Non-compete contracts suppress competition …, but they also protect valuable employer secrets. Which is more important for America?” – The Lonely Realist

Non-compete clauses are common legal provisions included in employment contracts to impose a waiting period before employees can take similar jobs with competitors or start a competitive business. Such “restrictive covenants” or “covenants-not-to-compete” are not ostensibly for the purpose of preventing former employees from switching jobs or suppressing capitalist competition. Rather, their role should be is to protect trade secrets and sensitive business information from being used by competitors – that is, from being sold by former employees to the highest bidder. How should this push-pull between American laissez-faire capitalism and employers’ interest in protecting their businesses be reconciled? What factors should determine whether non-competes should be left to negotiation between employers and workers or instead be subjected to limitations imposed by the government? Should the government restrict non-competes only for those private businesses that have dominant economic power over relatively low-wage workers?

On January 5th, the Federal Trade Commission (FTC) answered these questions by proposing a rule that would broadly and comprehensively ban all existing and future non-competes. It would not distinguish between low-wage and highly-compensated workers and would provide no exceptions for workers who have access to trade secrets or other competitively- or industry-sensitive information. The FTC’s proposal even implicates other types of agreements if they could be considered “de facto non-competes.” This follows from President Biden’s Executive Order of July 2021 on Promoting Competition in the American Economy in which he espoused a “government approach … to address overconcentration, monopolization, and unfair competition,” calling on the FTC “to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility” (an approach substantially similar to a good many recent Statist regulatory actions taken by Federal and State governments, a subject most recently discussed by TLR here).

The Economist in a January 14th editorial endorsed the FTC’s proposal, agreeing that America should prohibit the use of non-competes to prevent private employers from dictating contractual terms to their workers because the practice is anti-competitive. It argued that the public interest favors the spread of innovation and productivity and that allowing competitors to hire former workers who have knowledge and expertise gained at their former employers is the best way to spread ideas. While true, that’s quite a radical departure from existing business practices and inappropriately dismissive of the assertion that non-competes are necessary to protect intellectual property, trade secrets and confidential information. The Economist argued that adequate protections are afforded employers by intellectual property law and non-disclosure agreements.

As a practicing attorney and observer of business and legal realities, TLR respectfully (and forcefully) disagrees.

The Economist nevertheless was correct when it chose to highlight the Jimmy John’s chain of fast-food sandwich shops as the poster-child for non-compete agreement abuse. (Among other things, Jimmy John’s non-competes are for 2 years, which is unenforceably-long in all jurisdictions, even when applied to high-tech workers.) However, The Economist’s example of Jimmy John’s has no relevance when it comes to the damage that “highest bidder” competition would wreak on many of America’s cutting-edge industries. Simply put, non-competes that restrict low-wage workers are crass attempts to restrict trade with no redeeming capitalist – the is, trade secret or intellectual property— justification. Such shackling of blue-collar workers is readily actionable in every court in America (and is reflected, for example, in the success of recent FTC enforcement actions). Moreover, the American economic system contemplates employer-worker relationships being subject to State and local oversight (as right-to-work laws are), not a matter for Federal government intervention. There already are 3 States – California, North Dakota and Oklahoma – that prohibit non-competes, and 12 others, Colorado, Illinois, Maine, Maryland, Massachusetts, Nevada, New Hampshire, Oregon, Rhode Island, Virginia, Washington and the District of Columbia, that permit non-competes only for employees earning more than a statutory minimum.

Any number of uncertainties surround the FTC’s legal authority to promulgate the proposed rule (for example, the U.S. Chamber of Commerce has stated that it will challenge the final FTC rule in court – undoubtedly by first seeking a preliminary injunction that would prevent the FTC from implementing any portion of the rule). Resolution of those uncertainties may well be years away. The FTC hasn’t even considered the question of how the banning of non-competes might impact on American international competitiveness. Of further concern to TLR, however, are the practical effects the proposal itself will have on government processes and capitalist commerce. Also absent is a discussion of low-wage versus highly-compensated worker differences and their effects on domestic businesses. After all, preying on low-wage employees like those working at Jimmy Johns is unacceptable. Nevertheless, State governments already have been addressing this issue. It accordingly is inefficient for the Federal government to now intervene and preempt State efforts. The Federal government surely has better ways to deploy its limited resources. In addition, the question of whether highly-compensated workers require Federal government protection is a divisive one that would best be addressed after the petri dish experiments being conducted in the States of California, North Dakota and Oklahoma where non-competes already have been outlawed. Consequences will become evident soon enough. Why the rush?

When governments overreach, society suffers …, but lawyers flourish. Mirroring Governor DeSantis’s Statist efforts in Florida that are enhancing the profits of the legal industry, the Biden Administration’s efforts to foist government control, this time over non-competes, also will prove productive for the legal industry. Moreover, the FTC’s proposal already has triggered a rush to lobby Congress, a bonanza for Washington’s lobbying industry that does nothing to enhance America’s global competitiveness. Can there be any disagreement that companies doing defense work should be excluded from the FTC’s non-compete rule? Why then wasn’t such an exclusion carved out of the proposal? Silicon Valley’s interest in protecting America’s lead in AI also should be impactful, as will similar efforts by the biotech and financial services industries (as well as many others). Each will receive deference from elected officials who rely on their campaign contributions. In short, the FTC’s proposal, even were it a worthy one, will find it challenging to withstand the onslaught it will receive from affected special interests.

Why, then, make such a costly, controversial and likely fruitless proposal?

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Finally (from a good friend)

1 Comment
  • jeffcsiegel
    Posted at 07:39h, 05 February

    What is one of the secrets of Silicon Valley success versus say NY or Boston with their equally good schools? It is their lack of non-competes. College friends who left NY to go to their CA were unafraid to join startups. If the company fails, or takes a bad turn, just go elsewhere. You don’t have to move or even change your career in the Valley. These decisions are much harder elsewhere.

    I’ve seen non-competes used punitively to try to force people to stay with failing horrible companies in the “Right-to-work” states of Florida and Georgia. The employer threatens actions that may not even be strictly legal in those states as it may not pass certain rules, but the threat of legal action can paralyze the employee. (One employer told a friend, “If you try to leave before I’m ready to fire you I’ll sue you to make sure no one in this state can hire you in your field.”)

    Whether this belongs as a Federal or State rule is debatable, but in the vast majority of cases the rules should go.

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