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Published: 2008-03-26

Courts Affirm Employers' Right to Require Non-Compete Agreements



Your company has instituted a new wide-reaching policy that all current and future employees must sign non-competition agreements, conditioned upon receipt of additional consideration. One or more current employees refuse to sign. May the company properly terminate existing employees for refusing to sign?

This is an emerging issue in the law. Employers can take some comfort in the fact that the New Jersey, Oregon, Vermont and Wisconsin Supreme Courts, the United States Court of Appeals for the Seventh Circuit, and a Connecticut Superior Court have emphatically affirmed the right of employers to terminate employees for refusing to sign a non-compete agreements.[1] Each of these courts have reasoned that the essence of an at-will relationship is the right to fire an employee for any reason, including for refusal to sign a non-compete. Only one California court has ruled otherwise. California's unusual statutory prohibition on non-competes figured prominently in that decision.

Nonetheless, because the issue remains unsettled in at least forty-two states, and because of a dissenting opinion by a New Jersey Supreme Court Justice, as well as a contrary decision by the New Jersey Court of Appeals (ultimately reversed by the New Jersey Supreme Court), employers, particularly employers with employees in multiple states, should proceed cautiously.

I. Court Decisions Upholding The Right of Employers to Terminate Employees for Refusing to Sign Non-Compete Agreements.

Because of the strong adherence to the principle of at-will employment, six courts, including the Seventh Circuit, have affirmed the right of an employer to terminate an existing employee for refusal to sign a non-compete agreement.[2] See, e.g., O'Regan v. Arbitration Forums, Inc., 121 F.3d 1060, 1064 (7th Cir. 1997) (applying Illinois law); Madden v. Omega Optical, Inc., 683 A.2d 386, 391-92 (Vt. 1996); Tatge v. Chambers & Owen, Inc., 579 N.W.2d 217 (Wis. 1998).

The primary reason courts have cited for their unwillingness to recognize a claim of wrongful or retaliatory discharge is that non-compete agreements do not sufficiently implicate public policy to alter the fundamental nature of an at-will employment relationship. See Tatge v. Chambers & Owen, Inc., 579 N.W.2d 217 (Wis. 1998); Steward v. Cendant Mobility Servs., Inc., No. CV000337994S, 2002 WL 442385 at *7 (Conn. Super. Feb. 21, 2002) (finding no cause of action because covenants not to compete do not, in and of themselves, implicate public policy).

II. New Jersey Joins The Majority.

The New Jersey Supreme Court recently joined the majority position on this issue with its decision in Maw v. Advanced Clinical Communications, Inc., 846 A.2d 604 (2004), reversing a contrary decision by the New Jersey Court of Appeals. The Maw plaintiff was fired for refusing to sign a non-compete agreement that she believed was contrary to public policy. The district court dismissed her wrongful termination claim on a Rule 12 basis for failure to state a claim upon which relief could be granted.

The New Jersey Court of Appeals reversed the district court's Rule 12 dismissal, finding that the termination potentially implicated New Jersey's whistleblower statute, N.J. Stat. Ann. § 34:19-1, et seq. The statute insulates employees who object to or report conduct they reasonably believe to be illegal or "incompatible with a clear mandate of public policy concerning public health, safety or welfare or protection of the environment." New Jersey Stat. Ann. § 34:19-3c(3). The New Jersey Court of Appeals found that "New Jersey's strong prohibition against restraint of trade, and against unduly burdening employees by restricting their right to engage in their chosen field of employment, establishes the public policy necessary to support a . . . cause of action." 820 A.2d at 116. Accordingly, the Maw court suggested imposing on the employer the burden of demonstrating its legitimate interests required protection through a non-compete, an issue which it did not believe was susceptible to Rule 12 adjudication. See 820 A.2d at 113-14.

The New Jersey Supreme Court reversed, finding that Maw's objection to the non-compete provision in her employment agreement was purely a private dispute that did not implicate any public policy concerns. See 846 A.2d at 608-09. It rejected the potential harm to the employee, concluding that she could have either negotiated different terms or disputed the enforceability of the covenant if and when her employer sought to enforce it. Id.

Notably, Justice Zazzali dissented, arguing that the plaintiff's claim gave "rise to serious public-policy concerns that transcend a mere private dispute." 846 A.2d at 610. The dissenting justice argued that a "free pass" rule for employers would simply encourage them to require employees to sign unreasonably restrictive non-compete agreements, resulting in even greater disincentives for either the employees or potential employers to expend the resources necessary to challenge them in court. Accordingly, like the New Jersey Court of Appeals, Justice Zazzali recommended imposing the burden of proof on employers to demonstrate that the proposed non-compete agreement which the employee refused to sign was reasonable and enforceable.

Altogether six courts, including the New Jersey Supreme Court, have rejected the rationale of Justice Zazzali's and the New Jersey Court of Appeals. Nonetheless, because the issue has yet to be addressed by courts in forty-two states, a real possibility exists that a court in one of those states may adopt the rationale potentially permitting such claims. As a result, care should be taken to ensure that any proposed non-compete both is not longer than reasonably necessary to protect the employer's legitimate interests, and that only employees with access to confidential information or control over goodwill are asked to sign them. Moreover, the decision to terminate an employee with control over an employer's goodwill for refusing to sign a non-compete agreement may simply drive the employee into the arms of a competitor – the very result the non-compete was intended to avoid.

III. The California Exception.

In those states in which covenants not to compete are altogether unenforceable, courts differ on the issue of whether refusal to sign an agreement is appropriate grounds for termination. A California appellate court has found that employees fired for refusing to sign non-compete agreement may maintain a cause of action against the former employer for wrongful termination. See D'Sa v. Playhut, Inc., 85 Cal. App. 4th 927, 932-34 (Cal. Ct. App. 2000), rev. denied. Citing a "clear legislative declaration of public policy against covenants not to compete,"[3]the D'Sa court found that firing an employee who refuses to sign an unenforceable agreement sufficiently altered the at-will employment relationship and ran afoul of the state's common-law prohibition against wrongful termination. Id. at 932.

Although California is currently the only state that has expressly recognized a cause of action on these grounds, a similar rationale may be adopted in other states who likewise have strong public policies against enforcement of non-compete agreements. For instance, Colorado law, like California law, invalidates non-compete agreements for any reason other than protection of trade secrets. See Colo. Rev. Stat. § 8-2-113(2). North Dakota law also fails to recognize the enforceability of covenants not to compete. See N.D. Cent. Code § 9-08-06. An employee who declines to sign an unenforceable agreement in one of these states might well have a wrongful termination claim if the court in that case follows the rationale of the California appellate court in D'Sa.

But it is far from certain that the courts would do so. For example, under Oregon law, covenants not to compete signed after the commencement of employment are unenforceable unless the agreement is accompanied by a promotion.[4] Nonetheless, the Oregon Supreme Court has refused to recognize a wrongful termination claim where an existing employee was terminated for refusing to sign a five year non-solicitation agreement that was not accompanied with the offer of a promotion. See Dymock v. Norwest Safety Protective Equip., Inc., 45 P.3d 114 (Or. 2002). The Dymock court reasoned that the at-will employment doctrine should only be overruled when the employee is terminated for exercising an "employment-related right." Id. at 116. The court refused to read into the statute invalidating non-competes unaccompanied by a promotion an additional right to refuse to sign an unenforceable agreement. It is unclear whether Colorado and North Dakota courts would follow the California approach or the Oregon approach.

Conclusion

An employer contemplating terminating an existing employee for refusal to sign a non-compete has an impressive string of decisions from six separate courts to knock out a wrongful termination claim on a Rule 12 basis. Based on the now-reversed decision of the New Jersey Court of Appeals, and the dissenting opinion in the New Jersey Supreme Courts, however, a real possibility exists that the employer's rationale for requiring a non-compete and the terms of the non-compete will be scrutinized for reasonableness. Care should be taken, therefore, to ascertain that the non-compete will pass muster under whichever state's laws will likely be applied. The decision to terminate should be based on a case by case basis, and the employer should be prepared to demonstrate that its legitimate interests required protection through a non-compete signed by the employee in question.


[1]Maw v. Advanced Clinical Communications, Inc., 177 N.J. 439, 846 A.2d 604 (2004); Dymock v. Norwest Safety Protective Equip., Inc., 45 P.3d 114 (Or. 2002); Madden v. Omega Optical, Inc., 683 A.2d 386 (Vt. 1996); Tatge v. Chambers & Owen, Inc., 579 N.W.2d 217 (Wis. 1998); O'Regan v. Arbitration Forums, Inc., 121 F.3d 1060, 1064 (7th Cir. 1997); Steward v. Cendant Mobility Servs., Inc., No. CV000337994S, 2002 WL 442385 at *7 (Conn. Super. Ct. Feb. 21, 2002).

[2]This article does not address the issue of the consideration necessary to enforce a non-compete agreement executed after the inception of employment. Several states require that a covenant not to compete executed after the employee has begun work be supported by independent consideration. See, e.g., Freeman v. Duluth Clinic, Inc., 334 N.W.2d 626, 630 (Minn. 1983); George W. Kistler, Inc., v. O'Brien, 347 A.2d 311 (Pa. 1975); James C. Greene Co. v. Kelley, 134 S.E.2d 166 (N.C. 1964). In other states, continued employment is sufficient to support a non-compete agreement signed after the inception of employment. See, e.g., Lake Land Employment Group, LLC v. Columber, 804 N.E.2d 27 (Ohio 2004).

[3]See Cal. Bus. & Profs. Code § 16600 ("every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.").

[4]See Oregon Rev. Stat. § 653.295(1).