April 1, 2015 – The Wisconsin Legislature will consider dramatic reforms to the restrictive covenant statute, Wis. Stat. section 103.465, which governs restrictions on competition during and after employment such as noncompetition and nonsolicitation agreements between employers and their employees or agents.
Last month, Senate and Assembly Republicans introduced Senate Bill 69 and companion bill, Assembly Bill 91 (legislation).
If the legislation passes and is signed by the governor, it will impact the drafting, negotiation, and enforcement of restrictive covenants by Wisconsin attorneys in several important ways. This article explains the legislation and its potential impact.
The Current Statute
The current restrictive covenant statute, section 103.465 (statute), looks upon post-employment restrictive covenants that restrain trade and employee mobility with disfavor, which existed in Wisconsin case law before the statute’s passage.
The Wisconsin Supreme Court has recognized that, in order to be enforceable, a restrictive covenant must be reasonably necessary for the protection of the employer, provide a reasonable time limit, provide a reasonable territorial limit, not be harsh or oppressive to the employee, and not be contrary to public policy.
Daniel Finerty (Marquette 1998) represents public and private sector employers as well as tribal employers and tribally-owned entities in labor and employment litigation, compliance and counseling matters at Lindner & Marsack, S.C. in Milwaukee. He regularly drafts restrictive covenants and both enforces and defends restrictive covenant litigation matters.
In addition, Wisconsin’s canons of construction highlight the hostility to such agreements, which are prima facie suspect, must withstand close scrutiny, cannot be construed broader than permitted by their language, and must be construed most favorably toward the employee. One unenforceable provision often doomed the employer’s entire restrictive covenant.
While the overtly hostile nature of Wisconsin law toward restrictive covenants was moderated by the supreme court’s 2009 decision in Star Direct,1 which recognized that the unrelated, reasonable post-employment restrictive covenants could be enforced where divisible from other overbroad and unenforceable clauses. But questions still remain regarding what is “reasonable” under the circumstances and what goes “too” far.
Statutory clarity in terms of drafting as well as enforcement was, and is, lacking because each case is construed based on a totality of circumstances approach, which does not yield consistent or reliable results for Wisconsin businesses, employees, and their attorneys.
If passed and signed by the governor, the legislation would “repeal and recreate” section 103.465. In its place, the legislation creates a statutory analysis for drafting and enforcing restrictive covenants in several ways:
Application. The legislation will apply to any restrictive covenant that restricts or prohibits competition during or after employment; however, the legislation explicitly excludes agreements that do not restrict or prohibit competition, a clarification seemingly intended to limit such arguments in litigation.
Legitimate business interest. The legislation provides that a restrictive covenant is enforceable if an employer shows that one or more “legitimate business interests” justify the restrictive covenant and that any restraint on competition is reasonably necessary to protect such interests. Legitimate business interests include: trade secrets or confidential information that does not rise to the level of a trade secret; relationships with existing and prospective customers, customer, patient, or client goodwill associated with a specific geographic location; and/or unique, extraordinary, or specialized training provided by business as a result of the employment relationship, among other things. This list is, for the most part, a codification of what Wisconsin courts have recognized as protectable interests for decades.
- Valid consideration. The legislation outlines various ways an employer may provide valid consideration to an employee in exchange for the execution of a restrictive covenant at several stages of an employment relationship.
Valid consideration would include situations where a restrictive covenant is executed at, or within a reasonable time after, the commencement of employment, where the offer of employment or the continuation of employment, is contingent upon the execution of the covenant, the execution of the restrictive covenant occurs in connection with any payment or thing of value including monetary consideration e.g., a bonus, incentive, or access to a bonus or incentive program, additional paid time off, post-employment “garden leave,” or other valid consideration paid at the time of termination in exchange for the covenant’s execution.
The question of whether ongoing employment is sufficient consideration for the execution of a restrictive covenant, which is currently under consideration by the Wisconsin Supreme Court in Runzheimer International, Ltd. v. Friedlen, would be squarely answered in the affirmative, again subject to negotiation at the time of offer and acceptance.
Reasonableness. The legislation provides an outline for courts to consider in determining whether a restrictive covenant is reasonable including, among other things, evidence of common practice relating to duration, scope, and nature of restraints in a specific industry.
- Burden-shifting approach. The legislation outlines a “burden-shifting” approach. If the employer successfully establishes one or more legitimate business interests for the covenant and the reasonable necessity to protect those interests, the employee must establish the restraints imposed are overbroad, overlong, or otherwise not reasonably necessary to protect the legitimate business interest(s).
If so, the burden to reform the restraint and grant only such relief as is reasonably necessary to protect that legitimate business interest(s) is placed upon the court, presumably with the parties’ guidance in how to do so.
This approach arguably moves Wisconsin from a venue to avoid when litigating these disputes to the top of the list of states with strong enforcement statutes. Some business interests believe the legislation will lure high-tech manufacturing, biomedical research, and other employers that are heavily dependent upon research and development and need greater protection for the investment personnel.
Rebuttable presumption. The legislation creates a rebuttable presumption that a post-termination restrictive covenant of six months or less from the termination is reasonable. By contrast, a restraint of longer than two years from the date of termination is unreasonable; however, a court may be able to find that a restraint of two years or longer is reasonable if it had “clear and convincing evidence” that such restraint was necessary.
As of submission, the legislation has been referred to the Senate Committee on Judiciary and Public Safety and the Assembly Committee on Labor. Public hearings have not been scheduled but are anticipated in the next several weeks.
Generally, legislation signed by the governor must be “published” the day after and goes into effect the second day following the signature, under Wis. Stat. section 35.095. The legislation would first apply to any restrictive covenant that is entered into, extended, modified, or renewed following that date. It would not retroactively impact restrictive covenants in effect as of the effective date, which would continue to be subject to the current statutory analysis.
While there is no telling what final legislation will look like, the legislation’s biggest impact, if enacted, will play out in state circuit courts and federal district courts in employers’ post-employment enforcement actions.
Courts are likely to be more receptive than in the past to such enforcement actions. Further, even if a court determines that a restrictive covenant provision is overly broad, the employer’s covenant is no longer doomed to dismissal.
Rather, the court may enforce the employer’s covenant by reforming the restriction to better meet the employer’s legitimate business interests. Also, the legislation will impact the negotiation stage. If enforcement is more likely, it is conceivable that the “cost” of requiring a new or current employee to sign a restrictive covenant arguably may increase or change. Wisconsin business attorneys will need to creatively approach this issue when advising clients.
Finally, the legislation would also likely impact the hiring considerations by Wisconsin businesses. Under the current statute, a business may be inclined to take on some level of risk of an enforcement action by a competitor post-hire due to an arguably justified belief that a Wisconsin court would likely strike all or part of an arguably unreasonable restrictive covenant due to Wisconsin’s canons of construction and hostility toward such agreements.
This legislation would dramatically change that analysis and increase the incentives toward a negotiated, pre-litigation resolution in addition to competition among employers in similar industries to ensure their restrictive covenants themselves remain "competitive" from a hiring and retention standpoint.
Wisconsin business attorneys should keep track of this pending legislation and its potential impact when considering how to advise business clients regarding their current restrictive covenant regimen as well as the timing and impact of any subsequent legislative action.
1 2009 WI 76, 767 N.W. 2d 898, 319 Wis.2d 274.