Last month, the Federal Trade Commission voted 3-2 along party lines to impose a general ban on non-competes, claiming these arrangements stifle innovation, limit employee mobility and suppress wages. I blogged about the issue when the FTC proposed the ban last year.  So far, there have been three separate lawsuits seeking to block the ban, each asserting that the FTC has exceeded its authority and that the ban itself is arbitrary and capricious. Unless any of the legal challenges are successful, the ban will become effective on September 4, 2024.

While the FTC’s intentions to promote a more dynamic labor market are commendable, the blanket ban on non-competes is akin to throwing the baby out with the bathwater because it disregards its own acknowledgment that non-competes also have the effect of promoting innovation. Non-compete agreements, when used appropriately, play a crucial role in fostering training and research and development, thereby promoting innovation. A more balanced approach is needed to address the legitimate concerns while preserving the benefits non-competes offer.

The Innovation Debate

The FTC argues that non-compete agreements stifle innovation by preventing employees from moving freely between companies, sharing knowledge and starting new ventures. On the other hand, non-competes also promote innovation by providing companies reasonable assurance that investments in training and R&D will not be lost through employee defections to competitors.

Companies invest significant resources in training their employees, equipping them with specialized skills and knowledge. Non-compete agreements provide assurance that these investments won’t be immediately leveraged by competitors. Without this protection, companies would be less willing to invest in extensive training programs, fearing their trained employees could be poached.

Innovation also involves leveraging sensitive information, proprietary processes and trade secrets. Non-competes help safeguard these assets, giving businesses the confidence to innovate without the constant threat of losing their competitive edge to departing employees. This protection is crucial for maintaining a healthy cycle of innovation within companies.

R&D requires long-term commitment and substantial financial investment. Non-compete agreements help ensure that the benefits of these investments are not quickly eroded by employee turnover. Companies are more likely to engage in ambitious R&D projects if they can reasonably expect to retain the fruits of their investment.

Companies also often enter into strategic partnerships and collaborations to drive innovation. Non-competes can play a role in these arrangements by providing a framework for trust and cooperation. Partners are more willing to share valuable information and resources if they have assurances that their interests are protected.

Without non-competes, companies would be inclined to limit the number of people involved in R&D activities, thereby dampening collaboration and diversity of thought within the company, inevitably leading to fewer patents. Companies would also restrict access to expensive training. Raising capital would become more challenging.

What About Less Restrictive Alternatives?

The FTC maintains that even if employers have an interest in preventing former employees from disclosing proprietary information to a new employer that is a competitor, there are less restrictive means to accomplish the same goal, primarily through confidentiality or non-disclosure agreements.  That’s true in theory, less so in practice.  Breaches of confidentiality agreements are often very difficult to detect and prove.  Even if detected, the damage may have already been done and the toothpaste in this context can’t be easily put back in the tube.  Finally, legal enforcement is expensive and time consuming and can be enormously distracting to a company’s management team.

A Call for Balanced Reform

While the FTC’s concerns about the negative impacts of non-compete agreements are valid, a total ban is not the solution. Instead, we should aim for balanced reform that addresses abuses of non-competes without undermining their positive aspects.  A more nuanced approach would include some or all of the following:

• Context-Specific Regulation. Non-compete clauses could be tailored to specific job roles and industries.  High-level executives and employees with access to critical information might justifiably be subject to non-competes. However, applying these agreements to low-wage workers or those without access to sensitive information is usually unnecessary and counterproductive.

• Reasonable Scope.  Non-compete agreements should have reasonable timeframes and geographic scopes. Clauses that extend for several years or cover unnecessarily large geographic areas are unnecessarily restrictive. Limiting the duration and geographic reach of non-competes can protect legitimate business interests in protecting confidential information without unduly hindering employee mobility.

• Transparency and Disclosure: Employers should be required to clearly disclose non-compete requirements at the time of making an offer and before commencement of employment. Too often employees only learn about a non-compete when they’re asked to sign a bunch of documents on their first day of employment; many don’t even realize what they’re signing. Employees need to be fully aware of these clauses and their implications. Ensuring transparency can prevent surprises and enable better-informed career decisions.

• Consideration and Compensation. Non-compete clauses should come with adequate compensation or other benefits. Providing fair consideration ensures that employees are reasonably compensated for the restrictions placed on their future employment opportunities.

• Enhanced Legal Protections. Strengthening legal protections for employees and providing clear avenues to challenge unreasonable non-competes can deter misuse by employers. Ensuring that employees have recourse against overly restrictive clauses is essential for maintaining a fair labor market.

Conclusion

The FTC’s ban on non-compete agreements, though well-intentioned, risks discarding the valuable benefits these clauses offer in promoting innovation. By fostering employee training, protecting trade secrets, encouraging long-term R&D investment and facilitating strategic partnerships, non-competes can drive economic growth and competitiveness. Sensible reform, rather than an outright ban, is the key to balancing the interests of companies and employees and promoting innovation. With thoughtful regulation, we can address the concerns surrounding non-competes while preserving their role in fostering a vibrant and innovative economy.

[View source.]