There is currently a drumbeat of people and organizations, including the Antitrust Division of the U.S. Department of Justice (DOJ), several State Attorneys Generals and Congress,1 calling for the Federal Trade Commission (FTC) to flex its long dormant rulemaking authority to prohibit “unfair methods of competition” for the first time since 19682 to regulate non-compete clauses. Non-compete clauses have been used by businesses before Columbus set sail in 1492,3 but have come under scrutiny in recent years due to their increased use and the prevalence of non-competes without any reasonable business justification. In 2016, the Illinois Attorney General (AG) sued Jimmy John’s for compelling its sandwich makers and delivery drivers to enter into non-competes.4 The Washington AG investigated a coffee chain for compelling baristas to enter into non-competes. As a result both companies paid fines and agreed to stop imposing non-competes upon its employees. These cases and recent economic studies have put pressure on the FTC to address non-compete clauses. Senators, in a bi-partisan comment on the rulemaking, stated that “the FTC should act to limit the use of non-compete clauses. Reducing the use of non-competes would allow workers to get better jobs, boost wages, increase entrepreneurship, and spur innovation.”
FTC’s first step to making a rule was taken on January 9, 2020, when it assembled labor economists, and legal experts from academia, organized labor, government and the private sectors to discuss whether a proposed rule should entirely ban non-competes or, instead, impose specific restrictions on them.
There was general agreement among the diverse panelists that the overuse of non-competes has negatively impacted job mobility, wage increases, innovation and entrepreneurship, such that there is a “chasm between the legal justification of non-competes and the real-world impact.”5 An oft repeated example of the real world impact of non-competes on competition is the migration of the tech industry from America’s Technology Highway in Massachusetts to Silicon Valley in California in the early 1980s. Massachusetts enforced non-competes, making it difficult for engineers to move to rival companies or start their own; whereas California has banned them since the 1870’s. According to some, the job mobility available to engineers under California’s law allowed for the intense competition, start-ups and innovation that now exists in Silicon Valley.
Despite the Silicon Valley warning story, panelists acknowledged some positive market impacts of non-competes. For example, companies with CEO’s bound by a non-compete were more likely to hold their CEO accountable for poor performance. Another study showed that physician practice groups benefited from non-compete use, seeing for example a 17 percent increase in revenue per hour and increased physician wages. The pro-competitive circumstances identified by panelists are also instances where there are legitimate justifications for a non-compete; like the protection of trade secrets, partnership arrangements, and for CEOs.
The panelists agreed that the most corrosive non-competes are those without any legitimate business justification. The most obvious of these are those that bind low-skilled and low-waged, and non-executive employees, such as janitors, fast-food workers, nail technicians, and administrative assistants. According to a recent study, 53 percent of persons bound by a non-compete clause are hourly workers. Further, a company need not intend to or actually enforce the non-compete in order for such a clause to negatively impact the employee and thus the marketplace. Research found that most employees, regardless of education level, believe that a non-compete is enforceable – even in states where it is not.
FTC Commissioner Noah Phillips, agrees that non-competes are an important issue, but he is not confident that the FTC can successfully issue a rule to ban or limit non-compete clauses. The FTC has only issued one competition rule, back in 1968 which was never enforced and ultimately repealed in 1994.6 While there was lively debate among the panelists whether such a rule could be successful, it is clear that any proposed rulemaking by the FTC on non-compete clauses is years away.
The lack of an FTC rule does not mean that there will not continue to be lawsuits and investigations. In the absence of a federal law, FTC rule, or clear judicial ruling, several states have been trying to address non-competes on their own through legislation. Recently Massachusetts amended its law on non-competes, choosing not to follow California and ban non-competes, instead passing a law limiting the scope of non-competes.7 Other states have also opted to limit the scope of non-competes instead of a total ban. For example, Illinois, Washington, New Hampshire, Maryland and Hawaii have banned non-competes only for low-wage employees.8 In addition, State Attorneys Generals, DOJ and FTC will continue to investigate and litigate non-competes.
What does that mean for employers today? Common themes are:
- Non-competes should not be universally applied to employees. If a non-compete is baked into every new employee’s paperwork, the employer may come under scrutiny.
- If non-competes are bundled with other provisions (non-disclosure agreements, non-solicitation agreements, and intellectual property assignments), the non-compete may be overbroad and therefore unenforceable.
- There should be a legitimate business justification for the non-compete, such as the protection of trade secrets (non-public sensitive methodology or technology that is unique to your company). There was some debate about the protection of a company’s investment in training, but in general there was agreement that company training that results in an advancement of skills, not just the mere ability to perform a task, may qualify. For example, advanced training associated with an increased ability of employee to advance in wage or title versus to merely perform at their current position and rate. None of the panelists considered access to client lists a legitimate business justification.
When a company is using non-competes, there are also processes that can be employed to identify and prevent issues.
- Be transparent. One major issue identified with non-competes is that less than 30 percent of employees accept jobs understanding that they are expected to accept the company’s non-compete as a condition of employment. And almost half of employees are presented with the non-compete on or after their first day of work. As such, employees have accepted a job without understanding all the terms of their employment, and most are left without the ability to reject the non-compete, because they have already started work. Making it known at the time of offer, or even better, when soliciting employees, gives the employee the time and ability to consider the non-compete in the context of their employment decision. The more that the employee is able to negotiate a non-compete the more enforceable the non-compete will be because it will be less of a “restriction unilaterally imposed upon workers by their employers” and closer to “a willing meeting-of-the-minds between parties.”9
- Consideration. Another way to prevent issues is by giving the employee consideration for their time out of work in the form of a percentage of income or a bonus for signing the non-compete. This consideration demonstrates an agreement with the employee instead of a unilaterally imposed restriction.
- Narrow. The construction of non-compete cannot be overbroad. It should be narrowly tailored to the business interest that the company is seeking to protect, not too long (e.g. months not years), and limited in geographic scope.
The use of non-competes will continue to come under increased scrutiny. Companies should review any current non-compete clauses for improvement or if necessary, revision or deletion, as well as, take care when crafting any new non-compete agreements.
1 See. e.g. https://openmarketsinstitute.org/wp-content/uploads/2019/03/Petition-for-Rulemaking-to-Prohibit-Worker-Non-Compete-Clauses.pdf; https://www.ftc.gov/system/files/documents/public_statements/1544564/chopra_-_letter_to_doj_on_labor_market_competition.pdf; Letters to FTC from Attorney General from the District of Columbia, California, Delaware, Hawaii, Illinois, Iowa, Maine, Maryland, Massachusetts, Michigan, Minnesota, Nevada, New Jersey, New York, Pennsylvania, Rhode Island, Virginia, and Washington. https://oag.ca.gov/system/files/attachments/press-docs/11%2015%2019%20Multistate%20FTC%20Non-Compete%20Letter%20FINAL.pdf; https://www.blumenthal.senate.gov/imo/media/doc/Sen%20Blumenthal%20et%20al%20re%20non%20competes_vF.pdf
2 See FTC Men’s and Boy’s Tailored Clothing Rule, 16 C.F.R. § 412 (1968); 16 Notice of Rule Repeal, 59 Fed. Reg. 8527 (1994).
3 See e.g. John Dyer’s Case, Y.B. Mich. 2 Hen. 5, fol. 5, pl. 26 (1414). (English case regarding a non-compete agreement between a master dyer and his apprentice.)
4 http://www.illinoisattorneygeneral.gov/pressroom/2016_12/20161207.html; The AG suit was followed by a class action. https://www.law360.com/articles/1005474/jimmy-john-s-employees-challenge-franchise-noncompetes
5 Ms. Jane Flannigan, a former prosecutor that investigated the non-compete suit against Jimmy John’s.
6 See supra note 2.
7 The amended law for example, requires 10 day written notice, right to consult counsel; maximum duration of one year; payment during non-compete period (“garden leave”); and limited geographic scope. https://malegislature.gov/Laws/SessionLaws/Acts/2018/Chapter228
8 Several of the economists noted that skill-level was an inadequate demarcation to determine whether a non-compete has negative implications, citing to studies finding negative impacts markets for financial advisors as an example.
9 January 9, 2020 remarks of FTC Commissioner Rebecca Kelly Slaughter (https://www.ftc.gov/system/files/documents/public_statements/1561475/slaughter_-_noncompete_clauses_workshop_remarks_1-9-20.pdf)
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.