On July 9, 2021, President Biden issued a sweeping executive order, “Promoting Competition in the American Economy” (the Order). It covers a range of interesting issues, including a mandate to the Federal Trade Commission (FTC) to “exercise [its] 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 is still too early to ascertain the extent to which the FTC will run with this mandate, but it is clearly following a developing trend across the country disfavoring restrictions on employee mobility such as non-competition agreements. The evolution of the law on non-competition agreements is gathering speed, and this article will help employers keep pace with the recent trends.
The Workforce Mobility Act and Other Trends Across the Country
In February 2021, a bipartisan group of senators reintroduced the Workplace Mobility Act (WMA), which by its language seeks to ban non-competition clauses except in narrow circumstances, such as dissolution of a partnership or sale of a business. The WMA would also include a notice requirement for employers to ensure that employees are aware of their rights under the act, task the FTC and the Department of Labor with enforcement, and allow for a private cause of action for aggrieved employees. While it is unlikely the act will pass in its current form, its reintroduction highlights the reality that employee mobility is top of mind for legislators in a country where approximately 40 percent of working Americans are subject to restrictive covenants in employment during their careers.
This federal trend is reflective of an ongoing push by states to limit the enforceability of non-compete agreements. Many states across the country have either banned non-compete agreements entirely or limited their scope significantly. For example, California, North Dakota, and Washington, DC have codified the unenforceability of non-competes, subject to similar exceptions as outlined in the WMA. Another common trend, and one that the FTC may consider as it begins its rulemaking process, is to ban the enforcement of non-compete agreements for hourly or low-wage workers. Nevada, Maryland, and Virginia are among the states that have chosen this approach, which is underpinned by the idea that low-wage employee mobility poses a low risk to corporate trade secrets and legitimate business interests. Nevada banned non-compete agreements for all hourly workers, while Maryland and Virginia banned them for all workers making a wage below a certain threshold. Other states have enacted statutes that limit the time frame within which non-competes can be enforced. In Utah and Massachusetts, such agreements are unenforceable beyond one year. In New York, there is a proposed bill in the State Senate Labor Committee that has the stated purpose of prohibiting the use of non-compete clauses in the state. And it’s not just legislatures that are curtailing the use of non-competes. State attorneys general are using their offices and the weight of the antitrust laws to go after companies employing non-competes and no-hire agreements as tools to suppress competition. Following a 2020 workshop discussing the FTC’s authority to ban non-competes, 19 state attorneys general submitted extensive comments about the harmful effects of such agreements.
How Are Employers Responding?
While each state has its own specific standards and precedent governing non-compete agreements, employers should be mindful that the general standards of reasonableness related to duration and geography and sufficiency of consideration that have long governed the enforceability of such agreements appear to be under much greater scrutiny than they were ten years ago (as opposed to sale of a business covenants, which remain robust). State courts are increasingly willing to revisit well-established non-compete precedent to narrow its scope. For example, the Pennsylvania Supreme Court in 2020 invalidated a non-compete agreement that was signed after the start of employment for lack of consideration, in a reversal of long-standing precedent that allowed enforcement of non-competes even if they were signed after the employment relationship commenced. In New York, non-competes are enforced only to the extent their restrictions are no greater than necessary to protect an employer’s legitimate protectable interests, they do not impose undue burden on the employee or injure the public, and if they are reasonable in geographic scope and duration. It is increasingly clear that in states like Pennsylvania and New York, employers must tailor-fit non-competition language to the business’s most important interests and limit the scope and duration of the agreement to fit the circumstances of the individual employee and his or her relation to the business interests being shielded by the non-compete.
Even in states like California that have codified a prohibition on non-competes, employers of certain occupations may be able to protect their assets from pillage by former employees by contractual mechanisms such as fee tail provisions. Fee tail provisions are agreements by which an employee agrees to make payments to their former employer based on revenues derived from the employee’s relationship to his or her former employer but realized after the employee leaves employment for a competitor. They are most commonly found in industries where talent agents are central to the economic ecosystem. For example, the case of Hendrickson v. Octagon, 225 F. Supp. 3d 1013 (N.D. Cal. 2016), involved the departure of two high-profile football agents from one agency to a competitor. After leaving employment, the sports agents sued their former firm in an attempt to invalidate the fee tail provisions in their employment contracts, which required them to pay to their former firm a percentage of their agency fees received after they left employment. The federal court that heard the case ultimately upheld the fee tail provisions for revenues derived from clients that the agents had represented during their employment with the former agency, based on the premise that the fees were the fruit of the former firm’s resources and risk in funding the representation of those clients. The key factor for the court was whether the fees reflected the former employer’s return on bona fide investments in the employee.
We expect the trend against non-competes to continue and will continue to monitor developments regarding the WMA and any action taken by the FTC in response to the Order. If your organization has any questions about how to comply with state restrictive covenants laws, please contact the authors of this alert or any other attorney in Venable’s Labor and Employment Group.