Non-Compete Agreements Under Fire and What That Really Means

By Michael Powers - McMahon Berger P.C.

August 23, 2021

President Biden recently issued an Executive Order taking aim at anti-competitive practices in his “Executive Order on Promoting Competition in the American Economy.”  An area targeted by this Order and of particular importance to employers is the use of restrictive covenants, and specifically non-compete agreements. The President’s focus on such restrictive covenants should not come as a surprise as he previously has spoken about what he described as unfair use of non-compete agreements during his campaign.  Proponents of limiting or eliminating the use of non-compete agreements often mention the most extreme cases of their use, such as restaurant delivery drivers being required to sign agreements not to compete as a condition of their employment.  As most employers realize, however, such application is not the normal situation in which non-compete agreements typically are used, and many states and municipalities have already taken steps to prevent that type of situation.  Even so, for employers who rely on non-competes to prevent unfair competition and protect confidential information, the Executive Order marks the latest step in a disturbing trend.  With that in mind, what does this Executive Order actually tell us, and what can we expect going forward?

Why Non-Compete Agreements?

Some will read the President’s order and wonder why he is targeting non-compete agreements.  When used for legitimate purposes, restrictive covenants can be an effective tool for your business to protect clients, confidential information, proprietary processes, employees, and more.  Opponents of non-competes claim that confidential and proprietary information is adequately protected by state and federal trade secret laws.  Forty-eight states have adopted the Uniform Trade Secrets Act (USTA), which prohibits the misappropriation and misuse of a business’s trade secrets.  Only North Carolina and New York have yet to adopt this legislation. North Carolina has a state Trade Secrets law while New York has no legislation regulating trade secrets.

In practice, relying only on trade secret protections presents significant challenges.  It can be extremely difficult to prove a former employee or corporate competitor has acquired or used your company’s trade secrets.  Companies may find it particularly difficult to obtain injunctive relief to quickly limit harm upon discovering its trade secrets are being misused.  Additionally, damages available under the USTA for violations may be limited unless stringent notice requirements have been met.

A much more effective way to protect proprietary information is to prevent employees who are given access to such information from working for a direct competitor within the same industry for a given period of time and/or within a specific geographical proximity.  These agreements are contractual in nature, and generally subject to state, rather than federal, law.  Each state determines whether to allow non-compete agreements and what requirements must be met for such an agreement to be valid.  Some states place few requirements on non-compete agreements, favoring the freedom of parties to enter into contracts as they choose, while others place strict limitations on any such agreement.  California and North Dakota currently prohibit the use of non-compete agreements, as does the District of Columbia, and other states, such as Oklahoma, strictly limit their use.

Against this historical backdrop of state-controlled non-compete laws, the administration’s current push for federal regulation is something new.  The Executive Order describes non-compete agreements as anti-competitive and claims they drive down wages.  The Order describes non-compete agreements as a bar to overall economic development but relies on historical comparisons of business growth and correlative arguments to support those conclusions.  Regardless of whether the Order sufficiently supports its conclusions, the message sent is that non-compete agreements are detrimental to economic growth and should be controlled through federal action.  What, then, can employers expect in this area?

What Actions Does the Order Authorize?

The Order calls for a “whole-of-government effort” involving initiatives across “dozens of federal agencies” designed to limit what it describes as the detrimental effects of anti-competitive practices.  In fact, the Order is not concerned solely with non-compete agreements, but also addresses such disparate trade areas as prescription drug pricing, over-the-counter purchase of hearing aids, internet pricing, banking, airline refunds, and much more.  As for non-competes specifically, it remains to be seen exactly what actions the government will, or can, take.

The Order states that the agency actions will “make it easier to change jobs and help raise wages by banning or limiting non-compete agreements and unnecessary, cumbersome occupational licensing requirements that impede economic mobility.”  The Order specifically instructs the Federal Trade Commission (FTC), the federal agency tasked with consumer protection and antitrust regulation, to create rules and policies regarding non-compete agreements.

The first thing we can expect to see is the FTC will engage in a rule-making process.  During this process it will seek suggestions regarding proposed regulation, including from groups representing industry, organized labor, and workers’ rights.  Some predict that any proposed regulations will focus less on banning the use of non-compete agreements and more on prohibiting their use with lower paid employees who occupy positions of less sensitivity and have less access to confidential and proprietary information.  Regulation in this area may still receive push back but would count as something of a popular win for the administration without inviting major opposition from industries which are most reliant on the use of non-compete agreements to protect their legitimate interests.  In fact, many states have already implemented legislation which limits non-compete use by salary or type of employment.

All of this should come with a word of warning – while we may hope to see a measured and logical approach to any coming regulation, there is no guarantee that will be the case.  The Order specifically mentions the possibility of banning such agreements entirely.  If the administration takes that route, we can expect to see a major backlash from the business community.

Can They Do That?

Many who watch this area of the law are wondering whether the FTC can lawfully create nationwide regulations which ban or limit the use of non-compete agreements.  The answer is not yet known, and the outcome may ultimately depend upon how extensively the regulations seek to limit non-compete agreements.  Once again, this area has historically been governed entirely by state law.  The FTC derives its authority for regulating trade from the Federal Trade Commission Act, together with the Sherman Antitrust Law and the Clayton Antitrust Act.  All of these laws rely on the “Commerce Clause,” Article I, Section 8 of the U.S. Constitution, which empowers Congress to regulate commerce between the U.S. and foreign nations but also amongst the states.  That may seem simple enough, but it is important to remember that those powers not specifically granted to Congress and the federal government are reserved for the states themselves.  Many, many courts have struggled to clearly define the limitations of federal power to regulate commerce, often reaching contradictory conclusions regarding those limits.

As for the future of non-compete agreements, depending on what steps the federal government takes to limit restrictive covenants, any such regulation could present complex issues regarding their validity which ultimately will have to be decided through litigation.  All of that will take a long time to sort out and, again, will depend on how far the administration seeks to go in order to limit the use of restrictive covenants.  As with many areas of economic regulation, an irony of this situation is that the ultimate answers on whether the administration can limit or ban the use of non-compete agreements may not be known for quite a long time.  Regardless, it will be crucial for employers who utilize restrictive covenants to protect their business interests and monitor developments in this area.

The St. Louis employment attorneys at McMahon Berger have been representing employers across the country in labor and employment matters for over sixty years and are available to discuss these issues and others. As always, the foregoing is for informational purposes only and does not constitute legal advice regarding any particular situation as every situation must be evaluated on its own facts. The choice of a lawyer is an important decision and should not be based solely on advertisements.