Publications

The Case for Non-Competes

Apr 5, 2023Employment Law

By Paul F. Millus

As published in the April 2023 issue of Nassau Lawyer

Non-competition agreements between employers and employees are under wholesale attack. On January 25, 2023, the Federal Trade Commission (FTC) released a Notice of Proposed Rulemaking relating to non-competition agreements to prohibit employers entirely from imposing and enforcing non-compete clauses with their workers.[i] According to the FTC, non-competes:

significantly reduce office wages;
stifle new business and new ideas; and
exploit workers and hinder economic liberty.[ii]

The proposed rule and its breadth are presently under intense scrutiny. Nevertheless, in its present form, it is so broad as to significantly impact the employer-employee relationship. For example, it has been posited that the proposed rule also would stop companies from requiring workers to reimburse them for certain kinds of training if they leave their employ before a certain period of time has elapsed. The training repayment could be banned if it “is not reasonably related to the costs the employer incurred for training the worker.”[iii]

From the FTC’s standpoint, employers have other ways to protect trade secrets and other valuable investments that are significantly less harmful to workers and consumers. The FTC’s proposed rule is nothing new, but rather, it is a culmination of several years of efforts by Congress to restrict the use of non-competition agreements.

First, a little history. The oldest recorded legal action involving a non-compete agreement dates back to 1414. In that matter—known as The Dyer’s Case[iv]— John Dyer had promised not to exercise his trade in the same town as his former master for six months. The court invalidated the agreement on the grounds that the master had promised nothing in return. Protecting the apprentice’s right to earn a living was a paramount concern for the court.

Indeed, non-competes were disfavored under English common law until 1711. In that year, in the matter of Mitchell v. Reynolds[v], Mr. Reynolds opened a bakery within a specific distance from the bakery he had leased to Mr. Mitchell violating the terms of their noncompete. Ruling in Mr. Mitchell’s favor, the court found that Mr. Reynolds had received financial benefit of rent, that the restrictions were limited and specific and that there was no injury to the public. This case established the basic principle whereby reasonableness became the determinative factor as to whether a noncompetition agreement would pass legal muster.

At present, New York non-competes are still permitted. The general standard under New York law is that noncompete agreements are enforceable where the restraint is “reasonable” and only if:

it is no greater than required for the protection of legitimate interests of the employer; and
does not impose undue hardship on the employee; and
is not injurious to the public.[vi]

New York further recognizes the availability of injunctive relief (where the noncompete covenant is found to be reasonable and the employee’s services are unique).[vii]

This article does not attempt to analyze the myriad of circumstances in which non-competes in New York are found to be valid or invalid based on the reasonableness standard and the factors set forth in the seminal BDO Seidman decision. Rather, the prevailing question is whether non-compete agreements should exist under any circumstances, which question appears to be answered in the negative by virtue of the FTC’s new proposed rule, as well as in state legislation across the country seeking to prohibiting non-competes.

The FTC’s ruling attempts to address what has become low-hanging fruit. Specifically, as has been enacted in many states and has been promoted by both Republicans and Democrats in Congress, there is significant support for the abolition of non-compete agreements as they pertain to low-wage workers. It is difficult to argue the reasonableness of a non-compete agreement which would prevent a kitchen worker at McDonald’s from working at Burger King because of the “trade secrets” he learned or knowledge he obtained while employed at McDonald’s. An example of the absurd lengths that some employers would go to prevent competition can be found in the fast food franchise Jimmy John’s attempt to enforce a prohibition on its former workers at its sandwich shops from taking jobs with competitors in Illinois. In 2016 the Illinois State Attorney General entered into a settlement with Jimmy John’s which required the franchise to, inter alia, notify all current and former employees that their non-competition agreements were unenforceable and confirm that Jimmy John’s did not intend to enforce them.[viii] Likewise, former New York State Attorney General Schneiderman announced his office’s own settlement with Jimmy John’s.[ix]

In light of these legal actions, and the press that followed, congressional members of both parties sponsored several pieces of proposed legislation, such as the “Mobility and Opportunity for Vulnerable Employees Act,” seeking to prohibit the use of non-competes for “low wage employees” in 2015. The bill was not passed. Thereafter, in April 2018 the “Workforce Mobility Act” was proposed to impose a complete federal ban on the use of employee non-competes, and in January of 2019, the “Freedom to Compete Act” was introduced to amend the Fair Labor Standards Act of 1938 to ban non-competes for most nonexempt employees. Likewise, these bills could not garner sufficient support.

With the failure of these bills, the underpinnings of more drastic action, such as executive branch action, were in place. The problem is that when bureaucrats seek to change common law that has existed for centuries, they do so by citing to the most egregious examples of abuse they can to muster up the necessary support for their proposition, i.e. Jimmy John’s. Notwithstanding the deadlock in Washington D.C., states such as California, North Dakota and Oklahoma have each passed laws banning non-competes in their entirety.[x] In many other states, while non-competes are not void ab initio¸ they have been limited in significant ways or by various professions. In Idaho, for example, “non-key employees (those who have not gained a high level of insider knowledge, influence, credibility, notoriety, fame, reputation or public persona as a representative spokesman of the employer)” are exempt from non-compete agreements. Yet, in most states, the “reasonableness standard” abounds with various nuances applied on a state-by-state basis.

Based on the broad definition of the worker as defined by the FTC’s proposed rulemaking, if enacted, the FTC ban would arguably de facto prohibit non-competition agreements of all shapes and sizes in their entirety leaving employers to wonder if there is any way to protect themselves from the detrimental effects of highly-skilled and highly-trained employees leaving their employ to be employed by a competing entity. Accordingly, the FTC’s proposal has been characterized as another “throw the baby out with the bathwater” approach where much less intervention would be warranted to achieve more reasonable, common sense reforms.

It has been argued that there are other protections available to employers in the event they want to protect their trade secrets or other confidential information shared with employees to prevent former employees from utilizing that information unfairly after being employed by a competitor. For example, the FTC argued that nearly every state has approved the Uniform Trade Secrets Act (UTSA) and that Congress enacted the Defend Trade Secrets Act of 2016 (DTSA), both of which provide a civil cause of action for trade secret misappropriation.[xi] However, trade secret enforcement through civil litigation very often only provides merely after-the-fact consequences once the harm has already occurred. This “closing the barn door after the horse has left” approach has proved dissatisfactory as well as costly for employers. Discovering that trade secrets have been misappropriated can also be daunting, and the time and energy utilized proving damages (and collecting them) can dissuade employers from engaging in litigation in the first place. Finally, not all anti-competitive effects come from the disclosure of that is generally narrowly considered a “trade secret.”

It is true that nondisclosure agreements (“NDAs”) can be used to protect a broader range of confidential and competitive information than what might be considered a “trade secret” (which, based on practical experience, is a limited protection at that). However, the FTC’s proposed definition of “non-competes” can be interpreted so broadly that NDAs would be prohibited as well or, at a minimum, considered a “de facto” non-compete.

For sure, legal challenges will arise irrespective of the outcome of the FTC’s rulemaking process. However, the introduction of the FTC into this dispute appears to be a way of sidestepping the fact that Congress cannot come to an agreement on what limits—total or something less—should be placed upon non-competes, and it raises the question of the FTC’s rulemaking authority. Many in opposition will cite to the Supreme Court’s decision in AMG Capital Management v. FTC, which unanimously rejected the FTC’s claim that it had remedial powers it was permitted to utilize without an express grant of authority from Congress.[xii]

In sum, the road will be long and the outcome uncertain as it pertains to this proposed FTC rule. However, it should not be forgotten that courts and juries have been imbued with the power to determine reasonableness based on the facts of a particular case and applicable law in a whole host of cases to reach a lawful and just outcome. This begs the question: does the FTC really need to use such a blunt instrument as the proposed rule to remedy the specific instances where reasonable people can agree that a particular non-compete is simply unreasonable where a more precise and limited tool could be used to reach the right conclusion? Time will tell.

Paul F. Millus, Esq. is a Member at Meyer, Suozzi, English & Klein, P.C. and former chair of the NCBA Labor & Employment Law Committee

[i]https://www.ftc.gov/legal-libr....

[ii] The FTC could have been directly relying on the decision in Alger v. Thacher, 36 Mass. 51, 19 Pick. 51 (1837).

[iii] See proposed Rule, §910.1(b)(2)(ii).

[iv]Dyer’s case 2 Hen V, fol. 5 pl. 26 (1414).

[v] Mitchel v. Reynolds, Court of King’s Bench, 24 Eng. Rep. 347 (1711).

[vi]BDO Seidman v. Hirshberg, 93 N.Y.2d 382, 690 N.Y.S.2d 854 (1999).

[vii]Ticor Title Ins. Co. v. Cohen, 173 F.3d 63, 70 (2d Cir. 1999).

[viii]https://illinoisattorneygenera....

[ix]https://ag.ny.gov/press-releas....

[x] Cal. Bus. & Prof. Code sec. 16600; N.D. Cent. Code sec. 9-08-06; Okla. Stat. Ann. tit. 15, sec. 219A.

[xi] DTSA and UTSA.