On July 9, 2021, President Biden issued an Executive Order to coordinate all federal agencies around a national policy to promote competition, prevent and curtail abusive monopolies and monopolistic practices.
The Executive Order calls upon the Federal Trade Commission (FTC) to “address agreements that may unduly limit workers' ability to change jobs.” Under Section 5(a) of the FTC Act, the FTC can regulate “unfair or deceptive trade practices in or affecting interstate commerce.” Existing 2015 FTC policy targets “the promotion of consumer welfare.” President Biden seeks to expand that policy to include worker mobility: “to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.” But “unfairness” is not defined by statute. If a non-compete agreement is too restrictive, a worker might not find a new job with higher wages or better employment opportunities.
For business owners and tech investors, it is time to anticipate and manage potential challenges to non-competition covenants.
For employees, consultants,
business service providers and strategic alliance partners, new federal
regulations probably cannot replace the need for smart negotiations to prevent
possible abusive enforcement of a valid restrictive covenant.
What is a Non-Compete Clause? A
non-competition clause or “covenant” is a contractual obligation by an employee
not to compete with the employer’s business during employment and for some
limited period after employment. This
restricts the employee from joining a competitor until after a reasonable
“cooling off” period. But the
restriction is limited in scope, duration and, if appropriate, geography. Every situation is different, so courts
analyze the benefits, burdens and reasonableness. The non-compete clause typically includes
protections for trade secrets, which can exist forever (e.g., Coca Cola’s
secret formula for its soft drink).
Why Businesses Require Non-Compete Clauses. Non-compete clauses serve valid competitive purposes. They protect a business against:
· Poaching of the business’s clients and employees (but not forever);
· Unauthorized disclosure of trade secrets (both of the employer and third parties doing business with the employer) and other employer confidential information; and
· An employee’s abuse of his or her duty of loyalty while an employee.
What are the Public Policy Limitations on Enforcement of Non-Compete Covenants. In New York, such clauses are permitted as a matter of long-standing public policy (“common law,” not statute) to protect an employer. (An exception exists for the broadcast industry.) New York common law (“public policy”) already limits non-compete covenants. The covenant must be reasonable in scope of work (relating to the first employer’s business activities), duration and geography. As summarized by a former New York attorney general in 2017:
A non-compete [agreement] is only allowed and enforceable to the extent it (1) is necessary to protect the employer’s legitimate interests, (2) does not impose an undue hardship on the employee, (3) does not harm the public, and (4) is reasonable in time period and geographic scope. An employer’s legitimate interest may include protecting an employer’s trade secrets and confidential information and preventing employees from taking specialized skills they gained on the job to a competitor. A non-compete’s restrictions must be no greater than necessary to protect the legitimate interests of the employer. To determine if a non-compete is enforceable, courts consider an employee’s job duties, the employer’s business interest, and the language of the agreement.
In contrast, a California statute bans non-competition covenants as a “restraint of trade” unless negotiated as part of the sale of shares or the employer’s business. Exceptions apply to situations involving business exit transactions including the sale of the goodwill of a business, the seller’s entire ownership interest in the business entity, or all or substantially all of a business’ operating assets together with the goodwill. Calif. Bus. & Prof. Code §§ 16600 and 16601.
Negotiated Contractual Limitations on Non-Compete Clauses. To limit an overly broad limitation on mobility of workers and business service providers, employees, business service providers, licensors, strategic partners and others can negotiate limitations on non-compete clauses. For example, one might negotiate an exclusion for information and know-how that is “general skill and knowledge” in an industry. Or an employee might negotiate a separation bonus can seek some compensation, particularly where the employee to cover the post-termination period, especially where the termination was “without cause.” For new senior executives coming on board with broad substantive and strategic knowledge, a blacklist of “competitors” and a whitelist of “non-competitors” might be identified to give comfort to both employer and executive.
Planning How to Improve your Chances of Enforcing a non-Competition Clause. Anticipating new FTC regulations on interstate businesses, you can improve your odds of judicial enforcement of your non-competition covenants. In addition to carefully crafting your non-compete clauses, you can:
· Pay some money that is earned only during the post-termination period. This provides special “consideration” beyond one’s normal salary.
- In England, they send such employees to “garden leave” to do nothing but grow a garden.
- In Japan, the “corner office work” serves the same function, where job duties are restricted with full pay.
· Limit the scope to what is needed for saving your customers, your employees and your trade secrets from poaching.
· Protect trade secrets through internal management practices, manuals, trainings and segregation of functions, as well as clauses in employment agreements, licensing agreements, business services agreements (outsourcing), non-disclosure agreements, financings, strategic transactions, and any transaction for a change of control.
· Protect existing and prospective client relationships and employees from being poached by delivering good customer experiences and employee satisfaction.
· Link non-compete clauses to stock options, restricted stock units and/or deferred compensation.
· Negotiate with your new employees (and their attorneys) to have them agree the restrictions are reasonable.
· Require disclosure to new employers so that they can evaluate whether there is a risk of conflict and breach.
· Consult an attorney who understands your business model and can help you build, protect and securely exit your business.