Non-Competes

In the middle of last week’s hullabaloo over the Trump trial and SCOTUS’s immunity arguments, Lina Khan and the FTC issued a proposed blanket ban on non-competes. Traditionally non-competes have been regulated by the states, and the FTC is over a hundred years old and has never before tried to ban non-competes. That has led to the inevitable legal challenges, led by Eugene Scalia and filed in the Fifth Circuit as has become the standard playbook for such matters. My purpose here isn’t to handicap the likelihood of success of the challenges. Rather it is to describe what I consider to be the complete stupidity of Ms. Khan’s proposal.

There is some academic literature that suggests non-competes can have a slightly depressive impact on wages, especially at lower levels. Hence the criticisms of them. But they can also protect an employer’s important interests. That is why, in New York, non-competes have to be reasonable in duration and geographic scope, to avoid undue hardship on the employee, and they have to be necessary to protect a legitimate interest of the employer, usually trade secrets and goodwill.

Think of the classic example of an employee of a hair salon. The salon’s goodwill interest is in the loyalty of its customers, which is also embodied to some extent in the employee as well. A short non-compete, say three months, with a tailored geographical scope, say 10 miles, would give the salon a chance to convert customers to a new stylist before those customers migrate to the new salon where the stylist is now working. Moving across the street and starting next week is too close and too fast.

The facts can quickly get harder to evaluate. In the case of say, a software engineer, who is likely on a higher pay scale, the employer’s interest is more likely to be embedded in trade secrets than customer goodwill, and that is the appropriate means of analysis in that instance. But again the employer has the burden of proof to demonstrate the existence of a protectable trade secret interest.

All this has generally worked out satisfactorily in the common law state scheme. People get jobs, unemployment is under 4% and the interests of employers are accommodated. Why does the FTC have to step in?

In the case of California, there is a special statute, California Business & Professions Code, Section 16600, which prohibits the enforcement of non-competes except in the context of a sale of a business. But even that statute isn’t as broad as it seems to be on its face as California courts will protect trade secrets. This system, while somewhat more employer-restrictive and employee-friendly than New York, has also generally worked satisfactorily. Why is there a need for the FTC to have to enact its own rules?

But here’s the real thing in my opinion. If you want to protect employees who are looking for new jobs, while simultaneously protecting the legitimate interests of employers, isn’t the simplest solution to require “gardening leave” payments to make a non-compete enforceable? That’s been the custom in the UK for a considerable period. If the employer wants to stop the employee from working, he should pay the employee for the privilege. That will quickly sort out just how important and valuable the interests are that the employer is trying to protect. The FTC rule permits gardening leave, but it doesn’t require it. If you’re going to have the FTC get itself involved in the enforcement of non-competes, that omission is really, really stupid.

The proposed FTC rule does authorize severance, NDAs and non-solicits, of both customers and other employees, which are also ways to protect employers. So why not require gardening leave as a condition to enforcing a non-compete to protect employees too?

The proposed rule also does an inadequate job, in my opinion, in protecting employers. The FTC attempts to bridge this need by permitting employers to require “policy-making employees” making more than $150,000 to require those employees to sign non-competes. Maybe I’m too focused on New York City, but that’s less than first-year associates at Big Law make, and one can see many litigation fights over whether a particular employee is in a “policy-making” role, just as there can be litigations under the present system over the need to protect trade secrets or goodwill, so the $150,000/policy-making exception seems to me to be an inadequate way to provide employers with the protections that they need, or to provide employees with clarity when they start their job hunt.

In a post-industrial economy, we have many jobs where the assets, so to speak, go down the elevator every night. Advertising, accounting, banking, media and other service businesses depend on their employees staying and being loyal. (I’d mention law except we’ve carved ourselves out of that by special ethics rules that prohibit restrictions on lawyers moving firms based on the fiction that it protects the right of clients to select counsel.) Sometimes an investor needs the protection of a non-compete to keep employees around when he invests into a business, to make sure key employees are stable and will be around to create value, not just when the employee is on the way out. The FTC rule, like the California statute, permits non-competes in connection with the sale of a business, but it says nothing about non-competes when an initial investment into a business is made. There are, in my opinion, better ways to balance the needs of employers and employees than the policy choices than what the FTC has chosen.

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The views expressed here are those of the author, and do not necessarily represent or reflect the views of NYCLA, its affiliates, its officers, or its Board.