As he promised during the 2020 presidential campaign, President Joe Biden issued an Executive Order on Friday that directs the Federal Trade Commission (FTC) to curtail the use of unfair non-competes or other agreements that may limit employee mobility. This Executive Order is the culmination of efforts by federal legislators to ban or limit non-competes. A number of bills have been brought to the floor of the U.S. Senate, mostly by Democratic Senators, and none of been able to marshal sufficient bipartisan support to advance. As those legislative efforts fizzled, several of those senators then lobbied the FTC to ban non-competes, which in turn held hearings over whether to take regulatory action early last year.
As explained in greater detail below, the Biden Executive Order is short on detail and simply encourages the FTC to take unspecified action against unfair non-competes and other agreements limiting employee mobility. On its face, the Executive Order focuses on “unfair” agreements which have generally been understood to mean non-competes imposed on lower-wage workers. Should, however, the FTC take a more aggressive approach to ban all non-competes, that could harm one of the key drivers of employment in the U.S. — small and medium-sized businesses that more heavily rely on non-competes to protect their companies.
What’s Driving the Executive Order? Non-competes became the subject of national debate when the sandwich maker Jimmy John’s was sued for its efforts to impose non-competes on its low-wage workers and sandwich makers in 2015. Since that time, academics and political leaders have increasingly criticized non-competes for impairing employee mobility and effectively lowering wages. At least seven states (including New Hampshire, Illinois, Massachusetts, Maryland and Oregon) have moved to limit or ban non-competes for low-wage workers. For a good summary of the key features of the debate, check out Russell Beck’s analysis here and here.
Past Legislative Activity: Several federal bills have been introduced in the Senate with varying levels of restriction on non-compete agreements and restrictive covenants. None so far have found success.
In early 2018, Senators Elizabeth Warren, Chris Murphy, and Ron Wyden introduced the Workforce Mobility Act of 2018, seeking to ban all non-compete agreements nationwide. This bill followed a White House report from President Obama that criticized non-compete agreements for allegedly harming the economy by lowering wages, restricting competition, impairing worker welfare, and other criticisms. President Obama’s “Call to Action” laid out desired non-compete reform. In response, Senators Warren, Murphy, and Wyden sought an all-out ban on non-compete agreements by introducing the Workforce Mobility Act of 2018. The bill would have prohibited employers from entering, enforcing, or threatening to enforce a non-compete covenant against any employee. The bill died in committee in mid-2018.
In response to the Workforce Mobility Act of 2018, Senator Marco Rubio introduced the Freedom to Compete Act, seeking to amend the Fair Labor Standards Act to ban non-compete agreements for only entry-level and low-wage workers nationwide. The bill would have applied retroactively to void non-compete agreements against such employees. However, the bill also died in committee in late 2019.
Senators Chris Murphy and Todd Young resurrected The Workforce Mobility Act in late 2019. This time, however, the scope was more limited: it sought to allow non-compete agreements only in necessary circumstances, such as the dissolution of a partnership or the sale of a business. Moreover, it would have allowed the FTC and Department of Labor to jointly enforce such prohibition and impose civil penalties and file suits on behalf of a harmed employee. The bill also sought to limit non-compete agreements to a period of one year. However, the bill died in committee.
Past Efforts to Engage the FTC to Regulate Non-Competes: In June 2018, the FTC announced it planned to hold a series of public hearings on “whether broad-based changes in the economy, evolving business practices, new technologies, or international developments might require adjustments to competition and consumer protection enforcement law, enforcement priorities, and policy.” Although the FTC did not specifically address the issue of non-competes, in response to its invitation for public comments, the Open Markets Institute (OMI) submitted a statement urging the FTC to, among other things, “restrict or prohibit non-compete agreements that impair worker mobility and depress wages.” Democratic legislators subsequently weighed in, urging the FTC to take action under §5(a) of the FTC Act which they argued gives the FTC the authority to regulate employment non-competes as unfair methods of competition.
On January 9, 2020, the FTC held a public workshop to consider whether the FTC should issue a rule that would limit or forbid the use of non-competes in employment contracts and subsequently invited submissions from interested parties. The author signed a letter, along with nineteen other lawyers practicing in this area, expressing concern over the impact that a ban on non-competes would have on, among other things, the protection of trade secrets. The FTC has since invited further commentary, which closed on August 1, 2020.
The last iteration of an attempted federal ban came again from Senators Warren and Murphy in the summer of 2020. The Senators called on the FTC to take emergency action to limit the scope of non-compete agreements, claiming non-compete agreements were “poisonous” to the economy and would stifle post-pandemic job searches. The Senators pointed out that, at the time the Senators wrote to the FTC, between 20 to 30 million Americans had filed for unemployment, and non-compete agreements could prevent those unemployed Americans from finding new jobs or starting their own companies.
What Does the Executive Order Say? Not much. It simply states that “[t]o address agreements that may unduly limit workers’ ability to change jobs, the Chair of the FTC is encouraged to consider working with the rest of the Commission to exercise the FTC’s statutory rulemaking authority under the Federal Trade Commission Act to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.” It remains to be seen what rules the FTC will issue, and what agreements (non-competes, non-solicitation or confidentiality agreements) will be affected.
The Law of Unintended Consequences for Small Employers: There are legitimate causes for concern in connection with the use of non-competes by some companies. There is no dispute that they have been abused by some employers, as the Jimmy John’s dispute in 2015 brought to light. However, it likewise cannot be seriously questioned that there are employees who misbehave when they switch jobs, and who cannot be trusted to abide by confidentiality obligations in their employment agreements (Anthony Levandowski and his departure from Waymo comes immediately to mind). Striking the proper balance between protecting legitimate business interests of the employer while preserving the interest of an employee to find another job can be a challenging task when the employee leaves for a competitor and there is a risk that he/she will use the trade secrets of his/her former employer. Courts, employers and employees have often struggled with achieving that balance.
Unfortunately, like the trap that ensnares so many of the other debates of our day, for opponents of non-competes, the debate frequently veers towards the “David v. Goliath” narrative of employers taking advantage of and abusing powerless workers. Not surprisingly, some of the prefecatory language in the Executive Order, an inherently political document, tilts in this direction (“Powerful companies require workers to sign non-compete agreements that restrict their ability to change jobs”).
The reality is more nuanced and unfortunately, not yet fully captured by empirical analysis; therefore, the debate is inevitably heavily weighted toward anecdotal experience. So I will have to fall back on my own experience to introduce another common situation in trade secret and restrictive covenant cases that falls outside of this narrative — namely, the situation where a significantly larger competitor lures key employees away from a smaller company with the offer to indemnify those employees and assume their litigation costs, in the hope that they can outlast the smaller company in an expensive trade secret court battle.
In this situation, a complete ban on non-competes would disproportionately harm small and medium-sized businesses by taking away a critical and efficient tool to protect their trade secrets. Smaller companies are particularly dependent on key employees who have a deep understanding of the technology, business and trade secrets of that employer, particularly involving nascent or emerging technologies. Unfortunately, smaller employers frequently lack the resources for a drawn-out trade secret litigation with a larger, well-funded adversary.
Smaller companies therefore rely on non-competes to better protect themselves in these cases. This is due to the fact that disputes over non-competes or other restrictive covenants tend to be more surgical lawsuits. They normally revolve around the issuance of a temporary restraining order (TRO), an emergency order that can be obtained at the outset of a lawsuit, that often as a practical matter decides the dispute. And in those situations where the TRO does not decide the dispute and the litigation move towards the next stage, a preliminary injunction hearing, the focus of the non-compete litigation still is generally confined to the scope and enforceability of the agreement. As a result, the legal costs associated with these proceedings can be better managed and controlled by the smaller employer, and usually fall between $100K and $250K to litigate.
In contrast, cases that focus on trade secret claims tend to be significantly more expensive. While trade secret cases often involve the use of TROs and preliminary injunctions, they have other features that drive up costs. For example, trade secret cases frequently require the engagement of forensic consultants, who work with attorneys to determine whether there is direct or circumstantial evidence of misappropriation, by inspecting the usage of computers, phones and other electronic devices over an extended period of time. In addition, the exercise of identifying and defending specific trade secrets can be highly fact-intensive, and the more important the technology, the more incentivized the parties are for an expensive fight. Discovery is broader and more expansive, as the parties test one another’s claims and defenses over the value, secrecy and safeguards of the trade secrets at issue. Industry experts may be required on these and other issues. Not surprisingly, larger companies can better absorb these costs and more likely benefit from the longer period of time that in turn further drives up the legal costs.
The high cost associated with trade secret litigation is borne out by the American Intellectual Property Law Association’s (AIPLA) 2019 Report of the Economic Survey. The AIPLA’s Report provides the results of surveys of its members estimating the expense of different intellectual property legal proceedings, from patent applications to a wide range of intellectual property litigation (this highly useful report is available to members of the AIPLA and can be found here). For trade secret misappropriation litigation, the survey indicated that, for trade secrets valued under $1M, the average (mean) cost of the entire case was estimated by to be $648K. For cases in which the trade secrets were valued between $1M and $10M, the average (mean) cost of the entire litigation was over $1.6M. And for cases in which the trade secrets were valued between $10M and $25M, the average (mean) cost for litigating the entire case was estimated to be over $3.2M.
Again, I don’t think it can be credibly disputed that there are employers who abuse these agreements. But the better solution is to focus on legislation protecting lower wage workers and ensuring that employees have notice of what they are signing before they start working for their new employer, not discarding the reasonable use of non-competes in situations such as the one I outlined above. In addition, creating disincentives for employers who may be inclined to abuse these agreements — such as laws imposing “loser pays” sanctions — can be an effective deterrent.
What Can Employers Do in The Short Term? A lot will be written about whether the FTC can or should be regulating these agreements. It is also unclear what agreements the FTC will deem to be unfair and subject to scrutiny and regulation, and which may be left alone. Will it be agreements that impact low-wage workers? Will it include non-solicitation and confidentiality agreements, or will it be confined to non-competes? No rules have been promulgated yet and any action taken by the FTC will likely be challenged in litigation.
In the meantime, the obvious question is what employers should be doing in the short term. I am willing to bet that if you do a search on Google of what most lawyers think is the best way to effectively enforce a non-compete, you will find that the vast majority of those articles emphasize the importance of reasonableness in (1) drafting the terms of any restrictive covenant (such as limited duration and scope); and (2) enforcement of the restrictive covenant (i.e., trying to resolve the dispute first through compromise and resorting to litigation only when no other option is available).
There is a good reason for the consistency of these recommendations. Many jurisdictions provide their judges with the discretion to strike a reasonable balance between the interests of the employer in its trade secrets and customer goodwill and the employee’s right to earn a livelihood or compete in that industry. Consequently, courts will generally favor, and more likely enforce, reasonable agreements and employers that are acting reasonably in their enforcement of those agreements.
Although it is way too early to tell, one would expect that taking a reasonable approach will likewise help employers stay clear of the FTC. We’ll know more once the FTC announces its plans and until then, stay tuned.