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FTC proposal bars employer-employee noncompetition agreements

 

by Howard Lederman   |   Michigan Bar Journal

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.


ENDNOTES

1. Notice of Proposed Rulemaking, Non-Compete Clause Rule, 88 Fed Reg 3482 (January 19, 2023).

2. Gilbert, et al, Update on the Status of Non-Competes and What to Expect in 2024, 14 Nat’l L Rev 72 (2024) [https://perma.cc/ 6U5W-QN27] (all websites accessed March 12, 2024).

3. 88 Fed Reg at 3482.

4. Id. at 3483.

5. Id.

6. Id.

7. Id.

8. Id. at 3484.

9. BHB Inv Holdings, LLC v Ogg, unpublished per curium opinion of the Michigan Court of Appeals, issued February 21, 2017 (Docket No. 330045), p 1 n 1.

10. Id. at 1.

11. Id at 1-2.

12. Id at 2.

13. Arnow-Richman, Bargaining for Loyalty in the Information Age: A Reconsideration of the Role of Substantive Fairness in Enforcing Employee Noncompetes, 80 Oregon L Rev 1163, 1164 FN5 (Winter 2001). See also Bredemeier, In a Bind over Noncompete Clauses: More Workers Caught in Grip of Required Agreement, Washington Post (March 18, 2001), p E1; Stone, The New Psychological Contract: Implications of the Changing Workplace for Labor and Employment Law, 48 UCLA L Rev 519, 577-578 (February 2001) (showing a great increase in federal and state noncompetition cases from 1970 to 1995).

14. Chotiner, The New Yorker, What a Ban on Non-Compete Agreements Could Mean for American Workers [https://perma.cc /G73Q-Q2SG] (posted January 10, 2023).

15. Id.

16. 88 Fed Reg at 3485.

17. Id.; Prescott, Bishara, and Starr, Understanding Noncompetition Agreements: The 2014 Noncompete Survey Project, Mich St L Rev 2, 369-464 (2016).

18. Id.

19. O’Brien, Washington Post, Even janitors have noncompetes now. Nobody is safe, [https://perma.cc/C5Z3-9723] (posted October 18, 2018). See also Leon, Labor Notes, Non-Compete Agreement Leaves Workers Homeless and Jobless [https://perma.cc/F9AM-F3DD] (posted February 2, 2023).

20. Rothstein and Starr, Mobility Restrictions, Bargaining, and Wages: Evidence from the National Longitudinal Survey of Youth 1997 (November 30, 2021). [https://perma.cc/6FYU-5QN7].

21. Johnson and Lipsitz, Why Are Low-Wage Workers Signing Noncompete Agreements?, 57 J Hum Res 689, 700 (2022).

22. Lavetti, Simon, and White, The Impacts of Restricting Mobility of Skilled Service Workers Evidence from Physicians, 55 J Hum Res 1025, 1042 (2020).

23. Liyan Shi, Optimal Regulation of Noncompete Contracts, 91 Econometrica 425-463 (March 2022) https://onlinelibrary.wiley.com/doi/pdf/10.3982/ECTA18128.

24. Prescott, Bishara, and Starr, supra note 17.

25. 88 Fed Reg at 3486.

26. 88 Fed Reg at 3488.

27. Id.

28. Id.

29. Id.

30. Id. at 3490.

31. Id.

32. Id. at 3491.

33. Id. at 3492.

34. See, e.g., Prudential Securities, Inc. v Plunkett, 8 F Supp 2d 514, 519 (ED Va, 1998) (“[A] company spending a great deal of time and money cultivating clients may see its efforts destroyed when a former broker violates a restrictive covenant and solicits his former company’s clients.”); PSC, Inc v Reiss, 111 F Supp 2d 252, 256 (WD NY 2000) (Employers have an interest in preventing the employee from working for a competitor’s company where the “employee possesses highly confidential or technical knowledge concerning manufacturing processes, marketing strategies, or the like.”); Darugar v Hodges, 471 SE2d 33, 36 (Ga App 1996) (An employer had the “right to protect itself from the risk that the former employee might use contacts [cultivated while employed] to unfairly appropriate customers.”); BDO Seidman v Hirshberg, 712 NE2d 1220, 1225 (NY 1999) (Employers have “a legitimate interest in preventing former employees from exploiting or appropriating the goodwill of a client or customer, which had been created and maintained at the employer’s expense, to the employer’s competitive detriment.”); Reed, Roberts Assoc, Inc v Strauman, 353 NE2d 590, 593 (NY 1976) (recognizing an employer’s “legitimate interest in safeguarding that which has made his business successful and to protect himself against deliberate surreptitious commercial piracy”).

35. 88 Fed Reg at 3505-08.

36. 88 Fed Reg at 3505.

37. 88 Fed Reg at 3505-06.

38. 88 Fed Reg at 3536 (citing Pollack v Williams, 322 US 4, 17-18 (1944)).

39. 88 Fed Reg at 3537.

40. 88 Fed Reg at 3540.

41. Id.