McCarter & English, LLP

But Employers Should Still Review and Consider Narrowing Such Agreements.

On July 9, 2021, President Biden issued Executive Order 14036, which broadly addresses “promoting competition in the American economy.” In the run-up to and aftermath of this action, many news outlets reported that the Executive Order would or did “ban” employee non-compete agreements. While the Executive Order indicated that such agreements had become too common, may be unfair, and might inhibit competition, the Executive Order itself did nothing to change the enforceability of such agreements, which are generally governed by state law. Given the relatively broad range of discretion that judges have in considering when and how to enforce employee non-compete agreements, however, the relatively high-profile criticism of such agreements in the Executive Order should cause employers to carefully consider their use. Where they are necessary, employers should make such agreements as narrow and focused as possible in order to withstand scrutiny.

Executive Order 14036 begins by extolling the virtues of a competitive economy for many constituencies, including workers. It states that “a competitive marketplace creates more high-quality jobs and the economic freedom to switch jobs or negotiate a higher wage.” The Order then opines that some of those benefits disappear when too much economic power is concentrated in a few actors, noting that “[p]owerful companies require workers to sign non-compete agreements that restrict their ability to change jobs.”

Despite these statements, the Executive Order seems to recognize the limits of current federal power, at least on the part of the Executive Branch acting alone, as it relates to limiting employee non-compete agreements. The entire substantive text of the Executive Order as it relates to such agreements reads:

To address agreements that may unduly limit workers’ ability to change jobs, the Chair of the [Federal Trade Commission] FTC is encouraged to consider working with the rest of the Commission to exercise the FTC’s statutory rulemaking authority under the Federal Trade Commission Act [FTCA] to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility. [Executive Order 14036 § 5(g).]

There are, however, significant hurdles between this aspirational directive that the FTC “consider” steps to curtail some use of employee non-compete agreements and the promulgation of any actual new, legally binding restrictions on such agreements, including the following:

  • The FTC would need to first determine that it had the authority to address employee non-compete agreements. The Federal Trade Commission Act broadly states that “[u]nfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce, are hereby declared unlawful.” 15 U.S.C. § 45(a)(1). The law is more than 100 years old and, to our knowledge, has never been used with respect to employee non-compete agreements, although the FTC has recently relied upon Section 45(a)(1) in mounting antitrust challenges to non-competition covenants found in transaction documents for certain mergers and acquisitions.
  • Any FTC enforcement action or regulation is limited by statute to an act or practice that “causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition.” 15 U.S.C. § 45(n). Therefore, the FTC would need to make a factual record that could support such a determination.
  • Under the Administrative Procedures Act, the FTC would then need to publish a proposed rule, solicit public comment, and consider changes to its proposed rule based on such comment. That process typically takes a year or more.
  • Any rule so adopted would almost certainly draw court challenges on a variety of grounds. Litigation to resolve such challenges would further slow the ultimate implementation of the rule.

In short, there are significant hurdles to any federal regulation that might restrict employee non-compete agreements, and there should be a lot of lead time for employers to review any possible regulations that attempt to do so. Again, nothing in the recent Executive Order itself actually restricts any such agreements.

However, the publicity around the Executive Order and the concerns that have motivated it may well have an indirect impact on employee non-compete agreements. Enforcement of such agreements is a matter of state law. Some states, such as Texas, California, and Massachusetts, have specific statutes that make enforcement of such agreements impossible (e.g., California and, more recently, Washington, D.C.) or particularly challenging. Even in states that follow the general common law rules, there is often a bent to limit enforcement because of the impact of such an agreement on an individual’s ability to change jobs and due to the general public policy against restraints of trade.

With the additional media coverage of non-compete agreements spurred by the Executive Order, more employees are likely to challenge non-compete restrictions, and more courts hearing cases may look at such agreements skeptically. Therefore, when drafting employee non-compete agreements, employers should:

  • Carefully follow the laws of the state or states in which the worker will be performing services
  • Identify and specifically set forth what legitimate interests of the employer are furthered by limiting the employee’s employment after having left the employer
  • Address as many such interests as possible through confidentiality agreements to protect legitimate trade secrets and other confidential information
  • Limit the geographic scope of any employee non-compete agreement to the market actually served by the employer and in which the employee worked during his or her employment
  • Limit the time of the non-compete agreement to as short a period as is needed to protect the employer’s legitimate interests
  • Limit the use of non-compete agreements to employees who can do competitive harm to the employer because they possess trade secrets, confidential information, or company-generated relationships with customers and vendors

As state, and now possibly federal, hostility to employee non-compete agreements continues to grow, employers that believe such agreements are an important part of their business model need to be even more careful in drafting non-compete agreements that will hold up to increased scrutiny.

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