The Perils & Possible End of the Noncompete Agreement

Noncompetes have legal limits and can get pushback from employees — and a proposed FTC ban might end this common contract altogether.

Sometimes an excellent employment opportunity can turn into a surprising battle. We recently witnessed this when a business owner decided to promote a valuable executive to chief operating officer.

The owner designed a pay and benefits package with attractive incentives to keep this employee long-term, including a significant pay bump, profit-sharing bonuses, and job-security guarantees. It was a great deal that he assumed the executive would accept enthusiastically. Instead, the offer spurred a protracted negotiation involving lawyers.

Why? The contract included a noncompete agreement (NCA), used to restrict an employee from performing similar work, for a specified period of time, within a certain geographic area.

The NCA followed best practices: it was very narrowly written to specify a short time frame and limited geographic area. Nevertheless, the clause was a sticking point that not only threatened to derail the promotion but risked losing the executive altogether. It turned what should have been a positive into a negative.

This scenario illustrates one of the risks of noncompete agreements, which have become increasingly common. Employers should be careful when using and designing them.

But given recent news, those considerations might not matter. On Jan. 5, the Federal Trade Commission (FTC) “proposed a new rule that would ban employers from imposing noncompetes on their workers.” The Biden administration, including the current FTC leadership, considers these arrangements an “often exploitative practice that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses.”

Noncompetes have gained traction across industries and job types

Noncompetes aim to prevent employees from leaving a job and taking another one that gives direct competitors an advantage. The agreements were initially designed to keep higher-paid executives and technicians around while deterring them from sharing their expertise and the company’s proprietary information. But the use of NCAs has vastly expanded in recent years, with many employers issuing them as default clauses in employment agreements.

A “national survey of private-sector American business establishments with 50 or more employees” conducted by the Economic Policy Institute (EPI) found that:

• “49.4% […] of responding establishments indicated that at least some employees […] were required to enter into a noncompete agreement.”

• “31.8% […] of responding establishments indicated that all employees […] were required to enter into a noncompete agreement, regardless of pay or job duties.”

• The EPI researchers estimate that “between 27.8% and 46.5% of private-sector workers are subject to noncompetes.” Separately, the FTC projects that “as many as one in five workers has them.” Either number is an increase from a 2014 survey reporting that 18.1% of employees had noncompetes.

Growth in NCAs has expanded to lower-paid workers who don’t necessarily possess unique skills and individuals without access to proprietary knowledge.

“Baristas at coffee houses, sandwich makers, hairstylists, factory workers […] they’ve been applied to more and more people,” commented Wall Street Journal reporter Lauren Weber. “Any business owner or employment attorney could go online, find a template, cut and paste it into an employment contract.”

While some employees, like the executive mentioned earlier, push back on these agreements, many others don’t. Weber notes that “a lot of people don’t read the fine print on their employment agreements,” while others who really need a job aren’t in a position to refuse.

These issues, along with the growth of NCAs and their spread to lower-paid workers, have drawn government attention. Federal and state interventions are based on research indicating that the agreements may stifle innovation, wages, and worker equality, mobility, and freedom.

Current and pending legal issues surrounding noncompetes

Noncompete agreements have always faced some legal hurdles, as states have different laws that determine if and when they are enforceable.

NCAs are prohibited in California, North Dakota, and Oklahoma. Other states limit using or enforcing these agreements for workers who are under a specific wage, nonexempt, or fired or laid off. Illinois mandates 14 days’ notice before an employee has to sign a noncompete.

Nevertheless, the general rule in most states is that NCAs must be limited in scope to have a chance in court. For example, attorney Dana M. Gallup explains that these agreements are only enforceable under Florida law if:

• “[T]hey are reasonable with regard to time and geographical area.”
• “[P]rotect a legitimate business interest of the employer as defined by Florida statute.”

“Generally, restrictions of up to two years and covering areas where the employer actually does business will be considered reasonable by a court,” writes Gallup, who also notes the courts have “the authority to modify the agreement so as to impose more reasonable restrictions.”

Thus, noncompetes have always stood on somewhat uncertain legal ground, with many employers simply viewing them as an effective deterrent. And now, NCAs are in the federal government’s crosshairs.

The FTC’s announcement on January 5 was a Notice of Proposed Rulemaking (“NPRM”) that invites public comments until March 10, 2023. From there, the FTC decides “whether to issue a final rule and, if so, what, if any, revisions to make based on the comments.”

But given comments by FTC Chair Linda M. Khan, including that “by ending this practice, the FTC’s proposed rule would promote greater dynamism, innovation, and healthy competition,” it seems likely that some form of federal ban will be finalized.

Will that be the end of noncompetes? Not necessarily. Legal experts at JD Supra predict that “any final rule issued by the FTC will almost certainly be challenged in the courts for regulatory overreach.” And other analysts “believe the FTC may narrow its rule after hearing comments from the public […] The agency could, for example, allow noncompetes for highly compensated workers.”

Noncompete considerations for employers, including alternatives to protect proprietary knowledge

Whatever the eventual outcome of the FTC rule, noncompetes present some unique challenges and considerations. Employers must be well-versed in current and pending laws and think carefully about using the agreements in light of how they may affect hiring and retaining employees. Speaking with legal counsel is always advised.

While hiring has slowed in some sectors, the unemployment rate as of December was only 3.5%. Competition for workers remains high while NCAs are under greater public scrutiny, which may reduce some employers’ leverage to demand these contracts. Further, many companies doubt noncompetes’ legal future and are exploring “alternative mechanisms” for protecting themselves and keeping employees.

Among these alternatives are non-disclosure agreements (NDAs), laws that protect intellectual property as trade secrets, and nonsolicitation agreements. In addition, many organizations are looking at using ‘carrots’ instead of ‘sticks’ to retain valuable employees and their knowledge and skills.

“Do you get better results with honey or vinegar?” employment attorney Julie Levinson Werner commented to the Wall Street Journal. “If you want to motivate people and have them happy to stay, you have to look at compensation, the overall environment, how you treat them.”

In many cases, a well-tailored mix of compensation, incentives, benefits, and a positive culture may be a more effective way to retain high-value employees and a competitive advantage. And if a worker isn’t high-value or doesn’t have access to proprietary knowledge, an organization may not need them to sign a noncompete in the first place.

Karp HR Solutions helps businesses master the mix of finance and human resources. Contact us today for a free consultation.