Striking a Balance: Alabama’s Newly-Amended Restrictive Covenant Statute
Author: James A. Patton, Jr. (Birmingham)
Published Date: August 14, 2015
When Alabama Governor Robert Bentley signed House Bill 352 into law on June 11, 2015, he repealed Alabama’s bare bones restrictive covenant statute and replaced it with a detailed codification of much of Alabama’s restrictive covenant case law. The new statute, which will become effective on January 1, 2016, will make it much easier for the uninitiated to understand Alabama’s restrictive covenant enforcement standards. The law largely reflects Alabama’s friendly attitude towards restrictive covenants, but it also tightens enforcement standards in several areas and makes some significant changes to Alabama law, including shortening the nonsolicitation agreement period and the restrictive covenant time period for business owners who sell business goodwill.
The new statute, like its predecessor, begins by stating that all contracts restricting a lawful “profession, trade, or business” are void unless otherwise sanctioned by the statute. The statute then lays out six categories of agreements in which restrictive covenants can be enforced, including noncompetition and nonsolicitation agreements, agreements arising from the sale of business goodwill, and “no-switch” agreements, in which two or more businesses or individuals agree not to hire or employ individuals working for the other businesses or individuals. However, the statute makes clear that “no-switch” agreements will only be enforced as to individuals who hold positions that are “uniquely essential” to the running of a business. This is a higher standard for enforcement than what was previously required under Alabama case law.
There are several interesting points in the noncompetition and nonsolicitation agreement sections. Below is an overview of the most important aspects of the new law.
First, the new statute does not use traditional employee-employer language to define which individuals are subject to these agreements. Instead, it says that an “agent, servant, or employee of a commercial entity” may enter into these types of agreements. This language raises a question as to whether Alabama will now allow independent contractors to enter into such agreements.
While this issue will have to be decided by the courts, the statute makes it clear that an agent, servant, or employee of a commercial entity may enter into these types of agreements only with a “commercial entity.” This suggests that noncompetition and nonsolicitation agreements might not apply to some nonprofit entities that do not engage in commerce and will be a change from current Alabama case law.
An interesting feature of the new law’s provision on nonsolicitation agreements is that it restricts the solicitation of “current customers.” Previously, Alabama courts generally would also enforce nonsolicitation agreements as to prospective customers with whom a former employee had some contact during employment.
To be enforceable, the geographic scope of a noncompetition agreement must not only be reasonable, but also apply to areas where the commercial entity is actively doing business.
In order for an agreement to be enforceable under the statute, the commercial entity must show a protectable interest. The new statute’s definition of protectable interest—which generally follows the definition that has emerged from the existing case law—includes trade secrets, appropriately protected confidential business information, specialized training involving “substantial business expenditure,” and commercial relationships with “specific prospective or existing customers.” It is unclear why the statute makes a relationship with a prospective customer a protectable interest but does not specifically allow enforcement of a nonsolicitation agreement to prospective customers.
The statute tightens enforceability standards by carefully defining confidential business information and by bluntly stating that job skills “without more” are not protectable interests. This might make it difficult to enforce restrictive covenants against individuals who are not involved in executive, managerial, or sales roles, or employees with specialized training and knowledge paid for by the entity.
One of the most significant aspects of the new statute is the provision stating that restrictive covenants will be presumed to be reasonable if they are of a certain duration. Assuming all other enforcement standards are met, an agreement adopting the statute’s time limits will be presumed to be reasonable as follows.
Business Goodwill. An agreement that restricts the sale of business goodwill is considered reasonable if it is one year or less.
Nonsolicitation. An agreement restricting the solicitation of current customers will be considered reasonable if it extends for 18 months or for as long as post-employment consideration is paid, whichever is longer.
Noncompetition. A noncompetition agreement restraining an individual from engaging in a business is presumed to be reasonable if it extends for two years or less.
Currently, Alabama courts generally enforce noncompete and nonsolicitation agreements of two years or less and agreements for the sale of business goodwill of two years or longer. It is strange that under the new law, the most sophisticated and financially able party involved in the three agreements at issue—business owners— are limited to the shortest time period. On the other hand, the most restrictive of the three types of agreements—the noncompete—has the most generous period at two years.
The language allowing the extension of the nonsolicitation period through the payment of post-separation pay is a new concept in Alabama. Previously post-separation pay has not been required and has received little discussion from Alabama courts. Alabama employers will now have the option of using such payments to extend non-solicitation periods for departing employees.
The new statute continues Alabama’s “blue pencil” tradition, allowing courts to strike overly broad portions of agreements and rewrite them to make agreements enforceable. However, the statute also states that an agreement that strays from the statutory parameters may be voided in its entirety. While not explicitly stated, it appears that an agreement longer than the statutory periods may be completely voided.
Under existing Alabama law, a restrictive covenant signed before employment begins is void. The Alabama Supreme Court’s 2001 decision, Pitney Bowes Inc.v. Berney Office Solutions, focused on language in the currently effective statute, which allows agreements with “one who is employed as an agent, servant or employee.” In Pitney Bowes, the court held that the “is employed” language meant that the employment relationship must exist at the time the agreement is signed. An agreement signed before the employment relationship actually began was completely void.
Similarly, the new nonsolicitation and noncompetition sections state that an “agent, servant, or employee of a commercial entity” may enter into such agreements with a commercial entity. Applying the reasoning of the court in Pitney Bowes, it appears that the agent, servant, or employee relationship must exist at the time that the agreement is signed. Given the uncertainty, employers may want to wait until the employment relationship begins before entering into a restrictive covenant agreement.
The statute is silent as to how it will be applied to agreements signed before January 1, 2016. If the statute applies to agreements signed prior to its effective date, then a portion of those agreements will likely be unenforceable, as some agreements will not meet the tighter enforceability criteria and may not be saved by the blue pencil rule. Since agreements signed after January 1, 2016, will certainly be subject to these new standards, employers’ current agreement templates will need to be examined and likely modified to ensure they comply with the new statute’s requirements.
Jay Patton is a shareholder in the Birmingham, Alabama office of Ogletree Deakins and a member of the firm’s Affirmative Action/OFCCP Compliance Practice Group, whose experienced attorneys counsel and defend federal contractors and subcontractors throughout the United States on jurisdictional, compliance, and enforcement issues involving the United States Department of Labor’s Office of Federal Contract Compliance Programs (OFCCP). Jay focuses his practice on assisting federal...