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Working for the Competition – How State Legislation Banning or Limiting Enforcement of Non-Compete Agreements May Affect Your Franchise

The subject of non-compete agreements, a hot-button issue in franchising, has come to a head in Massachusetts, where just yesterday, the House of Representatives voted unanimously to approve limits to non-compete agreements. The New York Times reported this is an emerging trend in a number of states in recent years. The Massachusetts bill imposes strict limitations on non-competes, in an effort to encourage job growth in the technology sector. Franchisors and franchisees should both take note of this and other, similar, bills that seek to determine how they conduct their businesses.

What are non-competes?

Non-compete agreements are contracts, often between an employer and each of its employees, in which the employee agrees not to pursue jobs with a competitor for a certain period of time after leaving their job. Franchise Agreements typically contain ‘non-compete provisions’ which prohibit a franchisee from owning, operating or otherwise participating in a competing business for a period of time after the termination of the franchise. Non-compete contracts or provisions typically define the type of competing work or business the employee, franchisee or individual is prohibited from participating in.

When are non-competes enforced?

The enforceability of non-competes depends on the facts of each case, and the law that applies to the contract. For example, in New York, courts reviewing a non-compete will apply a “rule of reason test” to determine the non-compete is no stricter than necessary to protect the enforcer’s legitimate business interests. To determine reasonableness, courts in New York evaluate the length of time, the geographic limitation and other factors specific to each case.

Critically, in New York and other states, courts take different views toward non-compete covenants depending on whether their enforcement is sought in connection with the sale of a business or with employment. New York courts are more hesitant to hold non-compete provisions to be “reasonable” when the provision restricts an individual’s livelihood and will carefully consider the public impact of such enforcement. By contrast, if a business owner sells his business to a buyer and agrees not to compete, New York courts are likely to enforce that non-compete if the seller later opens a competing business nearby. The New York courts’ unwillingness to restrict employees is heightened when the provision applies to low-wage workers, an issue that was highlighted in the news recently, when Jimmy John’s, an Illinois-based sandwich franchise system, entered into a settlement with New York State, agreeing to terminate its practice of requiring store employees to sign non-competes agreeing not to work at restaurants or delis after leaving their job.

What is changing?

In May 2016, the White House released a scathing report about non-compete agreements, specifically about their spread to low-wage employees, such as the Jimmy John’s case referenced above. The report states that non-compete agreements can result in lower job mobility, worker bargaining power and entrepreneurship. The Massachusetts bill, as stated above, was enacted partly in an effort to encourage economic growth in the technology and start-up sectors.

In the coming months, businesses should keep an eye out for new state legislation addressing some of the issues raised by the White House’s report, including the following:

  • Enforcement of non-competes against low-wage workers and/or workers without access to trade secrets.
  • Employers’ practice of waiting until employees have accepted a job offer to give them a required non-compete agreement (meaning that the employees have already declined other offers and are in a weaker bargaining position).
  • The lack of information provided to workers regarding their non-competes.
  • Employers’ practice of writing overly-broad and unenforceable non-competes.
  • Enforcement of non-competes where an employee is fired without cause.
  • The public interest in limiting the enforcement of non-competes.

What does this mean for franchises?

Franchisees should be aware of any pending legislation in the state/s where they operate, and should be particularly mindful of legislation relating to the enforceability of non-competes against low-wage employees, higher level employees and employees with access to trade secrets. Franchisees should take care to ensure non-competes in any employment agreements are drafted in a way that makes them more likely to be enforced in the state where they operate.

Franchisors should also be aware of pending legislation in the states where its corporate locations and franchisees are located. It is unclear whether any pending legislation will apply to the enforcement of non-competes against former franchisees but, if it did, franchisor attorneys would likely take the position that those non-competes are more similar to non-competes in the sale of a business context, than in an employment context, and focus on the facts that the franchisee benefitted from the franchisors’ ability to limit competitors (by, for example, not allowing multiple franchisees in a single geographic area), from the franchisor’s trade secrets, and thus, that it would be unfair for former franchisees to compete, to the franchisor (and future franchisees’) detriment. As this legislation is passed, Franchisors should review all of their non-compete provisions to ensure they are drafted in a way that makes them more likely to be enforced in the states where their franchisees are located.

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