Non-competition agreements: an ongoing and heated dispute in US law

Few issues are as controversial and frequently discussed in US law today as non-competition agreements, a form of restrictive covenant usually referred to as ‘non-competes’. A non-compete agreement, which employees are typically required to sign as a condition of employment, prohibits employees from working for a competitor of their employer for a period of time and, in a particular, a certain geographical area after they leave the company they work for. Approximately 18 to 20% of all US workers, or about 30 million employees, are currently bound by non-competes.

Non-compete agreements, which originated in the late nineteenth century, were at first largely confined to executives and professionals, and particularly medical doctors. The primary rationale for imposing these agreements on employees was that they are necessary to protect a company from former employees disclosing trade secrets and confidential information to competitors. Non-competes apply both to employees who voluntarily resign and to those who are discharged.

From an early point, many lawmakers, jurists and attorneys expressed doubts about the fairness and ethics of non-competes. At the present time, four states – California, Minnesota, North Dakota and Oklahoma – have a full ban on the use of non-competes. Massachusetts and Colorado have implemented partial bans on non-competes, restricting their use to certain categories of employees, and other states have enacted more limited restrictions on non-competes. Still other states are considering prohibiting non-competes; among them is New York, where the legislature this year passed a bill making non-competes unlawful only to have the bill vetoed by that state’s governor. (The measure, likely with modifications, is expected to be re-introduced in early 2025.)

Despite the fact that they are disfavoured in some parts of the country and by the Biden Administration, the use of non-competes has actually expanded in recent years. Many companies now require a broad range of employees to sign these agreements, a practice that has even extended to lower-income employees such as workers in fast-food retail chains. (This trend began in 2014 when a national sandwich chain began requiring its sandwich makers to sign non-competes.) Critics of the practice assert that this makes little sense, as fast-food workers possess no special skills or knowledge that could provide benefits to a competitor.

In part because of what many perceive as overreaching by a number of large companies who appear to be imposing non-competes on workers when there is no legitimate business reason for doing so, the debate over these covenants has become increasingly impassioned. As such, a closer look at the issues surrounding the continued use and future of non-competes in the US is warranted.

The arguments for and against

Major segments of the business community in the US continue to insist that non-competes are essential to their core interests. They argue, as noted above, that without non-competes employees are free to move to competitors and share their expertise and knowledge about a company’s products and methodology at great cost to their former employers. Moreover, non-competes are said to usually be drafted narrowly enough so that they protect only a company’s fundamental business interests without impinging on employees’ right to earn a livelihood. Thus, defenders of non-competes are quick to point out, non-competes do not preclude former employees from working in another field or even in their own field, so long as they do not work for a direct competitor.

Further, employers point out that signing a non-compete is voluntary. If an individual is uncomfortable with signing a restrictive covenant, he or she is entirely free to seek employment elsewhere. Companies also stress that they often invest a great deal of money and effort in training new employees, and it is unfair to permit their competitors to lure away their workers in order to gain the benefits of a prior employer’s investment in those individuals. Thus, they assert, non-competes are an important way to level the playing field and prevent competitors from gaining an unfair edge. Finally, employers note that without non-competes, in situations where an executive or high-ranking manager goes to a competitor and takes trade secrets with them, suing that person for appropriating a trade secret is an unusually difficult and laborious process where the outcome is often in doubt.

Public interest organisations and other groups that oppose non-competes are having none of this. They sometimes refer to non-competes as ‘coercive waivers’, observing that individuals are, realistically, often in no position to turn down otherwise promising new employment in a difficult job market because of a non-compete requirement. Non-competes, they claim, stop workers from obtaining higher paying jobs and depress wages by reducing competition because they curtail employees’ ability to move to other jobs. As a result, many workers are forced to remain in positions where they are less productive and are paid less than what they could obtain in the broader job market.

With regard to wage suppression, opponents contend that when millions of employees are legally prevented from seeking new opportunities or leaving a job that doesn’t suit them, the outcome is a job market that reduces wages for all workers. Before the widespread use of non-competes, employees could use their ability to leave a job to demand higher wages, a tool that workers bound by non-competes cannot employ. Because employees who have signed non-competes are restricted with regard to where they can work next, job mobility is adversely affected. Non-competes also harm the overall job market, as they trap employees in their current positions and prevent them from moving to a new company where they could be more productive.

One of the more compelling arguments against non-competes, which many in the legal field feel believe employers have not persuasively countered, is that they are fundamentally unnecessary. Both employment and separation agreements routinely contain broad confidentiality provisions which prevent employees from disclosing confidential information or trade secrets to anyone. If these provisions are sufficiently well drafted, they should prevent the kind of damaging disclosures employers claim non-competes are needed to thwart. This fact, critics of non-competes assert, demonstrates that employers’ real motives in insisting on their employees signing non-competes are to restrict competition, suppress wages and prevent workers from going elsewhere.

The limited scope of non-competes

Even in states with no statutory limits on non-competes, court decisions and practical considerations often curtail their scope. New York State provides a good example. In New York, a series of court decisions has addressed the question of whether the restraints in a non-competition agreement should apply to employees who have been dismissed without cause. The majority view of New York courts is that such agreements are unenforceable unless the employer continues to pay the terminated employee’s salary for the balance of the non-compete period. The logic behind this principle is obvious: allowing an employer to fire an employee and then bar that employee from working in his or her field thereafter is grossly unfair and a violation of public policy.

New York courts are, in general, increasingly inclined to view unduly strict non-compete agreements as unenforceable. Many New York courts have concluded that any time limitation in a non-compete in excess of one year is overbroad and therefore void. Geographical limitations are also looked upon with suspicion. Although a global geographical limitation by a large multinational corporation might well pass muster, a similar limitation imposed by a smaller entity will likely be met with scepticism. If an employer, for example, only does business in the northeastern United States, a non-compete with nationwide scope might well be struck down. As a practical matter, the evolving view of the courts in New York regarding overbroad agreements, as in other states, has caused employers to act with caution when drafting non-compete agreements. Employment lawyers in New York who represent employees very infrequently see non-compete agreements with a time restriction longer than one year.

Nonetheless, state statutes and case law pertaining to the enforceability of non-competes vary wildly across the US, presenting a complex patchwork of rules and prohibitions. Illinois law prohibits private sector employers from entering into non-competes with employees, but only those who earn close to the minimum wage. Similarly, Maryland law also prohibits non-competes, but only for employees earning $15 per hour or less. Other states, such as New Hampshire, Rhode Island and Maine, disallow non-competes for workers earning ‘low wages’, although the definition of that term varies from state to state. Oregon, in contrast, deems non-competes for workers earning less than $100,000 annually to be unenforceable. Massachusetts has codified New York’s informal judicial limitation of one year’s duration for non-competes.

Notwithstanding these varied, scattered state law restrictions on non-competes, employees in much of the US are still subject to non-competes. And, even in the states that fully ban non-competes, some employers continue to impose the agreements on their employees in the belief that most workers will be unaware of statutory or judicial restrictions and will therefore comply with them. The use of non-competes as a deterrent to discourage employees from departing to work for a competitor is widespread.

Compounding the uncertainty for employees surrounding the use and meaning of non-competes is the fact many such agreements are silent as to geographical scope and to the meaning of ‘competitor’. Such careless drafting places employees in the position of not clearly knowing what future employers they are prohibited from working for. In an effort to resolve at least some of these problems, in early 2024 the US Federal Trade Commission issued a proposed rule banning non-competes nationwide on the ground that they are an unfair method of competition and therefore in violation of federal law.

The Federal Trade Commission’s Final Rule

In late April 2024, the Federal Trade Commission (FTC) announced its Final Non-Compete Rule, which prohibits post-employment non-compete clauses between employers and their workers. The Final Rule is sweeping in scope, but with a few exceptions. Non-competes with senior executives earning more than $151,164 are allowed, as are non-competes entered into as part of the sale of a business. Significantly, the Final Rule covers not only employees, but also independent contractors. This is significant because many US workers, according to the National Employment Law Project, or NELP, are in fact employees, but are deliberately misclassified by employers as independent contractors. Such misclassification, indicates NELP, allows employers to save between 20 to 40% of payroll costs by not paying health insurance premiums, unemployment insurance and the costs of other benefits for those considered independent contractors. The Final Rule thus allows workers treated as independent contractors to at least be able to move to new positions elsewhere, perhaps as employees, without being burdened by non-compete restrictions.

Additionally, the Final Rule has a broader impact than merely prohibiting the use of non-competes. In fact, it bans other forms of restrictive covenants that also have the effect of restricting employee mobility. A good example is forfeiture provisions, also known as ‘TRAPS’ (Training Repayment Agreement Provisions) or ‘stay-or-pay’ agreements. TRAP agreements, also usually executed at the beginning of one’s employment, require an employee who leaves his or her employer within two years of hiring to repay the employer for the cost of on-the-job training provided to them. TRAPS are increasingly used by US companies and have been criticised on the grounds that they effectively lock many employees into jobs that may be a poor fit for them and are abused by employers who use them to charge departing employees exorbitant amounts that far exceed the actual expense incurred in training them.

The Final Rule was due to become effective on 4 September 2024, with interested parties free to submit comments (and many did) during the intervening period.

However, in August 2024 two federal district court judges in Texas and Florida issued rulings in Ryan LLC v Federal Trade Commission and Properties of the Villages, Inc. v Federal Trade Commission, which found that the FTC’s Final Rule banning non-competes exceeds the agency’s authority. One month earlier, a federal district court in Pennsylvania had arrived at the opposite conclusion in ATS Tree Services, LLC v Federal Trade Commission, holding that the FTC’s promulgation of the Final Rule was pursuant to a proper ‘constitutional delegation’. These decisions either have been, or are soon expected to be, appealed to federal appellate courts. That the matter will eventually be decided by the US Supreme Court appears likely.

Notably, the courts in neither Ryan nor Properties of the Villages, Inc. attempted at any length to defend the use of non-competes by companies nor assert that the benefits of these agreements outweigh their many negative effects. Rather, the decisions focused largely on whether the FTC’s Final Rule was within the scope of its statutory authority under the Federal Trade Commission Act or whether the agency’s rulemaking represented an impermissible delegation of authority under the US Constitution. Some interpret this emphasis on agency authority as a tacit admission that non-competes in fact suppress competition and also enable business interests opposed to the Final Rule to avoid a discussion of the merits and fairness of non-competes.

Conclusion

Regardless of whether the US Supreme Court ultimately upholds or strikes down the Final Rule, the debate over non-competes is likely to continue for the foreseeable future. In the event that the Final Rule is invalidated, the struggle will then shift largely to state legislatures. Statutes limiting or banning non-competes will probably continue to be passed in blue, or Democratic-leaning, states. However, states controlled by the Republican Party may well continue to embrace non-competes.

The use of non-competes is likely to continue to distinguish the United States as among the least employee friendly of advanced democracies in the world. Proponents of the Final Rule hope that, in time, the US will take steps toward making the playing field more even for both companies and employees by, among other things, abolishing restraints on employee mobility, such as non-competes.