franchisee enforcement of non-compete agreements against employees. Jimmy John’s also agreed to inform its New York franchisees that non-compete agreements are disfavored by New York law and that franchisees in that state should void any such agreements. Additionally, New York franchisees that did implement non-compete agreements agreed to void them and discontinue their usage.

Jimmy John’s Non-Competes in Illinois

The same month in which New York ended its inquiry into Jimmy John’s non-competes, Illinois filed suit against the sandwich chain. That lawsuit alleged that the non-compete agreements were illegal under Illinois law, which provides that non-compete agreements must be premised on a legitimate business interest and narrowly tailored as to time, activity, and place. In announcing the lawsuit, the Illinois Attorney General stated that “[p]reventing employees from seeking employment with a competitor is unfair to Illinois workers and bad for Illinois businesses. By locking low-wage workers into their jobs and prohibiting them from seeking better paying jobs elsewhere, the companies have no reason to increase their wages or benefits.”

The lawsuit sought a declaratory judgment that the agreements were unenforceable, void and rescinded. Although Jimmy John’s initially told the Attorney General that the chain had stopped using the agreements in April 2015, following the district court’s dismissal of the plaintiffs’ claims for declaratory and injunctive relief in Brunner, Jimmy John’s later admitted that this policy change actually had not been implemented, nor had it been communicated to corporate-owned sandwich shops, employees, or franchisees.

In December 2016, Jimmy John’s settled with the Illinois Attorney General’s office, agreeing to pay $100,000 to be used to educate the public about the enforcement of non-compete agreements. It also agreed to (1) notify all current and former employees that their non-competes would not be enforced, (2) remove the non-competes from materials to be signed by new hires, and (3) notify franchisees to void any non-competes modeled after the Jimmy John’s corporate version. Finally, Jimmy John’s agreed that, in the future, all non-compete agreements would comply with Illinois law. Effective January 1, 2017, the Illinois Freedom to Work Act banned non-compete agreements for employees earning less than $13.00 an hour.

Federal Government’s Stance on Non-Competes

Illinois policy makers are not alone in their efforts to curb or ban non-compete agreements for lower-wage workers. On the federal level, legislation was introduced in the Senate in 2015 in direct response to reports that Jimmy John’s and other retailers were requiring lower-wage employees to sign non-compete agreements. The bill, called the Mobility and Opportunity for Vulnerable Employees (MOVE) Act, would have amended the Fair Labor Standards Act, the federal law that established a minimum wage and the right to overtime pay. The MOVE Act would have prohibited the use of non-compete agreements for employees earning less than $15.00 an hour, $31,200 per year, or the minimum wage applicable in the worker’s municipality, and would have required companies to inform job seekers in advance if they would be asked to sign one. The bill, however, failed to make it out of committee.

The Obama Administration also voiced support for measures at the state level to curb or ban the use of non-compete agreements for low-wage employees. In May 2016, the White House released a report outlining the potential negative impacts of non-compete agreements for low-wage workers. According to the report, several states have taken measures limiting non-compete agreements. For example, in 2016, Hawaii banned the use of non-compete agreements in the technology sector, while New Mexico banned them for healthcare jobs. Oregon law now bans non-compete agreements longer than 18 months, and Utah has banned agreements longer than one year. State legislatures in Washington and Idaho are considering bills that would limit non-compete agreements to certain designated “key employees,” who are more likely to have knowledge of sensitive corporate information.

The White House followed its May 2016 report in October 2016, with what it termed a “call to action” to the states, encouraging states to enact laws banning non-competes for workers falling below certain wage thresholds, or who are unlikely to possess trade secrets. Several state officials voiced support for the initiative, including New York Attorney General Schneiderman, who announced that he intends to introduce comprehensive legislation in 2017 curbing the use of non-compete agreements.

History of Michigan Law on Non-Competes

The legal validity of non-compete agreements in Michigan has moved back and forth over time, likely due to varying economic conditions. In the nineteenth century, Michigan common law provided that, while an agreement not to compete was a restraint on trade, the agreement could be lawful if it had been negotiated for a just and honest purpose and for the protection of legitimate interests of the party in whose favor it was imposed. The restraint also had to be reasonable as between the parties and could not be specifically injurious to the public. In subsequent decisions, these factors became known as the “common law rule of reason.”

In 1905, however, the Michigan Legislature abrogated this common-law rule of reason through the enactment of MCL 445.761, which provided that “[a]ll agreements and contracts by which any person, co-partnership or corporation promises or agrees not to engage in any avocation, employment, pursuit, trade, profession or business, whether reasonable or unreasonable, partial or general, limited or unlimited are hereby declared to be against public policy and illegal and void.” Thus, even if the parties had entered into a non-compete agreement that was reasonable, the agreement was still illegal and unenforceable.

The wind did not shift again for almost eight decades, until 1984, when the Michigan Antitrust Reform Act (MARA) repealed all previous statutory provisions regarding covenants not to compete. While MARA proclaimed that contracts made “in restraint of, or to monopolize trade or commerce” were unlawful, the Act also expressly stated that “[a]n employer may obtain from an employee an agreement or covenant which protects an employer's reasonable competitive business interests and expressly prohibits an employee from engaging in employment or a line of business after termination of employment if the agreement or covenant is reasonable as to its duration, geographical area, and the type of employment or line of business….” In essence, this provision returned the “common law rule of reason” to the analysis of non-compete agreements in Michigan.

In keeping with the nationwide examination of the use of non-compete agreements, the Michigan Legislature recently considered whether non-compete agreements should be made unenforceable by statute. In 2015, Michigan State Representative Peter Lucido introduced House Bill Number 4198, which would have amended MARA by making non-compete agreements enforceable only against business owners, principals or executives. The bill failed to gain any co-sponsors and never made it out of committee.

Current Michigan Law on Non-Competes

As the law currently stands, Michigan courts will enforce non-compete agreements that are reasonable. Determining what is reasonable requires an analysis of the circumstances of each particular case. In general, Michigan courts look at four factors: (1) the type of employment the employee is prohibited from engaging in; (2) geographical area; (3) duration of the agreement; and (4) the competitive business interest the agreement seeks to protect. As to the first factor, an agreement prohibiting a former employee from working for a competitor in any type of job, even one different from the one the employee performed for the former employer, most likely would be found to be unreasonable. If, on the other hand, the agreement only prohibits the employee from working for a competitor in the same capacity for which she worked for her former employer, it may well be deemed reasonable.

As to geography, the agreement must not prohibit the employee from working in too broad of an area. For instance, an agreement prohibiting an employee from working anywhere in the state likely would not be reasonable, but one limiting the prohibited geographical area to a limited number of miles within the former employer may be reasonable.

The third factor looks to how long the employee is prohibited from working for a competitor. There is no hard and fast rule in Michigan for how long a duration is reasonable. Non-compete agreements between six months and three years in duration have been found reasonable.

Finally, a court will examine what business interest the employer is trying to protect through the agreement. If the interest is something such as the employer’s confidential information, including customer lists and/or trade secrets, special training or technical information, a court would likely find it reasonable. Conversely, if the employer is merely trying to protect itself from a former employee’s general knowledge or skill, it would likely not be deemed reasonable.

Conclusion

The Jimmy John’s case and its subsequent legislative backlash is a cautionary tale for employers who implement non-compete agreements for their workforce. The lesson to be gleaned is that employers should be judicious in utilizing them, limiting their application only to those employees whose positions allow them access to sensitive company information. Determining which employees fit that description likely will require an analysis of the four factors outlined above to determine whether subjecting an employee to a non-compete agreement is reasonable in each case. This approach undoubtedly takes more time than the blanket approach used by Jimmy John’s, but in the wake of that case and the ensuing heightened scrutiny it brought to non-compete agreements, it seems a wise investment of employer resources.

Categories: Volume 7-3

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