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Proposed Restrictive Covenant Law Threatens to Handcuff Employers

Posted in Contracts, Legislation, Restrictive Covenants

Prepared by: Brian Confino

Most businesses possess confidential information or trade secrets that need to be safe-guarded, or intellectual property, equipment, or processes that set them apart from their competition. Many companies choose to protect this information using “restrictive covenants” – agreements in which employees promise not to compete with the business in the future, lure away its employees or customers and/or divulge its confidential information.

Recently, a new bill (A3970) was introduced to the New Jersey State Assembly which would invalidate certain restrictive covenants in order to address New Jersey’s high rate of unemployment. Pursuant to A3970, non-compete, non-solicitation and non-disclosure provisions would be unenforceable with respect to individuals who are eligible for New Jersey unemployment insurance benefits. (Generally, unemployment benefits are available to workers who are laid off or discharged for reasons other than gross misconduct).

The proposed measure is intended to limit barriers to employment in an attempt to reduce New Jersey’s above-average unemployment rate (9.3 percent compared to 7.6 percent nationwide). The bill’s sponsors, Peter Barnes, Joseph Egan and Wayne DeAngelo, hope that A3970 will allow unemployed workers to get back to work (and off unemployment benefits) sooner.

There may, however, be unintended consequences if this bill is passed.  For example, employers would be more likely to contest workers’ eligibility for unemployment benefits, in order to ensure that their restrictive covenants remained enforceable. The proposed bill might also discourage companies from establishing or expanding their businesses in New Jersey due to the inability to adequately protect their confidential information. In addition, companies may move high-level employees out of New Jersey into states where post-employment covenants are enforceable. The proposed legislation also creates incentives for employees who resign to argue that they were “constructively discharged,” or even to perform poorly in order to trigger a discharge that would relieve them of their post-employment obligations.

If enacted, this legislation would not be retroactive and would only apply to agreements entered into after the bill takes effect. Given the uncertainty raised by this very broad bill, employers should consider entering into restrictive covenants with high-level employees sooner rather than later. If the bill is passed, employers may also want to consider taking measures to ensure that key terminated employees are not deemed eligible for unemployment compensation, such as a structured severance payment covering the term of the restrictive covenant. We will continue to monitor the bill and will provide updates as they become available.