New Utah law limits use of noncompetition agreements

April 2016
Ryan B. Frazier
Utah Employment Law Letter

Many employers are confronted by the problem of former employees using company information or relationships they had access to or developed during their employment. Employers have sought protection by having employees agree to covenants not to compete. Noncompetition covenants are agreements designed to ensure that employees don’t compete with their former employer when the employment relationship ends. Employees who have access to confidential or trade secret information, build the goodwill of a company, or possess unique, specialized skills are frequently asked to agree not to compete with their former employer.

Lawmakers and courts don’t like noncompetition agreements, viewing such agreements as restricting an individual’s ability to earn a living and preventing an employer from hiring the employees of its choice. Employees, who are typically in a relatively weaker bargaining position than employers, are often seen as having little choice but to accede to restrictions on their future employment to secure immediate employment.

Despite an antagonistic attitude toward noncompetition covenants, Utah courts have generally enforced them when they satisfy certain court-imposed standards. As the law has developed in Utah, noncompetition covenants are generally enforceable when they are (1) necessary to protect the employer’s legitimate business interests, (2) negotiated in good faith, (3) reasonable in terms of the geographic area they cover and their duration, and (4) supported by adequate consideration (i.e., the mutual exchanges in a contract). A noncompetition covenant that fails to measure up to any one of those requirements is subject to being invalidated.

Now, the Utah Legislature has targeted noncompetition covenants. A couple of bills attempting to limit or ban noncompetes were presented to the legislature this year. When the legislative session came to an end, Utah lawmakers had passed one of the bills that proposes significant changes in Utah law related to noncompetition covenants. Employers need to be aware of this revision of the law and consider how it may affect the use of noncompetition covenants in the future.

Proposals before the 2016 Utah Legislature

Utah legislators set their sights on noncompetition covenants during the 2016 legislative session. More than one bill addressing covenants not to compete was considered by lawmakers. One of the bills would have required employers to offer something more than continued employment in exchange for an employee agreeing to a covenant not to compete. That bill didn’t get very far. Another bill sought to ban noncompetition agreements altogether. During the course of the legislative session, the second bill evolved from an outright ban to new restrictions on noncompetes.

Before the general session of the Utah Legislature came to an end on March 10, 2016, a bill limiting the use and duration of noncompetition covenants was passed by both houses. Governor Gary Herbert has since signed the bill into law. At this point, it’s unclear whether additional restrictions on noncompetition covenants may be considered by the legislature in the future.

New restrictions

The bill that passed (House Bill 251) imposes new requirements and restrictions on noncompetition covenants entered into after May 10, 2016. All requirements imposed under common law not specifically changed by the law are still applicable to noncompetition covenants. That means that noncompetition agreements must protect a legitimate business purpose of the employer and must be reasonably limited in geographic scope.

The primary change to the law is the creation of a statutory limitation on the duration of a covenant not to compete. According to the new law, employers and employees cannot enter into a noncompetition covenant
that lasts more than one year from the day on which the employee is no longer employed by the employer.

The new requirement modifies the existing common-law requirement that a covenant include a reasonable time period during which it will be enforced.
The reasonableness of the covenant’s duration was determined based on evidence showing why the specific time period was necessary. Courts in some states will “blue-pencil,” or modify, the duration of a noncompete
to make it reasonable in light of the evidence. It is unclear whether Utah courts would “blue-pencil” a covenant not to compete.

According to the bill, any noncompetition covenant that violates the law, including the one-year limitation, “is void.” Taken literally, this provision suggests that not even “blue penciling” may save a noncompete that is
longer than a year.

Exceptions to the law

Not all noncompetition covenants are subject to the new restrictions. Covenants embedded in “mutually and freely agreed upon” severance agreements at the time of termination of employment are specifically exempted from the bill’s restrictions.

The bill also doesn’t prohibit a restrictive covenant related to or arising out of the sale of a business in which something of value is given in exchange for the purchase of the business. The bill also carves out exceptions for
nonsolicitation agreements and nondisclosure or confidentiality agreements. Common-law restrictions and requirements are nevertheless applicable to the covenants that would be exempted from the law.

Risk of unenforceable covenants

The bill imposes potential liability on employers that seek to enforce noncompetition covenants that courts or arbitration panels decide are not enforceable. If the noncompetition covenant is deemed unenforceable, then the employer “is liable” for the employee’s arbitration costs, attorneys’ fees, court costs, and actual damages.

The risk of getting hit with those costs and expenses may cause employers to think twice before attempting to enforce a noncompetition covenant, even when they are generally confident in the enforceability of the covenant.
In fact, the legislation may have a significant chilling effect on future efforts to enforce noncompetition covenants: If they recognize that employers are not enforcing covenants not to compete, employees may be emboldened to flout their agreements. If that were to happen, the benefits of such agreements would be effectively vitiated.

Existing noncompetition covenants

According to its terms, the bill doesn’t apply to noncompetition covenants that are already in place. As noted above, the law would apply only to covenants that are created on or after May 10, 2016. It would not apply
retroactively to void or alter noncompetition agreements in effect prior to that date. Employers shouldn’t be concerned that any noncompetition covenants currently in effect will be voided or modified. Nevertheless, existing noncompetition covenants must comply with the current common-law requirements to be enforceable.

Employers may be inclined to have employees sign noncompetition agreements before May 10 to avoid having to comply with the new restrictions. Theoretically, noncompetition agreements signed before that date that last more than one year wouldn’t be subject to the new one-year restriction. However, courts may look to the statutory one-year limitation to determine the reasonableness of the duration of noncompetes created before May 10.

Going forward

Employers need to reconsider how and whether to use noncompetition covenants in the future. Although the legislature didn’t prohibit noncompetes, they are now significantly limited. Some employers may try to put covenants not to compete lasting longer than a year in place before May 10. However, there may be some risk in trying to enforce such agreements. A better approach may be to draft noncompetition covenants whose duration doesn’t exceed one year.

Employers also need to consider whether to attempt to enforce noncompetition covenants in the future. The potential liability could be significant if a covenant is deemed unenforceable. Before deciding to enforce a covenant, an employer should seek legal counsel on the risks and benefits of a lawsuit or some other proceeding.

Finally, employers need to keep their eyes on what’s happening in the legislature. It’s clear that some legislators want an outright ban on noncompetition covenants. Legislation imposing additional restrictions or completely prohibiting noncompetes is definitely possible in
the future. Employers may want to express their opinions on this subject to their legislators.

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