Banning Employee Noncompetes: Are Proposed FTC and State Prohibitions Legal and Wise?

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Ryan Lacey:  Hello and welcome to this Federalist Society webinar. This afternoon, Monday, March 4, we discuss “Banning Employee Noncompetes: Are Proposed FTC and State Prohibitions Legal and Wise?” My name is Ryan Lacey, and I’m an associate director for the In-House Counsel Network at The Federalist Society. As always, please note that all expressions of opinion are those of the experts on today’s call.

 

Today, we are fortunate to have an excellent panel moderated by Mark Schuman, whom I’ll introduce very briefly. Mark Schuman is an in-house public policy and securities attorney with Comerica Incorporated in Dallas, Texas, where his practice includes SEC disclosure, corporate governance, executive compensation, and capital markets. Mark has been an in-house attorney at a number of financial institutions since 1997 and earned his JD at Yale University in 1991 before clerking for then Third Circuit Court of Appeals Judge, Samuel Alito, Jr. He has been a Federalist Society member since 1988. He has served as secretary of the Society’s New York Lawyers Chapter and is currently on the steering committee for the Society’s In-House Counsel Network.

 

After our speakers give their opening remarks, we will turn to you, the audience, for questions. If you have questions, please enter them into the Q&A feature at the bottom of your screen, and we will handle questions as we are able towards the end of today’s program. With that, thank you for being with us today. Mark, the floor is yours.

 

Mark A. Schuman:  Thank you, Ryan. Appreciate that. I think we have a fascinating topic to study today with some excellent speakers. A number of U.S. jurisdictions have weighed in on whether employee noncompetes should be enforceable or restricted, and they’ve been at a number of levels of government. Some have been states and some at the federal level, so it presents an interesting law and economics, public policy, and lower case F federalist set of issues that I’m sure our speakers will help us really explore quite well.

 

Our first speaker is going to be Dr. Evan Starr. He is an associate professor of management and organization at the Robert H. Smith School of Business at the University of Maryland. His research examines issues at the intersection of employee mobility, human capital, entrepreneurship, and technology, with a focus on employer-employee contracting practices. He was formerly professor at the University of Illinois, and he received his PhD in economics from the University of Michigan.

 

We’ll then hear from Robert Driscoll, who’s a shareholder with Reinhart Boerner Van Deuren in their labor and employment practice. He counsels employers to help them avoid disputes with an emphasis on discrimination, wage and hour, and employment contracts of all kinds, including and as well as advising on collective bargaining, labor arbitrations, proceedings before the NLRB, and advising employers of their rights under the National Labor Relations Act.

 

Finally, we will hear from Tyler Badgley. He is Senior Counsel at the U.S. Chamber of Commerce Litigation Center where he focuses on capital markets, competition, and consumer protection among other issues. Before joining the center, Tyler clerked for Judge Edith Jones, working as Special Counsel at the Senate Judiciary Committee, and was an associate at Sullivan & Cromwell. Prior to becoming a lawyer, Tyler worked as a policy aid for Senator Pat Toomey, focusing on budget and tax issues.

 

You can see we have very well-qualified and I’m sure fascinating speakers to talk us through this. We’re going to start with Dr. Evan Starr. Please go ahead.

 

Prof. Evan Starr:  Thank you so much for the introduction, Mark. In typical fashion, I provided some slides, and so let me share those now. Okay. Everybody see everything okay? Okay. Looks great.

 

So today, what I want to do is just introduce you to the idea of noncompete agreements, walk through a little history, and then get us up to speed on kind of the current evidence and debate. And so let me start by asking this question. What are noncompete agreements? What are we talking about here? And noncompete agreements are post-employment constrictions. They’re contracts that apply after you leave a job, and they prohibit departing workers from joining or starting a competing firm. And they’re typically limited within a timeframe and a geographic area. Okay. They’re different from, although often found alongside, some similar terms like nondisclosure agreements, which say that you won’t share certain information, or agreements not to solicit your clients and coworkers after you leave.

 

So let me give you a few prominent examples. Some of these you may have seen in the past. Here’s a noncompete agreement from Amazon. It prohibits a worker for 18 months after they leave from engaging or supporting the development, manufacture, marketing, or sale of any product or service that competes or is intended to compete with any product or service sold, offered, or otherwise provided by Amazon. It’s a pretty broad noncompete. It’s global but 18 months after the worker leaves.

 

The one that really got this debate kicked off back in the mid-20-teens here is one by Jimmy Johns. This is a noncompete agreement. I won’t read it all the way for you, but it’s a two year noncompete that basically prohibits you from working after you leave in any kind of food-based establishment within three miles of any Jimmy Johns establishment. And so those are heavily populated in the Chicago area, so somebody made a map of where you would be prohibited from working if you happened to work as a sandwich maker at Jimmy Johns and signed one of these contracts.

 

So that’s what we’re talking about when we talk about noncompete agreements, and so today I’m going to review a little bit of the historical debate, talk about some initial evidence, and then talk about some tensions. And then there’s some new evidence which I think is kind of pushing on those tensions a little bit more.

 

So historically, the contours of this debate I think are quite understandable. There’s this kind of anti-noncompete view, which is that noncompete agreements fundamentally are restraints of trade in the labor and product markets. They prohibit workers from taking jobs with competitors, and so if you have a noncompete you might experience lower job mobility. You might be less likely to start a new company. You might have to forgo a better job. Okay.

 

This view also holds that noncompete agreements are not necessary for protecting legitimate firm interests. There are lots of other tools that firms can use: NDAs, trade secret law, other forms of IP protection. And so people of this view tend to see noncompetes as tools to reduce competition, job mobility, entrepreneurship, wages, and innovation.

 

Now, as you might guess, there’s kind of an equally compelling alternative view, and that view holds that workers would only agree to a noncompete agreement and firms will only offer a noncompete agreement if everyone was made better off by that contract. If the noncompete agreement actually hurt workers, they would have just paired it down in the first place. And so if you hold this view, you’d see a noncompete agreement as mutually beneficial.

 

The other point of this view is that noncompete agreements are necessary for protecting, for example, trade secrets because the other tools may be insufficiently protective. And noncompete agreements can be a prophylactic that are preventative in that they don’t allow a worker to move in the first place and thus preclude a worker sharing valuable information with a competitor. And this view sees other tools as insufficiently protective. And so if you prescribe to this view of the world, you’ll think that noncompete agreements would benefit workers and firms and that they would be really important for incentivizing investments and thus innovation.

 

So this is the debate, and we’ve been debating these issues for a very long time. Here’s your timeline in case you’re interested and you’re unaware. The first noncompete case was in 1414. These contracts grew in the Guild Era where master craftsmen were training apprentices. Courts originally saw them as really prohibiting workers from making a living, and so they were very negative until about 1711 where they came to the conclusion that partial restraints of trade could be good. And this is where we get the reasonableness standard that most states have adopted in the U.S.

 

If you fast forward to U.S. history, most of the movement in noncompetes has been at the state level, and it’s been recent. So in 2008, Oregon banned noncompete agreements for low wage workers. Just in 2016 Obama had the first kind of call to action at the federal level to consider noncompete agreements. In 2022 there were 98 policies proposed to ban noncompetes, mostly for low wage workers. And then the Federal Trade Commission proposed a full ban in January of last year, and Minnesota passed and implemented a full ban starting this year.

 

I’ll also say there’s been a renewed interest globally. There’s new evidence on noncompetes in Italy, Norway, Australia, the UK, all over the place. So you might wonder what happened in the last decade to spur all of this interest since these things have been around for a very long time.

 

Well, the first thing to happen is that there’s been a broader recognition among especially academic economists that labor markets are actually not as competitive as we thought. There’s been eye-catching cases of abuse, like the Jimmy Johns example that I gave. And then there’s been some specific evidence which have really tilted towards the anti-noncompete view.

 

The first is that surveys of firms and workers seem to confirm that noncompete agreements are used indiscriminately. About 30 percent of firms say they use noncompetes for all workers, and that’s how you get the janitors with noncompetes, the low wage workers that you’ve probably seen in the news. There’s evidence that workers rarely negotiate over noncompete agreements, and sometimes the firms will delay the noncompete until day one of the job when the contract is hidden in a pile of paperwork.

 

The other evidence that has come about is evidence of harm, and these papers tend to study state policy shocks like when Hawaii banned noncompete agreements for tech workers in 2015 or when Oregon banned them for low wage workers in 2008. And they tend to find that after those bans came into place that workers benefited and so did firms. And so there’s been this kind of evidence, and this is really I think what the FTC was mostly drawing on when it proposed its rule.

 

Now, with that said, once the FTC rule came out, all of these counterarguments and debate happened. There were over 25,000 comments to the FTC, and that really exposed this point of tension that I think some new evidence is really trying to resolve. So let me just review some of this briefly.

 

I think there’s general agreement about the use of noncompete agreements for low wage workers, and there’s general agreement about firms needing to be transparent with noncompetes, meaning not to surprise workers on day one with a noncompete when they have very little leverage. Where the tension is is when you get up to the upper levels: executives, tech workers, workers who are having access to really valuable information. Okay. There’s some evidence that executives and top managers earn more with noncompete agreements such that the arguments for low wage workers don’t apply to them, and there’s some evidence that noncompetes also spur investment.

 

And so there’s been new research which has tried to touch on this tension directly, so I want to just hit on some of this research very briefly. The first is do firms actually have to pay more for workers when they use noncompetes? In other words, do they have to compensate you extra to get you to sign a noncompete? The second is do firms actually value the ability to enforce noncompetes for high wage workers? The third is do noncompetes spur innovation or harm it? The fourth is can alternative restrictions protect trade secrets, and the fifth is does banning noncompetes actually increase trade secrete litigation?

 

So I’ll touch on these briefly and then pass it along. So in a very recent field experiment that I ran with Bo Cowgill and Brandon Frieberg, we studied HR recruiters. And what we did is we tried to hire about 14,000 of them, and we randomly deployed noncompete agreements in their contracts. And then we studied how they read their contracts and who agreed and how much we had to pay them. Okay.

 

And I’ll just summarize some of the findings and figures here, which I won’t have too much time to go into. What we found is that when you put the noncompete on page seven that 75 percent of people or more just skip right over it, don’t read it. They spend less than five seconds on the noncompete page specifically. Okay.

 

We find that workers with noncompetes are actually no more likely to bargain over them than workers without noncompetes. When workers bargain is when the wage offer is too low, not over their noncompete agreements. And then we also find that if you want to get a worker to sign a noncompete agreement that’s on page seven of the contract, you don’t have to pay them anymore. We kind of reject that there’s no difference in the wages that these workers accept with noncompetes. Okay.

 

The second one, do firms value the ability to enforce noncompetes for workers earning $100,000? So this is another recent study, and in this study what we’re looking at is a state policy in Washington where they banned noncompetes for workers earning under $100,000. And our core idea in this study is that threshold bans like this can help us reveal whether firms value the ability to enforce noncompetes. Okay.

 

So here’s the basic idea in a graph. When you set a threshold like this—in this case the threshold’s at $100,000—the idea is take a worker making $99,000. Under the new regime, that worker’s noncompete would not be enforceable in court unless the firm gives them a small raise. Think of it as like a voluntary minimum wage. And so if the firm gives the worker a small raise to get them to $100,000 or just above, then they can have the opportunity to enforce their noncompetes if they wanted to.

 

And so when would firms voluntarily give workers a raise? It’s when they value the benefits that they get, and so using data covering the universe of workers in Washington, we see if firms are paying workers at or above this threshold. And we broadly find no evidence, even industries like manufacturing, professional technical services, that firms are preemptively giving workers raises for the opportunity to enforce their noncompetes. And in a survey of Washington employment attorneys, they told us that the reason is that rarely do they need to go to court to enforce noncompetes for workers at this level and they have other tools to protect their investments.

 

A new paper by Matt Johnson, Mike Lipsitz, and Alison Pei studies approximately 40 some odd noncompete changes over about a 20 year period, and they find here when we look at innovation itself that noncompete agreements actually reduce innovation on the order of about 16 to 19 percent. Okay. And this is interesting because they also find that noncompete agreements spur investment, and their conclusion is that noncompete agreements spurring investment is investment is just one form of input into the innovation process while other inputs tend to go the other way. So workers tend to be less mobile. They tend to start new firms less, and kind of the net effect of all of those inputs is reduced innovation, even though firm investment rises. Okay.

 

And there’s a field experiment that Bo Cowgill, Brandon Frieberg, and I ran. We also tested whether noncompete agreements are effective in deterring trade secrets. Are they more effective relative to only NDAs? And I can get into the details later, but we find no evidence that noncompete agreements are more effective in deterring workers from sharing secret information than NDAs alone. Okay.

 

And just the last one here, a recent paper with Brad Greenwood, Bruce Kobayashi, we’re looking at this claim that is made often especially by lawyers that says when you ban noncompete agreements trade secrete litigation is going to rise. And the logic is pretty straightforward. If you ban noncompete agreements, it seems like workers will move more, which they do. And if workers move more, you think there’s a likelihood that they’re going to increase the likelihood that they would share secrets with the other firms that they’re moving to. And without noncompete agreements, you would think that firms are going to then engage in costly trade secrete litigation.

 

And so that’s the logic. And so what we did is we downloaded trade secret filings from Westlaw and from the Courthouse News Service. We exploit all the state level bans on noncompete agreements that we’ve seen since 2018, and we study how trade secret filings change before and after these noncompete bans. And what we find is that rather than rising, if anything you can see on the graph they’re pretty flat, but then they do fall over the longer run, especially for high wage noncompete bans.

 

So the logic here that noncompete agreements are necessary to spur innovation doesn’t quite seem to be born out. It does seem to be born out that noncompete agreements -- if you ban them that it’s going to lead to more trade secrete litigation necessarily, and it does seem like other protection tools are effective, at least in the context that we have available. So there’s been a lot of work done. It's been a fascinating area of discussion and work. So I look forward to more of this in this panel. Thank you so much.

 

Robert S. Driscoll:  Okay. Great.

 

Mark A. Schuman:  Thank you, Evan. Robert, why don’t you go ahead?

 

Robert S. Driscoll:  Yeah. Thanks, Mark. Thanks, Evan, for that presentation. I’m going to take a slightly different tact than Evan did and talk about this from the perspective of a practitioner, what I see on the ground litigating, drafting noncompetes for the past 15 years or so. And I think Evan provides a very helpful context for how noncompetes have formed over the years in both American and English common law, and I think that provides a really important backdrop for some of the limitations in the notice of proposed rulemaking that the FTC put out.

 

So at the end of the day, my thesis is federal regulation is probably uncalled for. It’s not nimble enough to address the various areas of noncompete law that exist and that have developed over hundreds of years with the States and the United Kingdom. And state level regulation is probably wise in many cases and leaves open the possibility of various approaches that are more narrowly tailored to individual state circumstances.

 

So the first point along those issues to kind of keep the background in view of everything, it’s very tempting in our society -- just political society generally to view noncompetes as an us versus them, workers versus employers, kind of a polarizing issue in the larger political landscape. That’s not the case necessarily when you’re litigating these types of agreements. Employers, for example, are often in a situation where they are trying to enforce a noncompete but also want to higher employees that have noncompetes and have to deal with the potential for being dragged into litigation involving tortious interference with contractors, some other similar theory between the employee that they’ve now hired and that employee’s former employer. So it’s not -- again, it’s not always workers versus companies.

 

The same is true with the bar, with attorneys. At least where I practice in Wisconsin, it’s very common for attorneys to practice on both sides of this, to be both a plaintiff’s attorney and a defense attorney. So the bar itself is not polarized, and that leads to, I think, a balance, a pretty well-balanced view of noncompetes and the restrictions because you see it from both sides of the fence.

 

Second point, and this goes to that backdrop of common law that Evan alluded to and provided a helpful timeline, one of those cases on that timeline was the Mitchel v. Reynolds case from the Queen’s Bench 1711, really kind of maybe setting off a trend of noncompetes that really flowered in the United States in the late 19th Century and has developed to this day. Now, the notice of proposed rulemaking actually cites that very case in it but curiously talks about some of the downsides of noncompetition agreements that they judge pointed out in the decision and neglecting to mention that the judge actually found that the noncompete in that case was reasonable and could be enforced because it had limitations on it.

 

It had geographic and time limitations that took it out of this concept of a general restraint of trade to kind of a specific restraint of trade that was reasonable in these circumstances. And that eventually became the rule of reason that many of us who practice in this area know today. It’s very common across states, whether they have limitations on noncompetes or not, that you have to first identify a legitimate business interest that the employer has to justify having a noncompete at all. That can be trade secrets, as Evan mentioned. It can be just confidential information.

 

But a third one that’s probably the one that I deal with the most is customer goodwill. It’s the one that, again, in Wisconsin all the other restraints are kind of tailored towards because that’s the concern that an employee will develop goodwill on behalf of an employer and then appropriate that goodwill to go take, say, a higher paying job with another employer who also benefits from that appropriation that was put together through the effort of the initial employer. And so when you have that combined with these geographic and temporal limitations, it renders an otherwise unenforceable, unreasonable restraint on trade enforceable and reasonable because it’s very specific.

 

Now, the case that kind of touched this off in a modern political climate, again, as Evan mentioned, is the Jimmy Johns case from Illinois. I think it’s about 2014, 2015, 2016 where the Illinois Attorney General actually brought an action against Jimmy Johns to invalidate these noncompetes. When you read that noncompete and you read the breadth of it—and that map was really helpful that Evan put up—and then you consider that this is for sandwich makers, it’s pretty clear that under existing Illinois law those would’ve been unenforceable and pretty blatantly so.

 

And it’s curious as to whether Jimmy Johns had actually ever brought a case to enforce one. I don’t know this for sure, but I kind of doubt they would have. And I think this is a case of maybe -- they call their sandwich makers sandwich artists to try and justify these broad limitations, and I think that’s a case of marketing or HR outrunning the law and causing a stir when maybe no stir really was needed because it was already unenforceable.

 

And states in general are pretty good about tamping down on overly broad restrictions, and Illinois has recently put in new restrictions in place. Oregon, Massachusetts, Minnesota, Colorado, all these states have kind of seen some of the drawbacks of a noncompetition agreement and have moved to limit them. And that says nothing about common law in many states where judges are developing different methods of addressing overly broad and unenforceable noncompetition agreements.

 

So the third point, the notice of proposed rulemaking is really somewhat myopic in its view. It really only views it from an unfair competition standpoint from the perspective of a worker, but again, as I mentioned before, an employer has just as legitimate of a claim as to unfair competition when its goodwill and information can be appropriated from it and has an interest in restricting even public access to that, maybe to an anticompetitive effect, when it has put time and effort into developing that. And so many states have already recognized this and rolled this into their analysis of noncompetition agreements.

 

Now, one objection to this line of reasoning I think is very legitimate is that the notice of proposed rulemaking applies only to noncompetition agreement and not to non-solicitation agreements, which would prevent contacting or soliciting customers on behalf of a new employer. And I think there’s at least two responses to that. First, as many have pointed out, the notice of proposed rulemaking states that there are some forms of agreements that even though they’re not noncompetes still may be treated as such because they have such a broader anticompetitive effect. And I think that could apply to a non-solicitation agreement that a salesperson, for example, would’ve signed. It’d be one of the first arguments at least I would raise for any type of broad non solicitation agreement that really limited a salesperson’s role in a marketplace in working for a new employer.

 

And I think second, I think there’s forgetfulness that there are other employees that have great effect on the competitiveness of a business, as Evan mentioned including tech workers and engineers, people that may never even see a customer but have very detailed understanding of an employer’s, say, processes, procedures, knowhow, machinery, etc., that could go and be used by another employer to great effect. A non-solicitation agreement really wouldn’t affect an engineer, and I think that’s kind of driven home by Chair Lina Khan’s comments to The Federalist Society’s National Convention last November where she specifically mentioned it being problematic that engineers are tied up by noncompetition agreements. And I think that’s a tell. It’s telling because, as I look at it, I think that’s a good thing for an engineer, someone who is higher level, higher wage, higher skill, to potentially be restricted to prevent them from taking information with them to a new employer.

 

So in conclusion, I think the better approach in this case is for state regulation. Some of the abuses that have been very legitimately identified can be addressed through statutes and through common law, for example, fee shifting for overreaches. For an employer that has a blatantly unenforceable agreement that is used simple to terrorize people into not challenging it, there can be fee shifting available that would be certainly a deterrent to having such an overbroad restriction. States like Florida for many years have also had limits setting out statutory limits on the presumptive reasonability of time limitations, so kind of giving some guidance there as to what a reasonable time limit is, having a sense of what the upper ceiling is.

 

A third way to go about this is limits on tolling provisions and agreements. So for those of you who may be unfamiliar with it, some states allow but could disallow a provision that says, hey, if you leave and you are in violation of a noncompete that that time period you were in violation, the two year limitation actually is full. So your limitation may now be three years or four years because you were violating it, and by the way, we’re going to get damages for that time period as well.

 

I think you can eliminate those either through statutory mechanisms or as parts of Wisconsin have done through the common law. So there are other means of addressing these very real problems that still exist in them. And I think having the variety of state courts and state legislatures to address them is superior than to a one fits all approach from the FTC.

 

Mark A. Schuman:  Thank you, Robert. On your advice, I’m going to look out if my employer starts calling me a disclosure artist. That might be a giveaway that bad news is coming. Tyler, why don’t you tell us your thoughts?

 

Tyler S. Badgley:  Thank you, Mark, for your introduction, for moderating and putting together this panel. Thank you to The Federalist Society for hosting this conversation and thank you of course to my co-panelists, Evan and Robert. As you’ve both already made abundantly clear, this is a very important conversation, particularly given all the activity at the FTC and in the states. I also need to say at the outset that my remarks are purely in my personal capacity and do not necessarily reflect the views of the U.S. Chamber of Commerce or its members.

 

So with that disclaimer out of the way, I have three central points I’d like to make with my opening. First, the FTC lacks competition rulemaking authority and therefore lacks the statutory authority to finalize its noncompete rule. Second, the scope of the FTC’s proposed ban on noncompetes is extraordinary, and the FTC made absolutely no effort to tailor its proposal. Third, there are positive use cases for noncompetes, both for employers and employees, and to take away that bargaining chip and further degrade freedom of contract is a problem.

 

So I know this isn’t the core of today’s conversation, but particularly as we discuss whether a 50 state solution or top-down federal government mandate is more appropriate, I think it’s important to at least ask can the FTC even do this. I think there are a lot of great legal arguments to take a look at, and maybe we or some future panel will dig into some of those a little bit more, whether noncompetes qualify as an unfair method of competition, the role of the major questions doctrine in a case challenging this rule, and a whole host of APA concerns. But I’d really like to focus in on whether Section 6(g) of the act, which the FTC relies on in promulgating this rule, actually provides the FTC the authority to issue competition rules.

 

Section 6 (g) is tucked into a provision of the act that empowers the Commission to investigate individuals and firms and to require those entities to furnish reports about their practices. It says not one word about substantive rulemaking. What’s more, at the time of its enactment, no other provision of the FTC Act mentioned rulemaking authority at all. Instead, the Commission could only enforce the act through individual orders under Section 5.

 

Now, to be sure, Congress has repeatedly amended the act, but it has only done so to give the Commission the authority to issue substantive rules unrelated to unfair methods of competition, specifically focusing on consumer protection rules through Magnuson-Moss proceedings and other processes. Congress’s decision to expressly provide rulemaking authority for some provisions of the FTC Act, but not others, counters any suggestion by the Commission that the authority has been there all along. So just a light touch on a critical legal issue.

 

What about the substance of the proposal? So I’d like to start with the scope of the FTC’s proposal. During his 2023 State of the Union Address, President Biden tackled the issue of noncompetes. He staked out a bold position that noncompetes shouldn’t be used to make it so that “a cashier at a burger place can’t cross the street to take the same job at another burger place to make a couple bucks more.” If the FTC turned around and wrote that rule, I probably wouldn’t be a part of this panel.

 

Instead, Chair Khan and the FTC responded with a blanket ban of all noncompetes. The breadth of the rule is frankly staggering. It reaches agreements with employers and independent contractors. It defines noncompete clauses to include any agreement that has the effect of prohibiting a worker from seeking or accepting employment. This is an attempt to broadly sweep in what the Agency refers to as de facto noncompetes, which Robert touched on a little bit and I’ll touch on a little more. And the proposal currently draws no distinction between workers based on their seniority, the skill required to perform their job, or their compensation.

 

So first, that means no person at the company, from the cashier to the CEO, can sign a noncompete. All the while, the Commission simultaneously concedes that many senior executives negotiate their noncompete clauses with the assistance of expert counsel. It also means that when a partnership or closely held company is looking to exit and sell to another company those partners or owners can’t sign a noncompete, so frankly, they’ll be paid less for their company.

 

If I were a dentist selling my practice, my most valuable asset is my patient list. If I can’t sign a noncompete when I sell to a neighboring practice, then there’s nothing stopping me from setting up Badgley Dental 2.0, moving down the street, and telling all my old patients to just rejoin me. The asset I’m selling will be essentially worthless or, at the very least, its worth will be far less determinable. Frankly, even California’s broad ban on noncompetes includes an exception for noncompete agreements in connection with a merger or the sale of a business.

 

And finally on this point, we should also be clear about what a noncompete is under this proposal, although the definition, perhaps intentionally, is incredibly unclear in the proposed rule. I mentioned that the Agency intends through its broad definition to sweep in so-called de facto noncompete agreements. Consistent with Evan’s analysis, the FTC suggests that businesses can use nondisclosure agreements as a substitute for noncompetes, but it simultaneously acknowledges in its rulemaking that its extremely broad rule would sweep in many nondisclosure agreements as well.

 

Forfeiture for competition agreements would also likely fall into the blanket ban’s broad sweep. These are agreements that don’t actually restrict where an employee can work. Instead, they condition supplementary, post-employment payments on an employee not working for a competitor for a certain amount of time after leaving his or her job. Many retention bonus programs, severance agreements, and claw back provisions could similarly be treated as de facto noncompetes under the FTC’s definition.

 

As I said, if this rule were just about burger chain cashiers, I probably wouldn’t be on this call, but there are positive use cases for noncompetes, which serve employers and employees alike. As the FTC’s own economist has explained, noncompete agreements can solve a hold up problem for certain types of investment into employees such as training or information sharing. And these hold up problems emerge when employers forgo making certain investments in their workforce knowing that employees would be able to subsequently quit and appropriate the value of that investment.

 

Noncompete agreements allow companies to reduce recruitment and training costs by lowering turnover, encourage mutually beneficial investments, and prevent a freewriting problem wherein competitor firms rely on poaching workers to reduce their own internal training costs. Noncompetes also protect crucial business information. Innovation and business development take large amounts of time, money, and trial and error. Without the protections afforded by noncompete agreements, firms may be less willing to engage in this essential development or may seek protection in other ways such as limiting employee access to sensitive data or simply involving fewer employees. If fewer employees are able to tackle these problems, develop the relevant skills, and use them throughout their careers, it will stifle growth, limit those employees’ future opportunities, and also hamper companies’ abilities to create new breakthroughs. Employees benefit from an employer that invests in them through training and opportunities for growth.

 

Now, I won’t sit here and pretend to have solved the line drawing problem. There’s a lot of interesting questions. It's very complex, and really, it’s well beyond the scope of my expertise. But noncompete agreements are not new.

 

In fact, some state legislatures and courts have regulated their use for hundreds of years. Although based on the timeline Evan showed, maybe I’m underselling state expertise in managing abusive noncompete agreements. There’s currently significant variation in innovation regarding the treatment of noncompete agreements in the states, but the overwhelming majority recognized that noncompete agreements can provide meaningful benefits to workers and businesses alike and should be enforced in many circumstances.

 

So to briefly summarize my remarks, the FTC’s rule, besides being outside the scope of the FTC’s legal authority, is bad policy because it is so broad and absolute. It sweeps in every positive use case for noncompetes, throwing out the good with the bad. Noncompetes are not appropriate for every employee in every situation, but neither are they an absolute evil for every employee, partner, or owner. With that, I’ll turn it back to you, Mark.

 

 

Mark A. Schuman:  Thank you, Tyler. Evan, you didn’t reserve time at the beginning, but we are deeming you to have reserved some of your time at the beginning to talk about what you heard and add your thoughts spurred by what you heard Robert and Tyler say.

 

Prof. Evan Starr:  Yeah. It was great comments both by Robert and Tyler, and I think the question of the wisdom of a federal rule versus kind of the status quo state approach that we’ve had is a really interesting debate. And I’m not a lawyer, so I’m not going to weigh in on issues of legal authority of the FTC.

 

I think I’ll just pose a few questions here on the state versus federal issue and then respond to some of Tyler’s remarks. So I think one of the challenges with navigating the varied state policies is actually that they’re getting increasingly divergent, and if you’re a multistate business trying to conduct work across many state lines, it’s very difficult. I’ve had students of mine who say their first jobs out of law school were to write a noncompete enforceable in all 50 states, and of course it’s not possible. And it’s getting increasingly difficult.

 

You’ve got noncompetes banned in D.C. for workers making under $150K. You’ve got California’s rules. You’ve got Washington. You’ve got Maine. You’ve got Nevada banning them for hourly workers -- Oregon. The list goes on and on and on, so navigating these constant changes across the states it’s quite difficult. So it matters for firms who are trying to recruit across states. It matters for workers who are trying to recruit across states, so I think there’s a legitimate question about whether a common rule, whether it’s adopted in the form of a uniform rule like the Uniform Trade Secrets Act -- for those who aren’t aware, there’s the Uniform Restrictive Employment Agreements Act.

 

And full disclosure, I was an observer on that committee. I don’t think a state has yet to adopt the rule that they promulgated, but that’s one avenue towards some kind of consistency. And they do regulate in that rule all sorts of employment restrictions beyond noncompetes, including NDAs and non-solicits and [inaudible 00:37:32] payment clauses, etc. And so I do wonder to what extent is a common rule across states a good idea and to what extent is the divergence we’re seeing going to hamper versus -- hamper innovation across states or mobility, etc.

 

On Tyler’s point I just want to say one thing which is that I think Tyler’s exactly right that when you get up to the higher levels and thinking of executives, they’re negotiating these noncompete agreements. They do have legal teams who are considering them. There are secrets being shared. This is, I think, where the tension -- the rubber meets the road with executives. And so I just want to point you guys to one paper on this which is a very recent paper by Liyan Shi, who’s a professor at Carnegie Mellon, and I cut it out of my presentation because I was told I only had ten minutes. And they made me do an overview. Okay.

 

But the paper’s called “The Optimal Regulation of Noncompete Agreements.” It’s in Econometrics, which is one of the top econ journals. And what Liyan studies is the market for executives, which is again where the rubber meets the road, and in her paper, noncompete agreements are mutually beneficial for firms and workers, for executives. The workers benefit from signing them. The firms benefit from using them. It’s the best use case as Tyler was saying, and a ban would hurt those workers.

 

But Liyan is looking at is not just whether the worker and the firm are better off, but she’s taken into account society. And the point that she makes is that when you have two parties that are bargaining, they don’t necessarily include the welfare effects on other parties, on consumers, on other companies. And so the terms that are agreed to are what we said bilateral efficient. They maximize how well off the two parties are but at the expense of other parties.

 

And under her work, she comes to the conclusion that even in the market for executives, the optimal policy is close to a ban. Even though the executive and the firm benefit, it’s that the rest of everybody else is worse off. And the reason for this—I’ll just be clear here—is that effectively you get a misallocation of labor. When a worker agrees to a noncompete agreement, they can’t go join a competitor. In the case of executives it can be up to five years. And if you’re not a good fit at your employer and something better comes along where you can produce much more output for society, a noncompete agreement can constrain you from taking that better job.

 

And that’s where that loss comes from. That’s why she comes to the conclusion that a ban on noncompete agreements is actually optimal. And so I think that’s really when we’re talking about a full ban, that’s where the rubber meets the road. And I just want to say that Tyler is right on theory, and I think the question is where in reality do we end up.

 

Mark A. Schuman:  So Tyler, I want to give you an opportunity. Is Evan right that wouldn’t it just be simpler if we had a same rule all across the United States and large employers didn’t have to worry about local rulemaking and differences jurisdiction to jurisdiction? What do you think of that point? Would it be more efficient just to have a nationwide rule?

 

Tyler S. Badgley:  I think it would certainly be simpler in many contexts, and there would certainly be efficiencies from that. But at that point, why not just have a federal rule except for the authority question aside? I think part of the point is that states can try different things, and they can find different things work in different communities. States have different industries that are larger in their states than others, and certain noncompete responses may be more appropriate to different industries.

 

You don’t necessarily want to regulate the pharmaceutical industry exactly the same way as farming. They’re just different. They call for different contexts and different analysis. So yeah, there’s certainly simplifications in efficiencies with having one rule across the entire country, but we haven’t had that yet. For a long time, states have had different understandings of what is reasonable. We’ve seen as Evan showed us that there have been states that have banned noncompetes for 200 years, so we haven’t had that. I don’t think we need that now.

 

 

Robert S. Driscoll:  Mark, if I can jump in here and say something about that?

 

Mark A. Schuman:  I want to add -- yeah, Robert, go ahead.

 

Robert S. Driscoll:  So I think this might be kind of the opposite in that, Evan, I think you might be right on theory, but in practice it might be a little bit more difficult. There are so many areas in employment law where there is a national rule on something but state laws still exist that preserve the complexity of it. So the Family and Medical Leave Act, a nationwide guarantee of unpaid leave for up to 12 weeks for certain serious health conditions -- many states, including my own of Wisconsin, have their own state Family and Medical Leave Acts that add complexity because now you have to abide by both. Any legislation that gives more rights to the employee are now still in effect, and so you’re kind of balancing those too.

 

And I think I’d add that obviously my time practicing is limited in a broader scope, but with electronic resources, the availability of law from other states is greater than it’s ever been. And so in some respects today it’s probably easier to comply with many of those other states regulations than it was 30, 40, 50, 60 years ago where maybe those resources weren’t as available and then you’re looking for attorneys that are practicing solely within that state and have that understanding, which is a lot more complicated. So there are some countervailing factors in other words to what you’re thinking.

 

Prof. Evan Starr:  Yeah. Mark, can I just jump in?

 

Mark A. Schuman:  Robert, let me ask -- yeah, go ahead.

 

Prof. Evan Starr:  Can I just jump in and respond real quickly? So I just want to make one point which is that this, I think, a really important discussion, and Tyler and Robert are right that this has been primarily a state issue. But there is of course only one occupation for which noncompetes have been unenforceable for about 50 years, and that’s the practice of law. And so that’s true across every state.

 

And so Robert was talking about how most of his cases involved goodwill and clients, and this is obviously the case in law. You guys work with enormously influential clients. They pay you lots of money. You have huge client lists. They follow you. This is, I guess, a question for you guys. If that seems to work in law, I don’t see the lawyers saying that we shouldn’t do this.

 

Really when the ABA made this rule back in the 1960s, it seems like the justification was about protecting clients. The law says basically that it’s because if a lawyer has to sit out then it’s the client that can’t get access to their lawyer. And so the cost of the noncompete is borne by a third party, which in this case is the clients. So I’m just throwing this out there because there is a use case here which is the profession that you guys happen to be in, and it is a national policy. Well, it’s been adopted in all the states, but it’s been around for a while.

 

Mark A. Schuman:  I would say it’s sort of a mixed bag when you talk about the regulation of the legal profession. There are some things that work and some things that don’t. The idea of having a noncompete may serve the interests of some and not the others. It’s also not the way the common laws or even statutes are. It’s made very differently usually by the top court or a delegate of the top court, so it’s interesting. There might be some distinctions.

 

Robert, I wanted to ask you what do you think of the point that, well, gees, companies have nondisclosure agreements. They have trade secret. Putting aside the FTC’s (sic) overreach in terms of whether those should be covered, let’s assume for the moment that those remained enforceable. Would there still be a need for noncompetes to cover the same sort of interests, or does that law work so well that we can get rid of noncompetes and figure that trade secrets and non-solicitations will be just fine?

 

Robert S. Driscoll:  Yeah. It’s a great question. I think Evan’s chart I find very easy to believe that trade secret litigation would not explode. I think it’s hard to bring a trade secret case. In many instances, you don’t have true trade secrets at issue, not all of them but in many. But what I’d say, Mark, to your specific question is I don’t think in most cases it’s enough.

 

First of all, again, if you’re talking about a non-solicit in salesperson, it’s really not going to go towards that customer goodwill. That’s number one. Number two, even when you’re dealing with someone who’s more of a knowledge worker, isn’t customer facing, is an engineer of some kind, it’s very difficult to prove that any confidential information, particularly if they have not taken any documents with them—it’s just in their head—has been disclosed unlawfully. It’s very difficult. And so there is, I think, a legitimate worry from employers that have people of that type leaving that their secrets and know how are kind of being shared even if the person isn’t explicit about doing so, saying, hey, Acme Company over here, this is the way they do it, which simply by act of putting their own processes in place.

 

Now, this is a fine line. Don’t get me wrong. It’s a very fine line between general know how and information they’ve learned from their employer. But that’s where a noncompete really comes in. It says we don’t have to make those tough calls. As long as it’s a limited restraint, we can be sure that that is not happening by prohibiting you from working for a competitor for a short period of time within a reasonable geographic territory. So it kind of short circuits that difficulty.

 

Mark A. Schuman:  Let me ask one question of everyone. There are jurisdictions outside the United States which have a so-called garden leave approach which is you want a noncompete? That’s great. You have to pay for it by paying the employee additional compensation either at some level or for some period of time. You don’t want a noncompete? You may have the choice to say, no, we don’t want the garden leave. Go and make that decision at the end of employment. How much of some of the issues we’ve been discussing would a garden leave requirement solve? And does that call for a lower case F federalist approach as opposed to a nationwide approach?

 

Robert S. Driscoll:  I’ve worked with those a little bit. They’re not too common, at least in my practice. I know that they’re more common in England from what I’ve read and heard. I’ve seen a couple pop up in New York State as well. I think it would be an interesting approach, certainly. Especially this goes to, Evan, your discussion of the executives where I think it’s a lot more viable for someone in that position. And then I think this is where the federalist approach would come in.

 

What the value of that gardening leave is could be set statutorily. What percentage of total compensation is enough? Does it have to be if you want a one year noncompete it’s a one year compensation, or can it be something less, six months for one year where it’s almost like an extended severance package of some kind? I’d be curious. I don’t know, Evan, if you’ve looked into this at all, if those have shown any sort of, I guess, traction in the literature. Do they have as much of an anticompetitive effect as you’ve seen elsewhere? Or have you analyzed them in other circumstances?

 

Prof. Evan Starr:  Based on the surveys I’ve done, Robert, they seem to be quite uncommon in the U.S., at least in the last five years or so. I have heard they’re much more common in the UK. Here’s how I see garden leave clauses.

 

Garden leave clauses, without them, effectively when you have a worker agreeing a noncompete, if you think the labor market is competitive, then that worker wouldn’t agree to a noncompete unless they were compensated for all of their post-employment concessions. And then once you hit post-employment, the worker’s not paid anything under the traditional noncompete. But they should’ve been paid at some point beforehand, either higher wages and more training, whatever it is.

 

Under a garden leave, it shifts that payment period to the back end, and it says okay, now, I’m going to guarantee that you’re paid some portion during this time which you have to sit out. And I think some people see that as more fair because they anticipate that workers are not going to negotiate for a sufficient extra compensation up front. And from the economist perspective, I think they can both protect trade secrets if you think that the value of those trade secrets or relationships depreciates over the time period during which the executive or whoever is tending their garden.

 

From a social perspective, the challenge is you’ve just taken a potentially highly productive worker and you’re putting them on the sidelines. So we may like those workers doing work for society, and so that’s the tension with garden leave and with noncompetes is that you’re taking a worker away from their potentially most productive use. I do think they solve these challenges potentially with fairness, but I think there’s still tension.

 

Mark A. Schuman:  So Tyler, let me ask you about the APA practice which is certain to occur after any rulemaking. This has been a real informative to me conversation about these. What hope does the FTC have to do a release where they can say that they followed what the APA would require them to before (inaudible 00:50:42) enacting a rule that would purport to govern everyone everywhere in the United States in all circumstances?

 

Tyler S. Badgley:  Well, Mark, so you cut out a little bit in the middle of that question, but with the statutory authority argument the answer is none. They can’t finalize a competition rule. They lack the authority to do so. That’s kind of the threshold issue, and frankly, that’s why the day the rule was proposed the Chamber’s CEO was out there saying this is a huge red line that they can’t cross. So there’s going to be all kinds of actual APA like cost-benefit analysis issues with what they do undoubtedly, but I think the statutory authority argument, the major questions doctrine are really where this case would be decided if it’s litigated.

 

Mark A. Schuman:  I think, Tyler, you and I had seen the SEC occasionally have challenges in upholding their rules, and they have a lot of practice in trying to get it right under the APA. The FTC venturing into this area of rulemaking, statutorily authorized or not, it’s a tall ask for the first thing out of the gate to be able to get a release right when an agency like the SEC, which has a lot of practice, doesn’t always get it right despite a lot of effort and resources being put into it. So I guess I will look forward to point two of whatever brief anyone files. The first being statutory authority, but hopefully point two is also the kinds of things that oppose the SEC challenges and need to be worked through under the APA.

 

Tyler S. Badgley:  No, I think that’s absolutely right. Just last year -- this is a case I was involved in -- the Chamber of Commerce sued the SEC over their stock BIDEX rule, and the Fifth Circuit ruled that it violated the APA for two main reasons: one, a deficient cost-benefit analysis, something that the SEC has been doing for decades, and two, failure to respond to comment letters. And the SEC had far fewer comment letters on that rule than the FTC has received on this noncompete rule. So that’s an agency that has fought off a lot of these challenges, that has a lot of experience in this area as compared to the FTC which is a relative newbie.

 

Mark A. Schuman:  Ryan, I believe we have a couple of questions from audience members. Why don’t you on their behalf ask that and see what our panelists think of them?

 

Ryan Lacey:  Yeah. Would be glad to. Our first question says what are the panelists’ predictions about this going forward? It seems unlikely that the FTC will entirely withdraw their proposed rule banning noncompetes. How likely is it for the FTC to make significant changes to the rule before submitting limiting their application? Also, litigation challenges to the rule seems likely. What is the likelihood of litigation challenging these rules to be successful?

 

Mark A. Schuman:  Tyler, I wonder if you have thoughts about those things.

 

 

Tyler S. Badgley:  Well, I have feelings about the statutory authority arguments, so maybe I should let others -- maybe let Robert take this one since I’ve already kind of stated my views.

 

Mark A. Schuman:  Okay.

 

Robert S. Driscoll:  I don’t have any special inside knowledge. I live in flyover country here, but I suspect that the reason why, just from human nature, that they kind of left open the possibility of alternatives is they knew what the pushback was going to be. And they’re going to narrow it in some respect. And maybe they’re going to carve out high income workers, whatever that definition is, as kind of a fallback position. My guess is that even if they do that, there’s still going to be litigation over it because there’s still going to be a concern over statutory authority as Tyler mentioned. And I think there’re legitimate arguments over major questions doctrine and other constitutional questions as well, but I certainly don’t have a crystal ball to predict.

 

Mark A. Schuman:  So Evan, let’s pretend for a moment that you are the FTC and you get to promulgate the rule that you think would be best. I’ll let you factor in any enforceability or APA concerns if you so dare. What rule, if you were the FTC, would you actually adopt as good policy in your opinion?

 

Prof. Evan Starr:  You’re putting me on the spot here, Mark. First, I’m an economist. I study these things. I’m not a policymaker, so what I say doesn’t matter at all in that sense.

 

I wouldn’t be surprised if the FTC kept the policy rule the same. I think that the evidence that they went with and based the rule off of at the time has only gotten stronger, especially the stuff I touched at the end. I think as I come across this there were legitimate theoretical arguments for why noncompetes could be beneficial, and then just study after study keeps coming back and finding deleterious effects on innovation that on top of policies, even for executives, is close to a ban. And so once you get to that point, I don’t think it would be surprising if the FTC maintained their perspective in a new rule.

 

Mark A. Schuman:  Ryan, do we have any other questions and time for them from the audience members?

 

Ryan Lacey:  Yes. We have time for perhaps a couple more. One of our next questions is if an employer’s position is that nondisclosures are too hard to enforce so they need a noncompete, would that be a defensible position when the ready answer is to draft it and then enforce it better under the FTC’s proposed rule, I assume they’re asking?

 

Robert S. Driscoll:  Yeah. Maybe this is going to a comment I made, so I can at least start with the response. I think if I understand the question correctly should the nondisclosure agreement be drafted better so that it’s more enforceable, from where I litigate it’s not necessarily how it’s drafted that’s difficult. It’s the factual underpinnings to prove that a disclosure has actually occurred. It can be a very difficult thing.

 

Now, I will say that many of the cases that actually wind up in litigation, there is electronic evidence that someone has actually taken information through email or putting it on a flash drive or still even sometimes taking a box of documents and walking out of the office with it, which may be a different story. But I think the concern would be someone who maybe doesn’t do any of that and still has the ability to take information that they’ve learned by virtue of their employment with their employer and disclose it or use it to the benefit of another person. So in that sense, I believe Evan completely when he says this could be a harm on innovation. It potentially could be. I don’t see why that’s, I guess, a nonintuitive position to take.

 

I think my question from a policy perspective was—and maybe someone else can answer this—isn’t that a good distinction to make though? Just because something helps another company and therefore leads to better innovation from them, is that fair to the person who first had it? It seems to go against a patent or any sort of trademark or any other intellectual property rights that may exist out there. But again, to the question of the commenter, I still think it’s a factual underpinning question. It’s not necessarily the way a nondisclosure is drafted.

 

Mark A. Schuman:  I guess I would add this is where being an in-house attorney I actually have something to add here. There are transaction costs in varying provisions in hire letters and executive agreements. And there are times when those transaction costs justify a sculpted approach, but there’s always a cost. And while the cost is sometimes that you have broader provisions that really shouldn’t be there and those have to be addressed, including by in-house counsel, saying, look, if you make this broad, not only are we not going to be able to enforce it. But you may not even be able to enforce it where you could otherwise.

 

But the idea that employers can always draft things better, people who are in-house actually have to be on the frontlines of that, and there are costs and benefits from improving drafting, from sculpting it, to putting it on a state by state basis. It’s not a reason to do bad work, but it is a reason to understand that you can’t just assume the latter. Magic wand. Draft them individually for every person who comes to your company. That kind of thing is not really practicable except at the very highest level, so maybe that makes Evan’s points better that where that comes in maybe that shows that that is where there’s some efficiencies that might be gained because the employer is willing to take the time to do that. Ryan, do we have time for any other questions?

 

Ryan Lacey:  We are coming up to the top of the hour, so I think we probably shouldn’t take any other questions. But we have a couple minutes for any last closing words for our panelists.

 

Mark A. Schuman:  I give it to the panelists. Any closing thoughts?

 

Prof. Evan Starr:  Can we come back in a few months after the FTC’s done their stuff and have a recap?

 

Mark A. Schuman:  You be careful what you offer there, Evan, because I will hold you guys to it. We’ll do a post-release. It couldn’t be Courthouse Steps. I guess it would have to be a Bureaucracy House Steps of the day that the release comes out, and I may in fact invite you all back. Thank you so much for this panel. I appreciate all your time and effort. I hope the audience got something out of it. Ryan, thank you for your help in putting this together. Back to you, Ryan, just to any wrap up you want to make.

 

Ryan Lacey:  Thank you so much, Mark. And on behalf of The Federalist Society and the In-House Counsel Network, I want to thank all of our experts for the benefit of their valuable time and expertise today. And I would like to thank our audience for joining and participating, especially with those great questions. We welcome listener feedback by email at [email protected], and as always, keep an eye on our website and your emails for announcements about upcoming webinars. I think there’s one coming up in about 30 minutes actually. Thank you all for joining us today. We are adjourned.