In January 2023, the Federal Trade Commission published a proposed rule barring employer-employee noncompetition agreements.¹ Though the FTC has no deadline for issuing the final rule, the general consensus is that it could come as soon as this month.²

Such noncompetition agreements bar employees “from working for a competing employer, or starting a competing business, within a certain geographic area and period of time after the [employee’s] employment ends.”³ A noncompetition agreement can also be a business-business agreement, like a franchisor-franchisee agreement barring the franchisee from operating a business in the same or similar line of business as the franchise business, again within a certain geographic area and period of time after the franchise agreement ends.

The FTC proposal would contain a limited exception for noncompetition agreements arising from the sale of a business where “the party restricted by the non-compete clause is an owner, member, or partner holding at least 25% ownership interest in a business entity.”⁴

NONCOMPETITION AGREEMENT EXAMPLES

The FTC cited a number of examples as part of its noncompetiton rule proposal, including:

• An agreement between a security company and its guards barring the guards after termination of their employment from accepting any employment in a competing business located within a 100-mile radius of the guard’s primary job site with the company and stating that the guards may not assist any firm, corporation, partnership, or other business to compete with the company.⁵
• An agreement between a glass container manufacturer and its workers barring them “for two years following the conclusion of [their] employment with the company” from performing or providing the same or similar services to any business in the U.S., Canada, or Mexico involved with or supporting the “sale, design, development, manufacture or production of glass containers in competition with the company.”⁶
• An agreement “between a sandwich shop chain and its workers stating that for two years after the worker leaves their job, the worker may not perform services for ‘any business [deriving] more than 10% of its revenue from selling submarine, hero-type, deli-style, pita and/or wrapped or rolled sandwiches’ located within three miles of any of the chain’s” 2,000-plus U.S. locations.⁷
• An agreement between a medical services firm and an ophthalmologist barring the ophthalmologist for two years after his employment from practicing medicine in two Idaho counties unless the ophthalmologist pays the firm either $250,000 or $500,000 depending on when the employment ends.⁸

A recent Michigan case — BHB Investment Holdings v. Ogg — offers another example. BHB owned and operated Goldfish Swim School of Farmington Hills, part of a franchise system which, as of early 2017, had “65 locations in 17 states.”⁹

Ogg, the defendant, worked part time for BHB from June 2012 through February 2015, starting as a swim instructor earning $10 an hour and ending as a deck supervisor making $12.50 an hour.¹⁰ When hired, he signed an agreement that, among other things, prohibited him from working for competitors within a 20-mile radius of any Goldfish location for one year after ending Goldfish employment and barred him from soliciting any Goldfish employees or customers for an 18-month period after separation.¹¹

The parties recognized Ogg had access to confidential Goldfish materials and information — trade secrets; instructional materials; proposed products and services; identities of customers and prospective customers; and more. The agreement required Ogg to keep that information confidential indefinitely.¹²

WHY THE PROPOSED RULE?

Noncompetition agreements are becoming widespread

Evidence of the growing use of noncompete agreements in employment contracts, while anecdotal, is prevalent. Among practicing attorneys, the consensus appears to be that such agreements “are being more frequently requested from a greater variety of workers and more vigorously pursued post-termination.”¹³

Noncompetition agreements “tend to cluster in high-skilled, high-wage jobs. Executives are the most likely to sign them — at a rate of like 60- 80% depending on the studies.”¹⁴ But according to one survey cited by New Yorker magazine, “the modal worker bound by a non-compete agreement is actually an hourly-paid worker who makes a median wage of $14 an hour. And that’s because hourly-paid workers actually comprise about two-thirds of the U.S. workforce.”¹⁵

The FTC estimated that approximately one in five U.S. workers — roughly 30 million employees — are bound by noncompetition agreements.¹⁶ The agency also cited a 2014 study by University of Michigan professors J.J. Prescott and Norman Bishara and University of Maryland professor Evan Starr, who surveyed 11,500 employees nationwide. They found that:

• 18% of respondents were working under a noncompetition agreement, and 38% had worked under such an agreement “at some point in their lives.”
• Among respondents without bachelor’s degrees, 14% were working under a noncompetition agreement, and 35% reported having worked under one at some point.
• Among respondents earning less than $40,000 annually, 13% were working under a noncompetition agreement, and 33% worked under one at some point.
• 53% of employees working under noncompetition agreements were paid hourly wages.¹⁷

Noncompetition agreements, once primarily used to keep top executives from taking trade secrets to rivals, are now much more common among all types of workers.¹⁸ For example, Amazon used them for warehouse workers; Jimmy John’s for sandwich-makers; doggy day-care chain Camp Bow-Wow for dog walkers; and commercial real-estate company Cushman & Wakefield used them for janitors.¹⁹

The FTC cited several other studies, among them:

• A study by Starr and Donna Rothstein of the U.S. Bureau of Labor Statistics from 2021 revealing that 18% of employees they surveyed worked under noncompetition agreements.²⁰
• A 2021 study by Duke University professor Matthew Johnson and FTC economist Michael Lipsitz showing that 30% of hair stylists worked under noncompetition agreements.²¹
• A 2020 study led by Ohio State University professor Kurt Lavetti indicating that 45% of doctors had noncompetition agreements.²²
• Carnegie Mellon University professor Liyan Shi’s 2021 study showing that 67% of CEOs had noncompetition agreements.²³

Noncompetition agreements have devastating impacts on employees

Employers imposing noncompetition agreements on employees are not the exception, but the rule. Employer-employee bargaining over noncompetition agreements is not the rule, but the exception.

The 2014 Prescott study found that about 10% of respondents with noncompetition agreements bargained over them; nearly 8% reported consulting a lawyer; and 11.4% thought they would have been hired had they refused to sign the agreement.²⁴ These findings show the perception that employees could not refuse to sign such agreements without risking their jobs.

In issuing its proposal, the FTC cited several studies showing that noncompetition agreements lowered employee earnings anywhere from 3-13%²⁵ and lowered earnings for employees without agreements by 3-6%.²⁶ One study showing that noncompetition agreements increased wage gaps based on race and sex;²⁷ the FTC estimated banning them would close those gaps by up to 9%.”²⁸ The agency also referred to studies indicating noncompetition agreements reduced labor mobility.²⁹

Other studies referenced by the FTC indicated that noncompetition agreements increased business concentration,³⁰ inhibited competitors’ ability to access talent by forcing future employers to buy out employees from their noncompetition agreements if they want to hire them,³¹ reduced entrepreneurship and new business formation,³² and decreased innovation.³³

FTC COMMISSIONERS UNPERSUADED BY PRO-NONCOMPETITION ARGUMENTS

The FTC considered justifications for noncompetition agreements and acknowledged the legitimacy of protecting trade secrets and confidential information.³⁴ Still, the agency recognized that nondisclosure and nonsolicitation agreements can accomplish the same goals while placing less of a burden on competition.³⁵

“[N]on-compete clauses restrict considerably more activity than necessary to achieve these benefits. ... These alternatives restrict a considerably smaller scope of beneficial competitive activity than non-compete clauses because — while they may restrict an employee’s ability to use or disclose certain information — they generally do not prevent [them] from working for a competitor or starting their own business.”³⁶

The agency added that trade secret law offers employers an effective legal alternative to noncompetition agreements.³⁷

FTC Chair Lina Khan and commissioners Rebecca Slaughter and Alvaro Bedoya declared that by their design, noncompetition agreements often close off workers’ natural alternative employment options — jobs in the same geographic area and profession — which can undermine economic liberties burden the ability to freely switch jobs.³⁸ The agency projects that the proposed ban would increase workers’ total earnings by close to $300 billion per year while decreasing consumer prices up to $150 billion annually.³⁹

In her dissent, then Commissioner Christine Wilson said the proposed rule represented a radical departure from centuries of legal precedent that employed fact-specific inquiries into whether noncompete clauses were unreasonable based on justifications for the restrictions.⁴⁰ She argued that the FTC lacked the authority to make rules regarding “unfair methods of competition” and speculated that the proposed rule will lead to “protracted litigation in which the [FTC] is unlikely to prevail.”⁴¹

CONCLUSION

Even if the U.S. Supreme Court invalidates the proposed rule, the notion of barring employer-employee noncompetition agreements will be reinvigorated. States may ban or severely restrict them. Thus, the proposed rule will lead to a major noncompetition law change nationwide or intensify the contradictions in state noncompetition law.