Non-compete agreements are “bread and butter” agreements in the business world. While the enforceability of these agreements has been a fundamental element in their drafting for many years, the environment is evolving more rapidly with the issuance of Executive Order on Promoting Competition in the American Economy dated July 9, 2021 (the “EO”). While the EO contains a variety of provisions relating to consumer protection and related matters, Section 5(g) of the EO asks the Federal Trade Commission (the “FTC”) to use its regulatory authority under the Federal Trade Commission Act to “curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”
The language of Section 5(g) is broad. Before we talk about what Section 5(g) of the EO is aimed at, let’s talk about the categories of non-compete agreements and when they arise.
|Sale of a Business||The selling owners are asked to sign a non-compete agreement to prevent them from competing with the business they are selling. These agreements are likely to be the most enforceable and can have terms of up to 5 years. There is a strong argument that these agreements protect business and do not negatively affect employment practices or competitiveness. This type of non-compete agreement is still enforceable in California (more on California below).|
|Sale of Stock||Sometimes investors are asked to agree to confidentiality clauses than can stray into non-compete clauses when they buy equity interests in a company. The rationale is that these investors will receive sensitive information as shareholders/members of the company, but also that investors cannot “ride two horses” in the same industry.|
|Engagement of a Consultant||Consultants may be asked not to offer or provide services to a competitor of a client. Depending on the circumstances, these clauses may be enforceable.|
|Employment Agreements With Executives||For this purpose, we are thinking of Executives who are highly compensated and hold policy-making positions in a company. If the non-compete is tailored properly to limit its duration and define specifically the industries and geographic areas where the restriction can be enforced, and if the non-compete agreement is part of an employment agreement that is offered upon initial engagement of the Executive (and not some time later when the Executive is already employed), it may be enforceable in most states, except California, Oklahoma or North Dakota (consult counsel). Also before considering such an agreement where the employee is a resident of Washington, D.C., Maryland, Virginia, Oregon, Nevada or Illinois, counsel should be consulted. Executives may be distinguished from lower-level employees|
|Employees Generally||This is where non-competes are increasingly out of favor and where the FTC is expected to focus its attention pursuant to Section 5(g) of the EO. These non-compete agreements can have the effect of limiting an employee’s ability to make a living, can negatively impact labor availability and competitiveness and are exacted in a context where the employer has asymmetrical negotiating leverage.|
Jimmy John’s Sandwiches is perhaps the most well-known example of where non-compete agreements crossed the line and triggered regulatory responses at the state and Federal levels. Jimmy John’s required its sandwich makers (that’s right – the people making the sandwiches) to sign non-compete agreements that, by their terms, would prevent them from working in a competitor’s store within a three-mile radius for two years. Calling these abusive and non-competitive the New York Attorney General (then Eric Schneiderman) took action to eliminate them. Illinois’ Attorney General also took similar steps. Jimmy John’s probably knew that the agreements would be unenforceable but used them as a threat to restrain employees from leaving for a similar job. In this way, non-compete agreements can be used not just as a “shield” to protect business, but as a “sword” against competitors and employees.
Jimmy John’s is one of the most well-known examples of non-compete over-reaching, but it’s by no means the only example. The practice has become sufficiently widespread that President Biden campaigned back in 2020 on how he planned to eliminate many non-compete agreements.
According to a 2019 report from the Economic Policy Institute (the “EPI”), 31.8% of private-sector businesses that responded to EPI’s survey (a total of 634 respondents were surveyed) reported that all of their employees had to sign a non-compete agreement, regardless of their job duties or compensation. And of the respondents that had an average wage of less than $13.00, 29% of them required all their workers to enter into non-compete agreements.
By making it harder for workers to find new positions, non-competes may also have slowed wage growth.
Currently, three states refuse to enforce non-compete agreements against employees:
- North Dakota
In many states courts will not enforce non-competes with workers paid on an hourly basis or who earn below a certain income threshold. At the Federal level, the Workforce Mobility Act of 2021 (the “WMA”) has been introduced in both Houses. If enacted, it would:
- Largely limit the use of non-competes to situations where there is a sale of a business or dissolution of a partnership;
- Authorize the U.S. Department of Labor to take steps to educate the general public about the limitations surrounding the use of non-compete clauses; and
- Give workers a private right of action to sue for violations of the WMA.
Of course, we have some suggestions for our clients.
|Maybe you don’t need a non-compete agreement – You need a non-solicitation agreement||Often employers use non-compete agreements with sales people where the true objective is to constrain the ability of the salesman to leave and take clients. We frequently recommend that an employer use a “non-solicitation” agreement in this context. A non-solicitation agreement restricts the ability of the salesman to solicit clients of the employer after leaving. Combined with a tight confidentiality agreement that prohibits taking or using proprietary company information for their own purposes or the benefit of a competitor, this approach can be much more effective at achieving a company’s true objective and should be enforceable in a lawsuit. It shifts the arguments away from whether the employee can make a living and focuses the narrative on whether the employee is stealing business.|
|You can prevent solicitation of your employees||A non-solicitation agreement is another common clause that is aimed at preventing your employee from attempting to steal other employees and move them to his/her/their new position with another company. Your employees know who the best people are in your company. These agreements should be enforceable.|
|If you introduce a non-compete agreement to current employers, add some compensation for signing it.||Two concepts come into play when dealing with current employees: (i) they have no negotiating leverage and (ii) the new restrictive agreement is like any other contract – it requires that consideration be paid for the agreement. To make restrictive agreements binding, add some consideration to the employee for the agreement, itself.|
|Plain English, Low Pressure||Non-compete agreements are more palatable where they are plainly written and employees are not under pressure to sign. If an employee wants to consult with a lawyer prior to signing a non-compete, that should be permitted, if not encouraged.|
The issues with non-compete agreements illustrate the overall point that while you can write anything in a business contract, making it enforceable can be a moving target and requires some legal input.
Jon Gardner at email@example.com
Danielle Fahey at firstname.lastname@example.org