Much has been written about non-compete agreements in light of Washington’s relatively new restrictions provided in RCW 49.62 et seq., which explains “…, the legislature finds that agreements limiting competition or hiring may be contracts of adhesion that may be unreasonable.” 49.62 goes on to place significant restrictions on covenants not to compete that involve employees and independent contractors.
It is quite difficult in process and contract to enter a valid non-compete agreement. Among other requirements, employees must receive minimum annual compensation of at least $100,000 ($250,000 for independent contractors), adjusted for inflation. From a procedural standpoint, noncompetition covenants must be disclosed “…in writing to the prospective employee no later than the time of the acceptance of the offer of employment…” RCW 49.62.020.
When it comes to members and managers of an LLC, Washington has a different policy[1]. RCW 25.15.038 states that members and managers must “… refrain from competing with the limited liability company in the conduct or winding up of the limited liability company’s activities.” It may come as a surprise to many LLC members and managers that the default rule states they may not compete with the LLC. Logically, this may lead us to ask what makes LLC members and managers different from employees and independent contractors? Why are agreements limiting competition unreasonable when it comes to employees and independent contractors, but members and managers of LLCs have the statutory duty to refrain from competing? For these questions, I have no answer.
Until recently, by statute, members of a Washington LLC could not voluntarily withdraw. Although that default rule has been changed, many LLC agreements include a provision prohibiting voluntary withdrawal. It is not clear whether the duty to refrain from competing with the LLC terminates when a manager no longer has that status. Could it be that the legislature believes the duty not to compete ends when a manager is no longer a manager and therefore a restraint on competition with respect to a manager only lasts until such time as the manager loses that status? This issue is settled law for members in a member-managed LLC. According to RCW 25.15.131(3)(b), when a member in a member-managed LLC is dissociated, said dissociated member’s fiduciary duties end with regard to matters arising and events occurring after their dissociation. Unfortunately, the issue remains unsettled regarding managers in manager-managed LLCs. However, it is likely that when managers cease to be managers, they would be treated similar to dissociated members under RCW 25.15.131(3)(b), Washington courts have simply yet to be confronted with the issue.
Considerations
There appear to be some options for businesses and LLCs within the boundaries discussed above. An LLC could make a key employee a member or manager, in order to obtain the necessary non-compete status from said employee. Further, non-solicitation agreements, which are not prohibited to employees or independent contractors, could protect an employer by restricting the ability of a former employee or contract to contact employees or clients from a company.
Changing the status of a key employee or contractor to that of a member or manager—merely to obtain non-compete restrictions—seems like a drastic step and comes with other consequences, such as the right to inspect books and records and bring a derivative action. LLCs should think long and hard before taking such action. Non-solicitation agreements will no doubt become more of a tool to protect a company from competition.
To learn more about non-complete agreements, please contact Beresford Booth at info@beresfordlaw.com or by phone at (425) 776-4100.
[1] I realize that members of a manager managed LLC have no fiduciary duty of loyalty to refrain from competing.