With a booming economy and job market, the movement to eliminate non-competes continues to gain federal traction and remains at the forefront of discussions around innovation and economic growth. Most recently, on July 9, 2021, the Biden Administration issued its Executive Order on Promoting Competition in the American Economy (“Executive Order”) calling on the Federal Trade Commission (“FTC”) and other antitrust agencies to limit or ban their application. Further restricting the use of non-competes in corporate agreements, however, is cause for concern for many businesses as they are often inherent to preserving value and ongoing success, particularly in the wake of increasing competition for talent and decreasing employee tenure and loyalty.
Non-competes typically range from one to two years for employees and three to five years for a sale of a business. The restrictive nature of non-competes, particularly on certain employee categorizations, has prompted decades of state-level action and legislation to govern and limit the impact of such provisions on worker mobility and business competition. Non-competes are generally disfavored and more than 20 states have enacted changes to their laws in recent years to further curtail them. Some of these changes include laws carving out employees who are paid hourly or fall below certain income thresholds and narrowly tailoring non-competes to protect legitimate business interests, while others impose an outright ban on the inclusion of non-competes in employment and similar agreements.
As indicated with the recent Executive Order, while non-competes were once within the province of the states, they have now increasingly garnered attention at the federal-level. The Executive Order, which emphasizes that the “American promise of a broad and sustained prosperity depends on an open and competitive economy”, asserts that non-competes create artificial barriers to competition which result in fewer players controlling increasingly larger shares of the market. This, in turn, drives down wages and drives up prices, a combination that diminishes a worker’s job mobility and ability to bargain for workplace standards, including fair compensation. Accordingly, the Executive Order promotes banning or limiting non-competes; however, it does not place a blanket ban on non-competes, nor does it provide a detailed itinerary of what changes need to be implemented.
Rather, it sets forth both prophylactic and retroactive guidelines. Prophylactically, it encourages the FTC to use its rulemaking authority to regulate non-competes that hinder worker mobility and antitrust agencies to coordinate efforts on prevalent market issues arising out of non-competes, including corporate consolidation. Retroactively, it encourages the FTC, antitrust agencies and the Department of Justice (“DOJ”) to look to long-standing laws that permit them to challenge prior business mergers in the hospital, banking and internet sectors, to name a few. The Executive Order also establishes a White House Competition Council to monitor initiatives set forth in the Executive Order and to coordinate a response to the “rising power of large corporations in the economy”. The Council will include the attorney general, secretary of labor, and the chair of the FTC, among others, to focus on overconcentration, monopolization and unfair competition, which may include an increased focus on barriers to entry when companies undergo the government review process for certain M&A deals. In any event, how this oversight will shape out is yet to be determined.
Impact of Increased Regulation on Businesses
Regardless, further curtailing, or even outright banning, non-competes needs to be carefully considered as fostering an open and competitive marketplace must be balanced against the equally compelling need to preserve business value through non-competes, which stave off aggressive poaching and the loss of key talent, know-how and trade secrets to a competitor. Indeed, covenants not to compete are a critical part of the M&A process and valuation, with buyers seeking comfort that the seller and key seller employees will not simply leave to work for a competitor or start their own competitive business immediately after close. It is therefore the hope of many business owners that in implementing the Executive Order the focus will be on protecting the job mobility of rank-and-file employees who have less negotiating power, while preserving the status quo on key employee and seller non-competes. It is likely, however, that some businesses will inevitably feel the impact of further restrictions.
The Outcome is Yet to be Determined
While the Executive Order’s intent is to diminish or ban the use of non-competes, the FTC, DOJ and other agencies referenced in such order are tasked with using their discretion in regulating the use and abuse of non-competes. This will likely encourage further discussion and detailed consideration on implementing the Executive Order’s recommendations, noting rulemaking is a several step process that includes publishing the proposed rulemaking, drafting text of the proposed rule and defending its rationale, a process that could take several years before any rules or regulations are put in place.
In the meantime, in an effort to preempt future challenges to non-competes, businesses should be more thoughtful about the geographical scope, duration and breadth of non-competes in their corporate agreements. If challenged, a business should be able to defend their restrictions as reasonable and point to a legitimate and justified business interest for their inclusion. For example, rather than including non-competes in every employee agreement, consider limiting them to those employees that are key to the success of the business and are attractive targets for poaching by competitors. Furthermore, in preparation for a potential ban on non-competes, businesses who place significant importance on trade secrets would be wise to ensure effective confidentiality agreements are in place as the Executive Order does not emphasize curtailing or banning confidentiality agreements or policies that prohibit an employee from disclosing the employer’s confidential or proprietary information.