The Evolving World of Colorado Non-Compete Agreements (US)
On March 8, 2018, the Colorado Court of Appeals issued much-needed guidance regarding C.R.S. 8-2-113(3) in Crocker v. Greater Colorado Anesthesia, P.C. (“GCA”). This statutory provision provides that “any covenant not to compete provision of an employment, partnership, or corporate agreement between physicians which restricts the right of a physician to practice medicine . . . upon termination of such agreement, shall be void; except that all other provisions of such an agreement enforceable at law, including provisions which require the payment of damages in an amount that is reasonably related to the injury suffered by reason of termination of the agreement, shall be enforceable. . . .” In its interpretation of this provision, the court concluded that the non-compete Dr. Crocker had signed was unenforceable for two reasons: (1) it was unreasonable to enforce a provision against a physician who was forced out of his employment by action of a merger, and (2) the liquidated damages were not reasonably related to the injury actually suffered as required by section 8-2-113(3), C.R.S. 2017.
A covenant not to compete is a contract between an employer and employee or contractor in which the employee or contractor agrees not to work for competitors of the employer during the term of the employment or engagement and/or for a specific amount of time after the employee or contractor completes their service to the employer. The Colorado Court of Appeals noted that, generally, a non-compete provision will survive a merger, allowing the surviving entity to enforce the non-compete restrictions. But here, the court found that Dr. Crocker’s shareholder rights in GCA were wed to his rights as an employee—he could not be an employee without being a shareholder, and he could not be a shareholder without being an employee. Finding no prior authority directly on point to evaluating a non-compete under such circumstances, the Court relied on non-compete law more generally and decided that it could only enforce the non-compete if it is “reasonable,” and to be reasonable, it must not impose hardship on the employee.
In evaluating reasonableness, the Court noted that Dr. Crocker was forced to quit his employment with GCA because he did not agree to a merger with a new company, USAP, where he would execute a new employment agreement reflecting a 21.3% reduction in pay. In addition, because according to the new agreement an anesthesiologist must live within 30 minutes of where he worked, he would have had to move or pay the liquidated damages. The Colorado Court of Appeals held that a liquidated damages provision in a physician non-compete agreement is enforceable only if the amount is reasonably related to an injury determined upon termination of employment, not related to any prospective injury estimated at the time of contract formation. The trial court found that because there was no evidence of any work diverted to him, any lost revenue or profit caused by his departure or anything other than conjecture to support the administrative portions of the formula, there were thus no damages. The appeals court agreed.
Non-competes often present unique enforcement challenges, especially in unique circumstances such as these. Because the law on this subject matter generally values free mobility of employees and free competition, non-competition agreements are looked upon with disfavor in almost every jurisdiction and are prohibited in some states. In the final month of 2017 alone, legislation was introduced by the Massachusetts and New Jersey legislatures to limit the use of employment non-compete agreements. And a bill proposed in Vermont would ban all employee non-compete agreements, following the example set by California in 1872. In the first few months of 2018, a similar trend is also starting to emerge, with Pennsylvania and New Hampshire introducing non-compete legislation of their own that would limit enforcement of non-competition agreements. Most states that are considering changes are taking a more measured approach, banning non-competes for low wage workers and for certain professions, like physicians such as Dr. Crocker, where there is public interest that outweighs the uses of non-competes, but there appear to be changes on the horizon nonetheless.
As employers, it is thus increasingly prudent to review any non-competition agreements your company is using to ensure they are “reasonable” and do not impose an undue hardship on the employee in order to avoid a court determining that the agreement is unenforceable. While “reasonableness” is somewhat subjective, courts have provided general guidance as to what they look at in determining whether a non-competition agreement is “reasonable.” These considerations include questions such as: Is it ancillary to another agreement and supported by adequate consideration? Does it protect a legitimate business interest (such as trade secrets, confidential and/or proprietary information)? Is it limited in time and geography? Does the employer have an interest in being protected from the competition of the employee? In addition to these fundamental questions, courts will most often look at all relevant circumstances, taking into consideration the relationships the employee has with customers as well. Considering the opinion in Crocker, liquidated damages clauses (at minimum in Colorado) should now also be reasonably related to the actual injury anticipated because of the employees departure, not on an arbitrary formula or fixed sum.