Are Non-Compete Agreements in Danger? The Battle Is On

The battle lines are being drawn around President Biden’s recent executive order instructing the Federal Trade Commission to clamp down on non-compete agreements.

The Biden administration has argued that non-compete agreements have the potential to harm workers, especially as they attempt to seek new employment opportunities. Around one-third of U.S. companies include non-compete clauses in their employment agreements, according to a recent study conducting by PayScale Inc.

In the wake of President Biden’s order, several labor organizations, including the AFL-CIO and others, submitted a petition requesting the FTC to initiate rulemaking to prohibit non-compete clauses in employment contracts on antitrust grounds. Similar organizations requested a rulemaking by the FTC on the use of exclusive contracts. Public comments in response to both are due by September 3.

In the Order, the President:

• Encourages the FTC to ban or limit non-compete agreements.
• Encourages the FTC to ban unnecessary occupational licensing restrictions.
• Encourages the FTC and DOJ to strengthen antitrust guidance to prevent employers from collaborating to suppress wages or reduce benefits by sharing wage and benefit information with one another.
• Calls on the FTC and DOJ to enforce the antitrust laws vigorously and recognizes that the law allows them to challenge certain mergers.
• Establishes a White House Competition Council to monitor progress on finalizing the initiatives in the Order and to coordinate the federal government’s response to the rising power of large corporations in the economy.

Meanwhile, a group of nearly 60 trade secret lawyers submitted a proposal to the FTC outlining arguments against a federal ban on non-compete agreements. The group argued that companies lose billions of dollars in value each when valuable trade secrets and information walk out the door when employees leave. Nearly 60 percent of employees have admitted to taking information from a previous employer when they left the company, according to a 2013 study by Symantec Corp.

As opposed to an outright ban, the group of attorneys suggested several alternative steps, including:

• A ban on non-competes for low-wage workers (defined as employees who are not exempt under the Fair Labor Standards Act).
• A ban on non-competes where the overriding interests of third parties should be given priority.
• A requirement that employers provide advance notice that a non-compete will be required.
• Mandate the so-called “purple pencil” rule to address overly broad non-competes. States take one of three general approaches to overly broad non-competes:

1. reformation (sometimes called “judicial modification,” in which the court essentially rewrites the language to conform the agreement to a permissible scope);
2. blue pencil (in which the court simply crosses out the offending language, leaving the remaining language enforceable or not);
3. red pencil (also referred to as the “all or nothing” approach, which, as its name implies, requires a court to void any restriction that is overly broad, leaving nothing to enforce).
4. A fourth middle ground option, adopted by some states, dubbed the “purple pencil,” is a hybrid of the reformation and red pencil approaches, requiring courts to strike a non-compete in its entirety unless the language reflects a clear good-faith intent to draft a reasonable restriction, in which case the court may reform it.

• Provide for “springing” (or “time-out”) non-competes. To encourage employers to limit their reliance on non-competes, they must have a clear and viable remedy when an employee violates other (less restrictive) obligations (such as nondisclosure and non-solicitation obligations), misappropriates the employer’s trade secrets, or breaches their fiduciary duties to the employer

While stakeholders will have an opportunity to respond before final rules are issued, and such rules will likely be subject to later legal challenge, employers are left with uncertainty regarding the implementation of restrictive covenants in prospective employment contracts. Comprehensive changes to existing non-compete agreements are not necessary at this stage of the regulatory cycle, but employers should be cognizant of overly broad competitive restrictions that lack correlation to a legitimate business interest, such as protection of corporate trade secrets or preservation of significant talent investment In terms of private sector engagement, major associations will likely submit general comments in response to the petitions followed by more detailed and substantive comments when more is known about what the FTC will propose.

Non-competes have typically been addressed at the state level. Twenty-six states currently have laws regulating non-compete agreements, while three states have an outright ban on non-competes.