Non-Compete Agreements: What Cannabis Business Owners Need to Know About Washington’s New Law

As the cannabis industry has matured, the competition between businesses has increased exponentially whether engaged in the sale of recreational marijuana, hemp, or CBD. A significant risk for any ongoing or new venture arises at the end of a term of employment, whether that end is voluntary or involuntary. That risk is of a former employee starting a business that directly competes with your business, using knowledge and skills she acquired in your employ. Depending on the state in which your business operates, you may use a non-compete agreements (NCA) to mitigate that risk. Each state’s laws carefully circumscribe the scope of an NCA. (In some states NCAs are not enforceable at all.) Generally, legislatures and courts frown upon NCAs because they restrict a person’s ability to engage in the livelihood their choosing. So NCAs must be carefully drafted to be enforceable — some states permit courts to reform NCAs under the “blue pencil” doctrine while others states apply the “red pencil” doctrine, known as the all or nothing rule.

Just last month Washington enacted a new law that radically changes the landscape for non-compete agreements. The bill was signed into law by Governer Jay Inslee on May 8 and takes effect as of January 1, 2020.

Before getting into the substance of the new law, let’s address why you might want to make use of NCAs in your cannabis business. There are several reasons:

• Your employees have access to confidential, proprietary, or trade secret information. An enforceable NCA can prevent former employees from using such information in their next venture. (See here for a discussion on the use of cannabis non-disclosure agreements, here for a discussion on cannabis trade secrets, here for discussion on cannabis patents, and here for a discussion about cannabis trademarks).
• You may sell your company at some point in the future. Enforceable NCAs may enhance the value of your company by protecting key customer relationships. NCAs do this by preventing employees from leaving the company upon its sale and taking those customers and business relationships with them to a new venture.
• Your willingness to share company secrets and protect your investment in training. Training employees is expensive, so is the possibility that an employee may leave having learned key processes or information that they can use in a new venture. An enforceable NCA can mitigate this expense and risk and may enhance your willingness to share information with key employees leading to additional innovation or productivity.
• You set expectations for employees and the consequences for future litigation. Employees subject to an enforceable NCA are less likely to believe they can simply jump ship to a new company that competes in your industry. This is especially true where the NCA provides for injunctive relief and liquidated damages.
• You put competitors on notice. Competitors are less likely to hire a person subject to an NCA and must be careful not to interfere with the NCE less they find themselves in court on a claim of tortious interference with contract.

With that, lets take a look at the highlights of Washington’s new law, and its severe restrictions on the use of NCAs:

• The law defines a non-compete agreement as any written or oral agreement that prohibits an employee or independent contractor from “engaging in a lawful profession, trade, or business of any kind”;
• The law creates a rebuttable presumption that any NCA longer than 18 months is unreasonable and unenforceable. A party seeking a longer NCA must prove by clear and convincing evidence that a duration longer than 18 months is necessary to protect the party’s business or goodwill.
• It renders void and unenforceable an NCA against employees who earn less than $100,000 per year or $250,000 per year in the case of an independent contractor. (Seattle’s tech giants lobbied for this threshold as it would not apply to many of their employees).
• The employer must disclose the terms of the NCA in writing “no later” than the time of the acceptance of the offer of employment. So disclose the NCA when making the offer of employment, or earlier. If the agreement is entered into later, it must be supported by independent consideration.
• For employees who are terminated by a layoff, an NCA is not enforceable unless the employee is compensated for the period of enforcement minus compensation otherwise earned by the employee during the period of enforcement. These amounts are subject to an annual inflation adjustment.
• By definition, an NCA does not include (1) a nonsolicitation agreement with respect to employees or customers of the employer; (2) a confidentiality agreement; (3) a covenant prohibiting use or disclosure of trade secrets or inventions; (4) a covenant entered into by a person purchasing or selling the goodwill of a business or otherwise acquiring or disposing of an ownership interest; or (5) a covenant entered into by a franchisee when the franchise sale complies with applicable Washington law.
• Persons who believe they are subject to an NCA in violation of the new statute may bring a cause of action (or the Attorney General may). If a violation is found, the violator must pay the higher of actual damages or a statutory penalty of $5,000 plus attorney’s fees and related costs and expenses.

The law becomes effective as of January 1, 2020. But by its terms, it applies to all proceedings commenced on or after January 1, 2020, regardless of when the cause of action arose. This means that, to some extent, the law applies retroactively.

The retroactivity provision of the law is important. It means that cannabis employers who attempt to enforce an existing NCA that does not comply with the new law may be subject to penalties. Although this provision may be subject to certain constitutional challenges concerning the impairment of contracts, cannabis businesses should strongly consider revising any existing NCAs to comply with the new law, including complying with the provisions concerning new consideration.

Does all this mean that you shouldn’t bother with an NCA in the Washington? No, an NCA can remain a useful tool in the right situation. But it does mean that you need to be careful in drafting NCAs to ensure that your NCA complies with the new law. Otherwise you may find yourself paying statutory fines and plaintiff’s attorney’s fees.