Noncompetition: the employer, the employee, and the entrepreneur
Extreme power trip or strategic business necessity (assuming the robots aren’t in charge)?
What do the Federal Trade Commission (FTC), hairdressers, the 1980s ska band Madness, company owners, and everyone who works for someone else potentially have in common? No, this is not a joke that starts with them all going to a bar. One thing they all have in common is an interest in competing or balancing competitive interests.
If robots are doing our jobs soon, noncompete provisions in employment agreements probably won’t matter much, mainly because we will be busy in our new jobs as human batteries for the robot world. But, until the robot uprising is complete (more on ChatGPT and the robot uprising in later issues), noncompete agreements are a way of life in business. “The White House estimates that noncompete agreements are used by roughly HALF of private-sector businesses for at least some of their employees, [and this affects] somewhere between 36 million and 60 million workers.” Last week, after much speculation and urging from a number of civil society organizations, the FTC released a proposed rule targeted at banning noncompete provisions in employment agreements.1
Remember previously on PrepOverCoffee, when we learned about the main sources of law? There is the U.S. Constitution, of course, the U.S. Code (federal statutes), and the federal administrative code (regulations). Each state follows this model, with its own laws, including state Constitution, state regulations, and state administrative rules. And then local municipalities follow, focusing on the things that apply specifically to their smaller geographic area.
Administrative law at both the state and federal level is where a lot of people get confused. Administrative law is created by administrative agencies established by the executive branch of the government (either federal or state) which often have broad rulemaking and enforcement powers.
Because administrative law is so difficult to explain (and I have to teach it next week to a classroom full of people), I’ve been thinking about some fun examples for class. What better illustration of how administrative law works than the FTC’s proposed ban on noncompetes (and other practices that limit employees’ abilities to accept new jobs and benefit from an open and free market)?
How can the FTC weigh in on private contracts that contain noncompetition language?
There are three primary federal laws related to antitrust: (1) the Sherman Act, which includes both civil and criminal components, prohibits unreasonable restraint of trade – think “price fixing” and “bid rigging” where otherwise competing enterprises might work together to control the market they serve, (2) the Federal Trade Commission Act, which created the FTC and bans “unfair methods of competition” or “deceptive acts or practices,” and (3) the Clayton Act,2 which prohibits mergers that create monopolies as well as interlocking directorates (where one person, due to a role on two separate Boards of Directors, is making decisions for two competing companies). In addition, most states also have antitrust laws as well.
It is clear that the current trend with regulation is to increase the enforcement and scope of these acts. And how do administrative agencies do this? By utilizing the law as it exists to creatively address the concerns that they have. According to the FTC, noncompete clauses are a “widespread and often exploitative practice that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses.” The FTC has also stated that noncompete provisions “block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand.”
By viewing noncompetition clauses with this lens, it pulls these provisions squarely into the Federal Trade Commission Act (Section 5) which, as we know from above, prohibits unfair methods of competition. In the meantime, the FTC has already commenced enforcement actions on these grounds for three employers and two individuals who used noncompetes in a manner that illegally stifled competition, especially for lower-wage workers.
Outside of the latest actions by the FTC, non-compete clauses are largely governed by state restrictive covenant statutes or common law. Many states significantly limit or outright prohibit (in the case of California, North Dakota, and Oklahoma) the use of noncompetes in employment agreements. Limitations to noncompetes typically come in the form of reasonableness (time, scope, and geographic boundaries), the worker’s total compensation (which often needs to be above a certain threshold for a noncompete to be enforceable), consideration (the worker receives something of value for agreeing to the limitation), and notice to the worker that the provision even exists.
With the FTC’s proposed rule, we can all pop some popcorn and wait for the legal challenges to begin. There is even disagreement among the FTC itself, with one member of the voting body dissenting from the proposed rule on the grounds that the FTC lacks authority to engage in this type of rulemaking, that there is no major question, and that it is impermissible delegation under the non-delegation doctrine.
Until the courts decide, we have to assume noncompetes will stick around.
So, what is the difference between noncompete, nonsolicit, and confidentiality provisions?
One of the most common things that I hear from business professionals seeking advice related to a new employment contract or seeking to leave their current employer is that they don’t understand the difference between noncompetition, nonsolicitation, and confidentiality.
The examples below are overly simplistic and not intended as form language for the lawyers out there, but hopefully illustrate the differences. And interestingly, each type of provision can often be expanded to prohibit competition, and thus will likely be of interest to the FTC.
NONCOMPETE SAMPLE: “I hope you’re with me when it’s over.”
Noncompetition provisions, which are the main target of current FTC activities, limit an individual’s ability to compete with the organization they are currently engaged or employed with.
Here’s an example: During the term of Employee’s employment and for a period of one year after employment is terminated (for any reason or no reason), the Employee agrees that the Employee will not engage in the same or similar activities as were performed for the Company in any business within a 50 mile radius of the Company.
NONSOLICIT EXAMPLE: “Say goodbye, don’t follow”
Nonsolicit provisions generally prohibit an individual from “poaching” or “interfering with” a company’s other employees, clients or customers for the benefit of another individual or organization, regardless of whether it is a competitor or not.
Here’s an example: During the term of Employee’s employment and for a period of one year after employment is terminated (for any reason or no reason), the Employee will not solicit for hire or hire any employee or engage any independent contractor of the Company on behalf of any other business enterprise, nor shall the Employee induce any customer, client, employee or independent contractor associated with the Company to terminate or breach any employment, contract or other understanding with the Company.
NONDISCLOSURE SAMPLE (aka CONFIDENTIALITY PROVISION): Shhhh! It’s A Secret, And It’s Not Your Secret To Tell
Confidentiality provisions prohibit an individual or organization from sharing the confidential information of an organization with any third parties.
Here’s an example: The Employee shall not use, publish, commercialize, or otherwise disclose Confidential Information to any person or entity. (Note: the definition of Confidential Information can vary widely depending on what the employee has access to, but generally includes financial information, customer contacts, intellectual property information, etc. Confidentiality provisions are also usually perpetual in nature, and can be enforced as long as the Confidential Information remains confidential.)
The Entrepreneur, Employer, and Employee Views on Noncompetition Provisions
The Entrepreneur - noncompetes when buying or selling a business: “I’m Still Standing After All This Time, Picking Up the Pieces of My Life Without You On My Mind”
Noncompete provisions when you sell your business are largely enforceable, and typically not limited by the same guidelines that apply to individual employees. As we learned in All I Want For Christmas Is A New Company, one of the considerations when buying a business is how long you want to limit the prior owners/leadership from competing with you, as it can dramatically affect the value of your purchase.
For example, Bobbi Brown (not My Prerogative Bobby Brown, but the inspiringly ageless makeup lady and 65 year old Tik Tok sensation) famously signed an agreement to sell her cosmetic company that included a 25 year noncompete. Evidently, the threat of competing with her was so dangerous to the value of Estee Lauder’s purchase, they locked her up for decades. But never fear, the Phoenix rose again when she started Jones Road, on the day her non-compete handcuffs expired. In the meantime, her noncompete was not so prohibitive that she sat around watching cat videos and counting her “I sold my business for nearly $75 million money” – it allowed her to do other things like starting a wellness brand, a hotel, and providing services as a health coach. She was only prohibited from working in cosmetics. And, the noncompete was enforceable even though it was decades long because it was negotiated as part of the sale of a company.
Thus, when buying or selling a company, the most important consideration related to noncompetes is exactly what is permissible during the term of the provision, and whether the value remains for each party with the limitations in place.
The Employer - noncompetes for employees and some practice notes: “Winning Ugly”
Even before the FTC stepped in, most states already had various rules and precedent related to the enforceability of noncompetition provisions. Under the complex fabric of guidance, the most important consideration for employers drafting noncompetition provisions is to ensure that they are reasonable in protecting the employer’s unique competitive advantage without being overly broad by limiting an employee’s ability to make a living. Often, courts will find a noncompetition provision “overbroad” and “unfair” if it is for too long of a time (usually if more than one year after employment ends) or covers too broad of a geographic area (such as more than 20 miles from the company location that the employee worked in).
Employers should consider the specific risk associated with each type of role, and customize any necessary noncompetition provisions accordingly. For example, is a low wage worker in your call center REALLY going to harm your business by taking their problem-solving skills to a competitor? Probably not. Is that salesperson doing anything unique to your business, or is your concern really just ensuring that they don’t “call on” your customers or clients (which can be limited with a nonsolicitation provision that does not dramatically hinder the sales employee’s ability to earn an income, just who they can call for business for a period of time).
Hiring A New Employee: Beyond the provisions in your own employment documents, asking early in the screening process about any prohibitions that apply to a potential employee is critical, especially when you are hiring a salesperson or a highly creative technology team member. In addition, a simple statement in an offer letter - like “By signing this offer letter, you attest to the Company that you are under no contractual nor any other restriction which would prohibit you from performing your duties to the Company” - can save a world of pain later.
Post-Employment Obligations: Finally, as an employer, it is a good business practice to remind departing employees in writing about any provisions that apply to them post-employment, including noncompetition, nonsolicitation, and confidentiality.
The Employee - should I agree to this noncompete? “I’m So Scared of Losing I Can’t Compete” (click link for the song that shockingly does not have a video)
What do you do when your potential new employer asks you to sign a non-compete? First off, never hesitate to negotiate the provision. Is there a way to narrow the provision and still address the risk that concerns the employer? Consider the specific limitations of the type of work, the geography, and the timeframe. Do you fully understand what it can include, what you would still be able to do, and how it might affect your future earning power and ability to find comparable work? Said another way, is the salary you are being paid enough to accept the elevated limitations to your future earning power? Finally, it helps to get a second opinion from a lawyer - or phone your “legal friend” who can tell you the likelihood of enforceability in your particular state.3
The “Madness” Of It All
As the FTC continues to expand its authority, individuals become more knowledgeable about the complexities of noncompete provisions, and everyone strives to find the right balance between viable employment opportunities, competition, and protecting the strategic insights of companies, we will have to wait and see how much we can all “compete with the best of the pack.”
And, you are welcome for the earworms…again. Enjoy!4
What is the process for proposing new Federal rules? When a rule is proposed, it appears in the Federal Register for comment, and those comments are accepted for approximately 30-60 days (here 60 days). After comments are received, the rulemaker reviews the comments and considers such before publishing a “final” rule. After a rule is published, it goes into effect no less than 30 days later (here 180 days). For noncompetition provisions, this would mean employers have 180 days after publication of the final rule in the Federal Register to comply, in most cases by rescinding any existing non-competes and informing those employees of the change.
Fun fact: Did you know that noncompete provisions are typically not enforceable against attorneys, at least related to their legal work? Probably because lawyers write and interpret (as judges) the rules in the first place!
And a special thanks to Comcast/Xfinity for another week of internet drama (we have not had reliable internet since January 1, which was evidently a special Happy New Year gift from the fine folks at Xfinity to me and many others). This is coming out early because I am afraid I won’t have internet again tomorrow. Since the FTC is doing a lot of public stuff, maybe the FCC can get in on the act and do something about companies that are de facto utilities but act like they are “entertainment.” Xfinity, you have reached a new low when Twitter is more reliable than you are.