Are Independent Contractor Non-Competes Treated Differently Under the Law Than Employee Non-Competes?
Sep 01, 2021
Workers provide services to their employers either of two ways: as employees or independent contractors. Some businesses engage both, oftentimes performing the very same tasks side-by-side. Therefore, it may surprise you to learn that under Minnesota law, different rules apply to enforcing contractor versus employee non-competes. This article will go through some of the main differences.
What differentiates an employee from an independent contractor?
First, the basics. A primary distinction between a W-2 employee and a 1099 independent contractor is manner of payment. Employees earn wages in the form of a salary, meaning a fixed amount per month (regardless of actual hours worked) or on an hourly basis. Contractors can be paid on a project, piecework or reported hours basis, virtually always under a written contract specifying the term and rate of pay. Contractors lack most legal protections afforded employees. Laws concerning minimum wages, overtime pay, wage deductions, employee indemnification, Family Medical Leave, etc. don’t apply to contractors. Ditto employer funded benefits such as unemployment insurance or workers compensation, FICA (social security) and Affordable Care Act required health insurance.
State and federal tax authorities care deeply whether businesses properly classify workers as independent contractors versus employees. The IRS employs a 20-factor test to make this determination, which looks to the continuity of the relationship, training, level of supervision, risk of loss, furnishing of tools, right to accept or reject assignments, and many other considerations. Courts in Minnesota examine the same facts, but under a more simplified five-factor test which evaluates the following:
- The right to control the means and manner of performance;
- The mode of payment;
- The furnishing of material and tools;
- The control of the premises where the work is done; and
- The right of the employer to discharge.
In essence, courts look to the degree of employer control over when and how the work is performed. However an employee is classified, the work remains the same. Logically, the risks to the employer remains the same if the employee or contractor quits and goes to work for a competitor. And yet, different rules apply to non-compete enforceability.
Are contractors entitled to consideration for mid-stream non-competes?
Post-employment restrictive covenants or “non-competes,” as commonly known, include non-competition and non-solicitation agreements. The former prohibit employees from providing services to competitors, and the latter prohibit employees from diverting a company’s business customers.
Agreements signed by employees after day one on the job are known as “mid-stream” non-competes. To be legally enforceable, they must be supported by independent consideration, meaning something more than just the right to remain employed. (“Sign this or be fired” non-competes are generally unenforceable under Minnesota law.) Consideration usually takes the form of a signing bonus, raise or significant expansion of job duties. This court-made rule helps in theory redress the imbalance of power between employers and employees and supports Minnesota’s longstanding policy disfavoring non-competes.
For independent contractors, a different rule applies. For them, mid-stream non-competes do not require independent consideration. In one case, a Minnesota court rationalized this rule by noting that the franchisee in question was allowed under the contract to terminate the relationship at any time, with advance written notice. The logic is dubious. A Subway restaurant franchisee who is contractually barred from switching to Quiznos will have a difficult time converting the leased premises to a permitted, non-food franchise, such as a Great Clips salon.
Will my non-compete remain enforceable after my contract expires?
In some instances, no. The Minnesota Court of Appeals in Burke v. Fine ruled that a non-compete contained in a two-year contract became void because the parties, after the contract ended, continued doing business together without formally renewing the contract. Significantly, the agreement in question lacked a survival clause, stating that the non-compete remains in effect even after the contract ends. As a result, the employee-employer agreement was just basically a handshake. Under these circumstances, the court held that the non-compete clause expired with the expiration of the original contract. The upshot is that even though non-competes for contractors are more easily enforced as a rule, the terms of the agreements will be strictly applied.
Does my status affect the maximum enforceable length of my non-compete?
By court decision, non-competes in Minnesota may have a maximum duration of two years. The average is one year, but the duration enforced by a court will depend on the nature of the competitive risk. For instance, does a customer relation become “stale” after six months? A year? Two years? Industries differ in this and other respects.
Longer periods may be imposed for non-competes signed in conjunction with the sale of a business. Up to and perhaps longer than ten years. Why? Because the buyer paid tens of thousands (or more) for the company’s goodwill and revenue stream and would argue that it should be allowed the opportunity to recoup its investment. This applies to professional services as well as retailers or manufacturers. Buyers of medical or dental practices routinely require non-competes from sellers, whether or not they remain in the practice under an independent contractor agreement.
To date, Minnesota courts have not addressed the maximum duration of non-competes for an independent contractor not involved in a business sale. Think contracts with individuals providing design, consulting or IT services. One could persuasively argue for either outcome, applying the rationale from the business sale cases versus the mid-stream noncompete cases. Stay tuned.
Contact Our Minnesota Non-Compete Attorneys
If you would like to discuss whether or not your non-compete is legally enforceable, contact the experienced employment attorneys at Baillon Thome Jozwiak & Wanta LLP.