Another Round: Do we really need further legislative restrictions on noncompete agreements?
In the most recent legislative session, the Utah Legislature passed House Bill 251, a controversial bill limiting the duration of noncompete agreements in employment contracts. While the bill as initially drafted sought to ban such agreements altogether, the Legislature ultimately adopted a scaled-back version of the bill limiting noncompete agreements to a single year.
Although the law has been in effect for less than a year, additional restrictions on noncompete covenants are likely imminent, as the bill’s sponsor, Rep. Mike Schultz, signaled his commitment to further tightening restrictions after the close of the legislative session, telling the Deseret News, “This isn’t over.” More recently, Schultz and House Speaker Greg Hughes participated in the creation of a White House policy that calls on states to ban or limit the use of noncompete agreements.
With additional limitations—or an outright ban—on noncompete agreements on the horizon, employers should carefully consider how further changes could limit their ability to protect investment in their businesses and employees.
To evaluate the impact of any changes, it is helpful to understand the current status of noncompete agreements in Utah. While proponents of HB 251 made much of the fact that the bill was the first attempt to legislatively regulate noncompete agreements in the state, Utah’s judicial branch has long exercised supervision over the enforcement of these agreements.
In the seminal case of Allen v. Rose Park Pharmacy, the Utah Supreme Court in 1951 held that noncompete covenants are enforceable only to the extent they are both reasonable and necessary for the protection of the employer’s business. Subsequent decisions have refined that analysis, balancing the employer’s interests with the hardship imposed on the employee as a result of the restraint. Specifically, courts have recognized that an employer may legitimately enforce a noncompete agreement to protect, at a minimum, its trade secrets, the goodwill of the business, and its investment in the training or education of employees.
But courts have tempered the impact on employees by restricting the enforcement of noncompete agreements against employees engaged in “common callings,” instead requiring the employer to demonstrate the services rendered by the employee are special, unique or extraordinary. And courts carefully consider whether the duration and geographic scope of a noncompete agreement are reasonable in a given case in light of the location and nature of the employer’s business. The case-by-case approach developed by Utah’s courts regulates the enforceability of noncompete agreements in a way that legislative action cannot, carefully considering the specific facts and circumstances of each particular employment relationship.
If Representative Schultz is successful in abolishing noncompete agreements in Utah, employers may find themselves with limited means to protect trade secrets, goodwill and investment in employees. Of course, employers would still have some tools to protect trade secrets from disclosure by former employees, including nondisclosure agreements and the remedies available under Utah’s Uniform Trade Secrets Act. However, the efficacy of these tools may be limited, as an employer must generally prove actual or threatened disclosure to avail itself of judicial remedies—a significant challenge where both the former employee and the interested competitor have every incentive to keep such a disclosure under wraps. Only in the exceptional case, where an employer can meet the high bar of demonstrating a former employee will inevitably use the former employer’s trade secrets, can an employer preemptively act to prevent disclosure before it is imminent or has already occurred.
Furthermore, the law provides few alternative avenues for protecting a company’s goodwill and investment in training when a key employee departs. These losses are most acute where an employee has been trained and entrusted to service the employer’s customers and, by virtue of the employee’s contacts with those customers, the employer’s goodwill becomes associated with the employee. Such a key employee’s defection to a competitor carries a substantial risk of drawing away customers and irreparably damaging the former employer’s goodwill.
Without noncompete agreements to help mitigate these losses, employers must consider alternative approaches. For example, employers may consider reducing investment in specialized training of employees in favor of outsourcing or targeted hiring of more experienced personnel. And employers may need to monitor the relationships of employees with key clients to ensure the goodwill of the business remains with the company. While such changes are bound to create new challenges for businesses, employers may find these approaches more palatable than continuing to train and develop employees who may simply leave for a competitor with clients in tow.
The legislature’s passage of HB 251 last session restricted, but did not eliminate, noncompete agreements and left intact the judiciary’s important role in carefully evaluating their validity on a case-by-case basis. Any further restrictions of noncompete agreements may adversely affect many Utah businesses. Employers should be aware of the effect of potential legislation and be prepared to act if and when the legislature next takes up the issue.