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The Future of Employment Non-Competes: The Federal Trade Commission Considers Rulemaking and Signals an Appetite for Stricter Enforcement

On January 9, 2020, the Federal Trade Commission held a public workshop to consider whether the FTC should issue a rule that would restrict or prohibit the use of non-competes in employment contracts. The FTC workshop was prompted by a Petition for Rulemaking filed by labor and public interest organizations, as well as several individual advocates and scholars.

In short, the petitioners asked for a rule that non-competes are an unfair method of competition that is illegal per se under Section 5(a) of the Federal Trade Commission Act. Further, they asked that any employer presenting, enforcing, or otherwise using non-competes with workers be subject to FTC enforcement action. Nine Democratic Senators and one Republican Senator have submitted comments encouraging the FTC to initiate this rulemaking.

The Petition and the workshop reflect growing attention to the increased use of non-compete agreements in today’s labor markets, and in particular, their impact on low-wage or low-skill workers and worker mobility. A study referenced in the FTC workshop states that one in five employees in the United States is bound by a non-compete, as are 12% of workers without a bachelor’s degree and earning less than $40,000 per year. The Petition argued that public policy justifications for non-compete agreements are outweighed by economic harm to employees and anticompetitive effects on labor and consumer markets.

At present, the enforceability of non-compete clauses and other restrictive covenants is governed by state common law and (in growing instances) state statutory law, which can vary significantly by jurisdiction. The FTC has not regulated in this area, and there are divergent views as to whether the agency has the authority to supplant or supplement the current patchwork of state laws. Regardless, the likelihood of imminent rulemaking on this issue is unclear.

The Present State of Non-Competes

Currently, three states — California, North Dakota, and Oklahoma — ban the judicial enforcement of employee non-competes. Several other states prohibit enforcement to certain categories of employees, for example, low-wage workers (Illinois and Maryland), information technology workers (Hawaii), and physicians (New Hampshire, New Mexico, and Texas).

Some jurisdictions require the employee to have notice of a non-compete requirement, and some other jurisdictions will not enforce the non-compete if the employee is terminated without cause. Massachusetts recently implemented a statute permitting the enforcement of non-competes only if employers satisfied certain conditions, for example, the requirement that they provide employees with at least 50% of their salary during the term of the non-compete (so-called “garden leave”).

Generally speaking, most states will enforce non-compete clauses if they are deemed to strike a reasonable balance between the employer’s interests and the interests of the employee and the public. This standard typically requires an analysis of whether the non-compete is reasonably limited in duration, geographic scope, and the scope of restricted competitive activities.

Non-competes are typically not enforced if they are broader than necessary to safeguard an employer’s stated legitimate interest. Although state law can vary on what constitutes a legitimate employer interest, those interests can include the protection of customer relationships and goodwill, confidential customer or other business information, trade secrets, and investments that employers have made in training their employees, particularly those providing unique or specialized services.

State law also varies on how courts treat non-compete clauses that they determine are unreasonably overbroad. Courts in so-called “red pencil” states (like Virginia) will not enforce a non-compete if any aspect of it is deemed overbroad. “Blue pencil” states (like Maryland) permit courts to enforce non-competes that are overbroad in part by severing the overbroad portion and giving effect to the remainder. Finally, courts in “reformation” states (like New York) are permitted to re-write an overbroad non-compete and enforce the revised version of the clause.

The stated basis for the Petition, and a theme underlying a number of presentations at the FTC workshop, is the idea that the current law governing non-competes fails to adequately address their negative impact on employees and the broader public interest, specifically, mobility, wages, and economic markets.

As to mobility, studies referenced in the FTC workshop claim empirical support that non-competes have a “chilling effect” on job mobility, even where they are per se unenforceable and regardless of whether employers seek to enforce them.

As one court noted: “For every covenant that finds its way to court, there are thousands which exercise an in terrorem effect on employees who respect their contractual obligations and on competitors who fear legal complications if they employ a covenantor.” Reddy v. Comm’y Health Fdn. of Man., 298 S.E.2d 906, 916 (W. Va. 1982). To that point, the studies referenced by the Petition and in the workshop assert that 49.4% of workplaces in California have at least one employee subject to a non-compete agreement, even though state statutes preclude their enforcement.

In “blue pencil” or “reformation” states, panelists argued that employers may be incentivized to present overly broad non-competes, in the hope that some employees will adhere to them without challenging them, and that if they do challenge them, a court will modify an overbroad non-compete to the actual scope required to make it enforceable. Supporters of an FTC rule also argue, in the Petition and at the workshop, that the impact of non-competes on worker mobility includes employees subjected to hostile work environments or other forms of discrimination or harassment.

As to wage rates, studies relied on claim there is empirical support that non-competes depress wage rates because the employee’s inability to leave for greener pastures limits their bargaining power to negotiate higher wages from their current employer. These studies further note that the impact is felt most acutely by low-wage employees — e.g., workers who are least likely to have access to trade secrets or customer goodwill, and for whom employers are least likely to invest in specialized training.

In contrast, studies have shown that non-competes actually increase wages for the highest level workers, such as CEOs and other c-suite executives, as they are more able to obtain legal advice, negotiate terms, and extract concessions to compensate for the terms of the non-compete.

As to economic markets generally, supporters of an FTC rule argued that non-competes could deprive other companies of workers they need, contribute to a company’s market power over rival firms, and impede the creation of start-ups in states that rigorously enforce non-competes.

The FTC as a Mechanism to Regulate Non-Compete Agreements

The Petition and a number of commentators maintain that Section 5(a) of the FTC Act gives the FTC the authority to regulate employment non-competes as unfair methods of competition. Remarks on this point by two FTC commissioners, however, reveal a lack of consensus within the agency as to the scope of its rulemaking power in this area.

On one side of the spectrum, Commissioner Rebecca Kelly Slaughter expressed strong support for an FTC rulemaking proceeding to regulate non-competes under the agency’s Section 5 authority. Although Commissioner Slaughter declined to “prejudge[e]” the outcome of such a proceeding, she encouraged the FTC to “make it a priority to examine and investigate” not only non-competes but also “other conduct and potential restraints that may be inhibiting competition for labor.”

In contrast, Commissioner Noah Joshua Phillips sounded a note of caution about whether such an application of the FTC’s Section 5 authority would survive scrutiny by the courts. He observed that the FTC has never issued a rule premised “solely on the FTC Act’s prohibition of ‘unfair methods of competition,’” and thus, the scope of the agency’s authority under Section 5 remains untested. Commissioner Phillips also expressed concern that the FTC’s issuance of a rule governing non-competes could be perceived as an unconstitutional delegation of legislative power under the “non-delegation doctrine”—a legal theory championed by Supreme Court Justice Gorsuch.

Public Comment Period

The FTC is accepting public comments on the issue of (1) whether or to what extent the agency should use its rulemaking authority under Section 5 of the FTC Act to regulate non-compete provisions in employment contracts, and (2) the appropriate scope and terms of any FTC rule governing non-competes.

Although the Petition requested the issuance of a rule that would categorically ban the issuance and enforcement of non-competes, several presenters proposed more limited regulatory action, which includes:

  • A rule that bans non-compete enforcement for low-wage workers or other vulnerable categories of employees;
  • A rule that permits non-compete enforcement only with respect to employees with access to trade secrets;
  • A rule that requires stricter judicial enforcement of non-competes (for example, a rule banning judicial “blue-penciling” or “reformation”);
  • A rule that requires employers to offer employees consideration beyond continued employment in exchange for their agreement to a non-compete;
  • A rule that requires employers to offer employees “garden leave” as a condition of requiring their agreement to a non-compete; or
  • A rule that imposes stricter transparency and notice requirements (for example, a rule requiring employers to present employees with any non-compete agreement before a job offer is extended).

Comments are due by February 10, 2020.

Bottom Line

There is a trend toward limiting the use of non-competes. This trend is evidenced by actions taken by some state legislatures and some state Attorneys General, judicial decisions in some jurisdictions, and, now, the consideration of FTC action to impose federal restrictions.

Though it is unlikely we will see any imminent federal rule banning or limiting the use or enforcement of employment non-competes, the viability and enforceability of a company’s non-compete program are more likely to be the subject of a rigorous review today than in the past. For this reason, to ensure enforceability when it matters most, companies should review the scope and terms of their non-compete program (including the categories of workers to whom they are distributed) and the degree to which their non-competes are sufficiently and narrowly defined to meet

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