Colorado Legislature Dramatically Changes Non-Competition Law

Elizabeth Chilcoat

Non-competition agreements have been a political hot-button issue for the last year out of growing concern, on both sides of the aisle, that these agreements are overused to the detriment of employees.  On the final day of the 2022 legislative session, Colorado’s General Assembly significantly changed Colorado’s law on restrictive covenants with HB 22-1317.  The bill now heads to Governor Jared Polis, who is expected to sign it into law.  The changes to Colorado law will then go into effect on Tuesday, August 9, 2022.  The changes affect Colorado employers and any business that employs (including as an independent contractor) a person who primarily lives or works in Colorado.

Summary of the Old Law

Between 1982 and 2021, Colorado’s law governing non-competes existed relatively unchanged.  The law generally prohibited agreements not to compete and provided exceptions for non-competition obligations contained in a contract for the purchase and sale of a business or its assets, a contract to protect trade secrets, and agreements with executive and management personnel, officers, and employees who constitute professional staff to executive and management.  The law also allowed employers to recover the expenses of educating and training an employee who left employment having served the employer for less than two years.  Non-competition agreements with physicians were void, but monetary damages could be enforced against a physician who breached the agreement provided that the physician did not treat patients with rare medical conditions.  Colorado courts treated agreements not to solicit customers like non-competition agreements and required that any non-competition agreement be reasonable in geographical reach, duration, and scope.  The law did not impose any limitations on confidentiality agreements, which were often used to protect both trade secrets and competitively-sensitive business information that might not rise to the level of a trade secret.  In 2021, the General Assembly amended the law to make an employer’s violation of the law a Class 2 misdemeanor.

Dramatic Changes

HB 22-1317 applies to covenants not to compete, but the General Assembly’s failure to define those covenants coupled with provisions of the law that address agreements that have not typically been considered to be covenants not to compete, leaves questions about the scope of the law.  At a minimum, the new law addresses a wide variety of restrictive covenants that might be used to limit an employee’s post-employment mobility, including non-competition agreements, covenants not-to-solicit customers, and even nondisclosure and confidentiality agreements.  The changes apply to any agreement entered into or renewed after the law becomes effective (on August 9, 2022).  The structure of Colorado’s restrictive covenant law is maintained; restrictive covenants are generally prohibited unless they satisfy an exception.  The most profound changes come in the form of strictly limiting the types of restrictive covenants that are permissible, the imposition of financial penalties upon employers who get things wrong, and expanding the law’s reach to a larger number of employers.  The following is a summary of the important points in the law.

1. Why It Matters: Criminal and Civil Penalties.

Colorado has long prohibited the use of “force, threats, or other means of intimidation” to limit a person from pursuing any lawful occupation.  HB 22-1317 makes clear, through a redraft of the 2021 amendment, that doing so is a Class 2 misdemeanor.

In addition, an employer who presents to a worker or prospective worker a non-competition agreement as a term or condition of employment even though the agreement is void, or who enters into a void non-competition agreement, or makes any effort to enforce a void non-competition agreement will be liable for financial penalties and actual damages.  In addition, a court may enter an injunction preventing the employer from engaging in similar conduct in the future.  The penalties for a violation are $5,000 per worker or prospective worker harmed by the employer’s conduct.  Penalties may be reduced if the employer proves that its action was not only in good faith but also that the employer had reasonable grounds to believe it was not violating the law.  Proving those “reasonable grounds” will be difficult because, as most attorneys will tell you, the enforceability of any particular non-competition agreement is uncertain until a court rules on the issue.  Any worker or prospective worker harmed by the employer’s actions may pursue legal remedies, and the law also permits the Attorney General to take legal action against employers.

2. Permissible and Impermissible Restrictive Covenants.

HB 22-1317 narrows the types of restrictive covenants that are permissible in Colorado.  Unlike the old law, which was principally concerned with non-competition agreements, Colorado will now regulate the permissibility of confidentiality agreements, as well.

a. Protecting Trade Secrets.

The use of non-competition agreements to protect trade secrets is common around the country.  Even California, with its draconian view of non-competition agreements, permits employers to protect their trade secrets proactively with a reasonable non-competition agreement.  In contrast, HB 22-1317 eliminates an employer’s ability to elicit a non-competition agreement from most of its employees even if the goal is to protect trade secrets.  Simply stated, an employer’s interest in protecting its trade secrets from disclosure by an employee who primarily lives or works in Colorado will no longer be sufficient to justify a new or renewed non-competition agreement.

HB 22-1317 permits two narrow exceptions to protect trade secrets.  First, an employer may enter into a covenant not to compete to protect trade secrets if the agreement is (a) no broader than reasonably necessary to protect the trade secrets and (b) so long as the employee, both at the time of signing the agreement and when the employer wants to enforce it, earns annualized cash compensation equivalent to or greater than the threshold amount for a highly compensated worker under Colorado’s PAY CALC order.  Colorado recalculates the threshold on an annual basis.  For 2022, the threshold is $101,250.

Second, an employee may enter into an agreement not to solicit the employer’s customers provided that (a) the restriction it is no broader than necessary to protect the employer’s legitimate interests in its trade secrets and, (b) at the time of signing and enforcement, the employee’s annualized cash compensation is equivalent to 60% of the threshold pay for a highly compensated worker under Colorado’s PAY CALC Order.  For 2022, that means that non-solicitation agreements are permissible only if the employee earns at least $60,750 in cash compensation for the year.

In both of these instances, non-cash compensation, such as equity or in-kind benefits, cannot be used to satisfy the compensation threshold requirement.  Special rules apply to annualize compensation for an employee who works less than a full year for a company.

b. Limitations on Confidentiality Agreements.

HB 22-1317 also limits employers’ ability to enter into confidentiality agreements with employees.  Often, employers use confidentiality agreements to protect business information that does not rise to the level of a trade secret but, nevertheless, is competitively-sensitive.  A “reasonable” confidentiality provision that is “relevant to” a company’s business will be permitted under HB 22-1317, but only if the non-disclosure agreement does not protect information that arises from the worker’s “general training, knowledge, skill, or experience.”  Because most confidential information is conveyed to employees in training and through their work experience, it is not clear how courts, much less employers, will determine whether a confidentiality agreement is permissible.

c. Executives and Managers

Significantly, HB 22-1317 eliminates the exemption that permitted a non-competition agreement with executive, manager, officer, and professional staff to executives or managers.  As a result, position within the organization will no longer justify a non-competition agreement.

d. Reimbursements for Training and Apprenticeship Scholarships.

HB 22-1317 also changes the ability of an employer to recover training costs if an employee does not remain with the employer long enough.  An employer may recover the reasonable costs of education and training as long as the amount of the employer’s recovery decreases over the course of the two years following the training.  The reduction in the employer’s recovery must be proportionate to the number of months that have elapsed since the training.  One benefit to employers of this amendment is that they will be able to recover training costs from employees who have worked for the company longer than two years.  Employers should exercise caution, however, because they cannot recover the cost of normal, on-the-job training.  As a result, employers must consider whether the training they are offering the employee is normal on-the-job training, or if it is something different.

HB 22-1317 adds a special provision allowing an agreement for repayment of a scholarship for an apprenticeship program if the apprentice fails to comply with conditions of the scholarship agreement.

e. Selling a Business.

When a business or its assets are sold, it is not uncommon for a buyer to insist that the seller not compete with it for some period of time.  Colorado courts have recognized that the business’s goodwill may be vested in the seller and, if the seller were to compete immediately, the buyer would not get the benefit of its bargain.  HB 22-1317 makes no change to the law; covenants not to compete are permitted as part of the purchase and sale of a business or its assets.

f. Physicians.

HB 22-1317 reenacts without changes the previous law concerning non-competition agreements by physicians.  In short, although a physician cannot be prevented from competing with an employer, the physician may be financially liable to their previous employer for the damages that result from their competition.  HB 22-1317 retains an exception permitting a physician who treats a patient with a rare disorder to notify that patient (or those patients) of the physician’s new professional contact information without being required to compensate the employer if the patient follows the physician to the new practice.

3. Reasonableness Standard Retained.

Colorado will continue to require that restrictive covenants be reasonable.  Thus, satisfying the statutory requirements for a restrictive covenant is insufficient.  An employer must also ensure that the agreement contains a reasonable geographic limitation, a reasonable duration, and a scope that is no broader than necessary to protect the employer’s legitimate interest.

4. New Procedural Requirements for Entering Into a Restrictive Covenant.

HB 22-1317 imposes new requirements on an employer for giving notice to an employee about an otherwise permissible restrictive covenant.  Employers who do not follow these procedural rules will see their otherwise valid restrictive covenants voided.

First, employers need to be aware of new deadlines for the notice the employer must give.  The employer must give a job candidate the required notice before the candidate accepts employment with the employer.  The employer must give existing employees notice at least 14 days before the earlier of the date the covenant not-to-compete will become effective or 14 days before the effective date of any additional compensation or any other change in employment conditions that provides “consideration” for the restrictive covenant.  “Consideration” is a legal term that refers to what the employer promises or gives the employee in exchange for the non-competition covenant.  The 14-day notice requirement calls into question the future validity of Colorado case law holding that continued at-will employment is sufficient consideration for a covenant not to compete.

Second, HB 22-1317 dictates the form and content of the notice that the employer must give.  Simply handing the candidate or employee an agreement containing a covenant not-to-compete is insufficient.  Instead, the employer must provide written notice that is separate from any contract and that clearly and conspicuously advises the employee of the covenant.  The notice complies with the law if it (1) identifies the agreement that contains the covenant by name and states that the agreement contains a covenant not to compete that could restrict the candidate’s or employee’s options for subsequent employment following their separation from the employer, (2) directs the recipient to the specific sections or paragraphs of the agreement that contain the covenant, and (3) is accompanied by a copy of the agreement that contains the covenant not-to-compete.  The notice is insufficient unless it is signed by the employee.  Additionally, the notice must be in the language that the employer and worker communicate about the employee’s job performance.

5. Copies of the Covenant Not-to-Compete.

Employees who covenant not to compete may request an additional copy of their agreement once every calendar year.  Although an employer is not required to provide a copy of the agreement more than once a year, it is difficult to imagine many situations where it would be wise for an employer to refuse the employee’s request.

6. Colorado’s Very Long Arm.

Generally, the parties to a contract may agree that their contract will be governed by the law of a particular state so long as that state has some interest in regulating the contract.  Starting on August 9, 2022, the parties to a contract containing a restrictive covenant are prohibited from choosing the law that will apply if the worker primarily lives or works in Colorado.  If a worker primarily lives or works in Colorado, the restrictive covenant must be governed by Colorado law and can only be enforced in Colorado.  This is true even if the employer’s entire business and all of the employer’s dealings with the worker take place outside of Colorado.  Colorado will have to depend on courts outside of Colorado to follow its rules, and there is no guarantee that courts outside of Colorado will find themselves to be bound to follow Colorado law asserting primacy over any other state’s ability to adjudicate disputes or determine whether a non-compete should be enforced.  One issue will likely become whether an employee “primarily” lives or works in Colorado.  The General Assembly’s attempt to impose Colorado law on entities whose only connection to Colorado may be the employment of a worker who lives in Colorado but travels to and performs all work in another state is a continuation of Colorado’s efforts to regulate beyond its borders, and may lead some businesses to choose not to employ workers who live or spend significant time in Colorado.

7. Next Steps for Employers.

In light of these significant changes to restrictive covenant law and the significant civil and criminal liability that attaches if an employer gets things wrong, employers should take the following steps to ensure that they are in compliance with Colorado law before August 9, 2022.

  • Contact a competent employment attorney to determine how the new law will impact the employer’s practices regarding restrictive covenants.
  • Review existing agreements containing covenants not-to-compete, agreements not-to-solicit customers, and confidentiality clauses to determine whether they are contained in automatically renewing agreements, such as employment agreements for a set term that periodically renew. Restrictive covenants in these agreements may need to be separated out from the underlying agreement or modified to comply with Colorado’s new legal requirements.
  • Review existing practices for eliciting agreements not-to-compete, agreements not-to-solicit customers, and nondisclosure or confidentiality agreements and ensure that they comply with the new notice provisions.
  • Review your incentive, equity and equity-based, deferred compensation, and similar plans, programs and arrangements to identify whether they contain restrictive covenants and the individuals who have received awards. These types of plans and arrangements can require a grantee to agree to various restrictions as a condition of participation or receiving an award. It will be particularly important to identify those plans and forms of grant or award agreements under which ongoing award grants are being made. Employers will need to carefully analyze their plans and arrangements to determine the applicability of the new law and to ensure documentary and operation compliance with the new requirements.
  • If you routinely ask new or promoted employees to enter into restrictive covenants, review those form agreements and ensure that they are permissible as of August 9, 2022.
  • Adopt new procedures for giving candidates and employees notice about any restrictive covenant that you ultimately decide remains valid after August 9, 2022.
  • If you enter into non-competition or non-solicitation agreements that require minimum annual cash compensation at the time of enforcement, implement a system to review, at the beginning of each year, the threshold so that you can make any payroll adjustments necessary for the agreement to remain enforceable.
  • Develop alternative strategies to protect trade secret and competitively sensitive information going forward.
  • If your business relies on non-disclosure agreements with non-employee workers, such as subcontractors who provide technical support or who have access to competitively sensitive information, ensure your non-disclosure agreement complies with Colorado’s new restrictions.