Although antitrust enforcers' concern for anticompetitive effects in labor markets has been escalating for some time (read our 2022 article about labor market developments here), the focus on perceived anticompetitive effects of employer/employee non-compete provisions has recently become much more acute.
Table of Contents
- Proposed US FTC Rule Banning Non-Competes
- What are the key features of the proposed rule?
- If issued, what happens if you violate the proposed rule?
- What employers would be bound by the proposed rule?
- How would the proposed rule impact non-competes entered as part of an M&A transaction?
- How would the proposed rule impact executives and executive compensation?
- Does the proposed rule ban garden leave?
- What happens next with the proposed rule, and when could it go into effect?
- Recent Wave of US FTC Enforcement Actions Against Worker Non-Compete Agreements
- White House and US Antitrust Enforcers' Commentary on Non-Competes
- Changes at the State Level
- California Strengthens Its Ban on Non-Competes
- UK Proposes Stricter Approach to Non-Competes
- UK publishes research report on competition and market power in labor markets
Proposed US FTC Rule Banning Non-Competes
On January 5, 2023, the U.S. Federal Trade Commission announced a Notice of Proposed Rulemaking (NOPR) that would ban non-compete clauses in employer-employee contracts. (You can read the FTC's FAQs press statement here).
While the vote to issue the rule had three votes by the Democrat-appointed commissioners, Commissioner Christine Wilson (now former Commissioner) dissented. Commissioner Wilson's dissent, (which you can read here), notes that the proposed rule would be a "radical departure from hundreds of years of legal percent." It also explains that the appropriateness of non-compete clauses deserves a "fact-specific inquiry" and that enactment of the proposed rule would have "a much larger raft of unintended consequences."
Indeed, in former-Commissioner Wilson's Wall Street Journal Op-Ed published on the day she announced her resignation, Wilson highlighted the FTC's proposed non-compete rule as an example of the FTC's policy agenda causing her to resign. She explained: "In January, 2023, the commission launched a rulemaking that would ban nearly all noncompete clauses in employee contracts, affecting roughly one-fifth of employment contracts in the U.S. This proposed rule defies the Supreme Court's decision in West Virginia v. EPA (2022), which held that an agency can't claim ‘to discover in a long-extant statute an unheralded power representing a transformative expansion in its regulatory authority." Former Commissioner Wilson's WSJ Op-Ed is here.
What you need to know:
- What are the key features of the proposed rule?
- The proposed rule is broad. It would prohibit employers from imposing non-competes on workers (including independent contracts and unpaid workers), and the ban would extend to all contract provisions that create "de facto" non-compete clauses; i.e., any other contractual clause that may have the "effect" of prohibiting workers from seeking or accepting other employment. This means that an NDA that has the "effect" of limiting a worker's mobility may also be banned. (Proposed Rule § 910.1(b)(1)-(2) is here.)
- The rule would apply retroactively. Should the rule be enacted in its current form, not only would preexisting non-compete agreements become unenforceable, but the rule would also require employers to proactively rescind the non-compete, i.e., to tell individual employees that such provisions no longer applied. **The proposed rule would not affect any other provisions negotiated for in exchange for the non-compete, like a severance package. (Proposed Rule § 910.2(b) is here.)
- There is a narrow exception to allow non-competes in "sale-of-business" agreements, but the exception only applies where the individual has at least 25% ownership in the business. (Proposed Rule § 910.3 is here.)
- It would supersede all contrary state laws.
- If issued, what happens if you violate the proposed rule?
- What employers would be bound by the proposed rule?
- Most employers will be subject to the proposed rule if issued. Certain entities, however, are exempt form the FTC's jurisdiction under the FTC Act (pursuant to which the FTC purports to be issuing the proposed rule), so it follows that those exempt entities should also be exempt from the proposed rule. Those entities generally include certain financial institutions (banks, credit unions, savings and loans), some non profit organizations, and air carriers.
- As explained below, however, the FTC and Department of Justice Antitrust Division have separately raised concerns about non-competes as an antitrust violation under Section 1 of the Sherman Act.
- How would the proposed rule impact non-competes entered as part of an M&A transaction?
- The proposed rule would apply to, and therefore ban, employee non-competes with entered as part of a merger or acquisition. The only exception, as explained above in the "key features" question, is for non-competes entered as part of the sale of a business for a person holding 25% or more of the company.
- How would the proposed rule impact executives and executive compensation?
- Does the proposed rule ban garden leave?
- Under the proposed rule, garden leave may or may not be prohibited depending on how it is structured. The proposed rule defines a "non-compete clause" as one that prevents the worker from seeking or accepting new employment "after the conclusion" of the current employment. Therefore, a garden leave provisions whereby the employee remains employed (i.e. with full salary and benefits) but is simply not allowed to access the business during the garden leave period should be permissible, but the proposed rule is not clear.
- What happens next with the proposed rule, and when could it go into effect?
- The process to implement a rule can take quite a while. The public comment period closed on April 19, 2023. A total of 16,459 comments were lodged. Leading themes included (1) the adverse impact on the protection of intellectual property (IP) and the absence of any IP exception to the proposed non-compete ban; (2) the proposed rule's tendency to disincentivize investments in worker training; and (3) concerns that non-profit healthcare providers would be unfairly advantaged by the proposed rule since they are exempt from it.
- The proposed rule is an extreme departure from historic business practice and even broader than the EU principle of free movement between countries and jobs—but without the EU structure that allows non-competition clauses, limited in geography and time, for certain classes of employees (e.g., key-person and IP related) that are compensated separately (e.g., garden-leave).
- Before the FTC can enforce the rule, it must publish a final version in the Federal Register, which contains all government agencies' rules and regulations. There is no specific date by which the FTC must publish the final rule. If issued, the final rule would go into effect 60 days following publication in the Federal Register and companies would have to be in compliance 180 days after publication. Still, enforcement could be further delayed by legal challenge.
- As of May 25, 2023, the FTC has not made any public statements indicating what its next steps are or when it intends to publish the final rule. However, a group of U.S. senators and house representatives led by Senators Elizabeth Warren (D-MA) and Richard Blumenthal (D-CT) urged the Commission "to resist calls for additional postponement and act quickly to protect as many workers under this rule as possible." The letter from these lawmakers to FTC Chair Lina Khan is here.
- The most current reporting indicates that the FTC may vote on the final version of the rule in April 2024.
Recent Wave of US FTC Enforcement Actions Against Worker Non-Compete Agreements
The FTC's proposed new rule announcement came within 24 hours of the FTC signaling its intention to achieve its anti-non-compete clause views through enforcement.
- On January 4, 2023, the FTC announced that it had filed suits—for the first time—to stop companies from enforcing non-compete restrictions. The FTC's press release is here.
- The suits involved three companies with non-competes for a range of workers, including low-wage workers, which lasted for one to two years. As a result of the suits, the companies were ordered not to enforce the non-competes, as well as put other remedies into place, such as providing notice for the next 10 years to employees that they may freely seek any job following their employment.
- In these actions, the FTC sued under Section 5 of the FTC Act, which governs unfair methods of competition. The FTC argued that the non-competes harmed employees because they result in lower wages, lower salaries, and less favorable working conditions. The FTC also argued that the non-competes harmed new competitors in the glass food and beverage containers industry, noting that the non-competes would impede entry and expansion of new competitors in a concentrated market.
- On March 15, 2023, the FTC ordered another glass container company to drop non-compete restrictions on more than 300 workers across a variety of positions, again arguing that the non-competes harmed workers and competition in the industry. The FTC's press release is here.
- The FTC and Department of Labor (DOL) have signaled that more non-compete enforcement actions may be on the horizon. On August 30, 2023, the FTC and DOL signed a Memorandum of Understanding that sets out coordination in investigations and sharing of information between the DOL and FTC related to labor and competition issues. The Memorandum of Understanding is here.
- According to the FTC, "the MOU identifies areas of mutual interest for the two agencies: collusive behavior; the use of business models designed to evade legal accountability, such as the misclassification of employees; illegal claims and disclosures about earnings and costs associated with work; the imposition of one-sided and restrictive contract provisions, such as non-compete and training repayment agreement provisions; the extent and impact of labor market concentration; and the impact of algorithmic decision-making on workers" (emphasis added). The FTC's press release is here.
- According to the FTC, "the MOU identifies areas of mutual interest for the two agencies: collusive behavior; the use of business models designed to evade legal accountability, such as the misclassification of employees; illegal claims and disclosures about earnings and costs associated with work; the imposition of one-sided and restrictive contract provisions, such as non-compete and training repayment agreement provisions; the extent and impact of labor market concentration; and the impact of algorithmic decision-making on workers" (emphasis added). The FTC's press release is here.
Both the rulemaking and enforcement actions are in line with the FTC's November 2022 policy statementannouncing that the FTC would invoke Section 5 to challenge conduct beyond that covered by the Sherman Act.
White House and US Antitrust Enforcers' Commentary on Non-Competes
In the midst of these events, individual enforcers at both the FTC and the Antitrust Division of the Department of Justice, as well as at the White House, have been vocal about their perceptions and goals for the future of non-compete enforcement:
- A comprehensive listing of public statements by the DOJ Antitrust Division on employer-employee non-competes
- A comprehensive listing of public statements made by FTC officials on non-competes
- And see our article covering what the July 9, 2021 Executive Order 14036 says about non-competes.
Changes at the State Level
State legislatures have also shown a growing interest in new proposals to ban or limit non-compete agreements.
For example, on June 20, 2023, the New York State Legislature passed a bill that would have prohibited almost all new non-competes in New York and created a private right of action enabling workers to void their non-competes and recover up to $10,000 in liquidated damages, in addition to lost compensation, damages, and reasonable attorneys’ fees and costs. Governor Hochul eventually vetoed the bill, calling for a carveout to the ban for higher-wage workers. The bill’s sponsor in the State Senate has said that he will reintroduce the legislation in 2024.
California Strengthens Its Ban on Non-Competes
California's new non-compete laws went into effect on January 1, 2024, bolstering the state's existing protections against non-competes. Though most non-compete clauses have been void in California since 1872, California's newly enacted AB-1076 and SB-699 create additional bars to enforcing non-competes in the state. SB-699, signed into law in September 2023, expands the reach of California's non-compete ban to contracts signed outside the state and creates a new private right of action for workers to sue employers who enter into or attempt to enforce a non-compete. AB-1076, enacted just a month later, codifies California Supreme Court precedent which made including a non-compete clause in an employment contract or requiring an employee to enter a non-compete unlawful unless an exception applied. AB-1076 also requires that California employers notify employees who are subject to unlawful non-competes that their non-competes are void by February 14, 2024.
- What are the key features of the bill?
- SB-699 makes most non-competes unenforceable in California, "regardless of where and when the contract was signed." Section 2(a). The law also prohibits employers and former employers from attempting to enforce a non-compete, even if "the employment was maintained outside of California." Section 2(b). The law could prevent out-of-state employers from enforcing non-competes against employees who leave to work at California companies.
- Under SB-699, an employer that enters into a prohibited non-compete commits a civil violation that can be enforced through a new private right of action which enables a current, former, or prospective employee to sue for injunctive relief and actual damages as well as reasonable attorney's fees and costs. Section 2(e)(1)-(2).
- AB-1076 codifies California Supreme Court precedent in Edwards v. Arthur Andersen LLP, 44 Cal.4th 937 (Cal. 2008), which clarified that any non-compete that falls outside the scope of California's preexisting exceptions is void, regardless of how narrowly tailored the non-compete is. Section 1.
- AB-1076 also provides that California employers must notify both current employees and former employees employed after January 1, 2022 who are subject to unlawful non-competes that their non-competes are void. Section 3(b)(1). Written notice must be provided to these employees by February 14, 2024, and failure to provide such notice constitutes an act of unfair competition subject to a $2,500 penalty per violation. Section 2(b)(2), 2(c).
- Do the laws apply to all non-competes?
- No. California allows non-competes in the context of the sale of a business, the dissolution of a partnership, or upon the dissolution or termination of interests in a limited liability company, so those agreements will remain outside the scope of these laws. Cal. Bus. & Prof. Code Sections 16601, 16602, 16602.5. There is also no guidance as to the interplay between AB 1076 and Labor Code 925, which permits the possible use of non-California law (and non-California forum for disputes) for employment-related agreements entered into on or after January 1, 2017 if the employee is individually-represented by legal counsel in connection with negotiating such agreement.
- How does the CA law differ from the FTC’s proposed rule?
- The FTC's proposed rule covers slightly more non-competes than California's ban. Both the FTC's proposed rule and California's law contain exceptions for certain sale-of-business transactions. However, the FTC only allows a non-compete to be enforced against a "substantial" owner, member, or partner, that is, a person who holds at least a 25% ownership interest in the business. (Proposed Rule § 910.3 is here.) California's exceptions have no similar ownership interest threshold.
- The FTC's proposed rule generally excludes non-solicitation agreements, whereas California courts have generally applied California's non-compete proscriptions to non-solicitation agreements. The FTC's NOPR stated that the proposed rule would generally exclude non-solicitation clauses from its reach because these provisions do not prevent workers from seeking or accepting new jobs after the termination of their employment. However, non-solicitation agreements may fall within the scope of California's new non-compete prohibitions given that AB-1076 "shall be read broadly," Section 1(b)(1), and California courts have interpreted the state's non-compete laws to make non-solicitation clauses "allowable only when they protect trade secrets or confidential proprietary information." Thompson v. Impaxx, Inc., 113 Cal.App.4th 1425, 1431 (Cal. Ct. App. 2003).
UK Proposed Stricter Approach to Non-Competes
In a policy paper on "Smarter Regulation to Grow the Economy," the UK government has announced proposals to limit the duration of non-compete clauses in employment contracts to three months.
This proposal reflects the growing concern worldwide concerning the use of non-competes. As discussed above, earlier this year, the U.S. FTC took even more extreme action than the UK, by publishing a proposed rule to ban non-compete clauses completely.
- What is the approach to non-competes in the UK?
- There are currently no statutory restrictions on non-compete provisions in the UK.
- Under case law, non-competes will only be enforceable if they are no wider than reasonably necessary to protect a legitimate interest (e.g. protection of confidential information or customer contacts) and are not contrary to the public interest.
- The UK courts have in the past enforced up to 12 month non-competes in employment contracts in certain sectors, particularly in case of non-competes imposed on founders or senior management. In other contexts, including partnership agreements and shareholder agreements, non-competes that apply for a longer duration have been enforced by the UK courts.
- What are the proposals?
- The UK government proposes to limit the duration of post-termination non-compete clauses in employment contracts to three months.
- The three month limit will only apply to non-competes in contracts of employment and the contracts of certain other workers who benefit from certain protections under UK employment law. The UK government does not propose to apply the limit to wider workplace contracts, such as partnership or shareholder agreements. This is on the basis that there are fundamental differences in the balance of bargaining power with these wider workplace contracts. Based on the consultation document, it appears that equity incentive documents, such as employee share option agreements, would be considered a wider workplace contract as well.
- There are carve-outs. The proposal will not limit or interfere with the employer's use of:
- non-solicitation clauses;
- paid notice periods or gardening leave; or
- confidentiality clauses.
- The proposal also will not affect the restrictions on former UK public sector employees under the UK business appointment rules.
- The proposal follows a consultation period between 4 December 2020 and 26 February 2021 that explored and ultimately rejected the following two alternatives:
- the complete prohibition of post-termination non-compete clauses; and
- making post-termination non-compete clauses permissible only when the employer provides compensation for the period of restraint.
- The UK government estimates that there are around 5 million employees subject to non-compete clauses in Great Britain and that a typical duration is around 6 months.
- Whilst recognising that non-compete clauses "can play an important role in protecting businesses who invest in their staff", the proposal claims that, "unnecessarily burdensome clauses have become a default part of too many employment contracts, including where they fulfil no purpose." The proposal states that non-compete clauses "can inhibit workers from looking for better paying roles, and limit the ability of businesses to compete and innovate".
- The proposal's stated aims are to give "UK workers greater freedom to switch jobs, apply their skills elsewhere and even earn a pay rise." They also aim to "provide a boost to the wider UK economy, supporting employers to grow their businesses and increase productivity by widening the talent pool, and improving the quality of candidates they can hire."
- Why no complete ban on non-competes?
- In contrast to the US FTC's proposal, the UK government has ruled out a complete ban of non-competes. Following a review of "available evidence, research, and literature", the UK government considers that the risks and potential for unintended consequences could outweigh the potential benefits of a complete ban. While the UK government recognises that a complete ban could have "a positive effect on competition and innovation", it considers that "there is some evidence to suggest that in certain circumstances, non-compete clauses can act as a mechanism to align incentives between workers and employers, and enable investments."
- What should employers do?
- Employers should start to consider other ways they can protect their business interests once the proposed limit comes into force.
- In the UK, the most robust way of protecting an employer's business interests in an employment contract of a senior employee who holds valuable trade secrets is a long notice period combined with an express garden leave clause. A 12 month notice period is fairly typical for a C-suite executive.
- Where a long notice period is not appropriate or cannot be agreed, then employers may consider including non-competes in wider workplace contracts. In particular, if equity incentive documents will ultimately be considered a "wider workplace contract" under the final legislation, then granting an option or other equity interest which includes a carefully drafted (and longer) non-compete in its terms might well be a sensible and enforceable alternative.
- What is the proposed timetable?
- The proposal states that the UK government intends to legislate "when parliamentary time allows." There is currently no clarity as to whether, if legislation does pass in this area, it will apply retroactively to existing employment contracts and contracts with workers and if so, whether pre-existing non-competes that apply for longer than 3 months will only be enforceable for 3 months after termination, or whether such non-competes will be unenforceable and void in their entirety.
UK publishes research report on competition and market power in labor markets
On 25 January 2024, the UK's Competition and Markets Authority (the CMA) published a research report on competition and market power in labour markets.
What is the report on "Competition and market power in UK labor markets"?
- The Report is the first “flagship” research study published by the CMA’s Microeconomics Unit, which was recently established to conduct economic research focussed on issues of competition, innovation, and productivity to support growth in the UK economy. The Microeconomics Unit has been set up as an independent and open-access centre of microeconomic research expertise for the UK government as a whole, and so the Report is aimed not just to inform the CMA's work, but also to be of wider policy interest.
- The Report examines employer market power and labor market concentration, the prevalence of restrictive covenants (including non-compete clauses), as well as changes in the labor market, including hybrid and flexible working and the gig economy, which features an increased amount of temporary positions and freelance work. The CMA is planning to use the findings to inform its current increasing scrutiny of potentially anti-competitive conduct in labor markets, as well as broader government and policy thinking.
What does the report say about non-compete clauses in UK employment contracts?
The Report finds evidence that post-termination non-compete clauses in employment contracts (preventing an employee from working at a competitor for a prescribed amount of time after they leave their current employer) are common in the UK.
According to the research:
- Non-compete clauses impact around:
- 26% of workers in the UK;
- 40% of UK workers in information and communication technologies and professional and scientific services; and
- 20% of UK workers in retail, education, and food services.
- The most common duration of UK non-competes is 6 months, applied by 43% of employers who use non-competes. About 33% of employers who use non-competes include year-long clauses.
CMA chief executive Sarah Cardell questions specifically in her published speech (accompanying the Report) the high number of non-competes prevalent for the lowest-paid workers. She notes that, while non-competes are typically justified on the basis of enabling investment to develop workers (through training/sharing confidential information), "we might expect to see non-competes only in particular industries or groups of workers where this sort of investment is happening". The use of non-competes for rank and file workers at fast food chains throughout the U.S. has been a focus of enforcement actions by state enforcers and the U.S. DOJ especially since 2016.
What are the implications of the Report?
- The Report's findings (specifically the findings that well-functioning labor markets benefit workers and the economy more generally) will bolster the CMA's determination to ensure that businesses do not restrict competition between them in labor markets, through for example no-poach and wage-fixing agreements.
- Employee non-competes usually fall outside the scope of UK antitrust law, but are governed by employment law. The UK is currently planning to legislate to limit post-term non-competes to 3 months in the UK (as explained above). In her accompanying speech, Sarah Cardell states that the evidence in the Report "supports this direction of travel", and comments that "the widespread prevalence of non-competes across the economy could act as a barrier to job switching."
- Highlighting the possible need for further education, it is interesting that the Report notes that 40 per cent of respondents to the "Business Insights and Conditions Survey", with 250+ employees, stated that they were "not sure" what types of restrictive covenant they use in their employment contracts.
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