ANALYSIS: Employers Would Be Fine Without Noncompetes

Ever since the Federal Trade Commission announced its proposed regulation to ban noncompetition agreements in employment, legal commentators have been worrying about the impact on businesses’ proprietary information.

But even if the FTC’s regulation goes into effect as proposed—an uncertain outcome given the likelihood of litigation—we shouldn’t expect the sky to fall. Wide swaths of the workforce have been functioning without noncompetes for decades, and employers still have plenty of tools to protect themselves from unfair competition. In fact, employers don’t need noncompetes and, like their employees, may even be better off without them.

Why Noncompetes?

Employers use noncompetes to prevent employees from taking confidential business information to a competitor. Barring a former employee from working for a competitor decreases the risk that the employee would still have relevant information when they’re able to compete again a year or two later.

Proponents of noncompetes see them as necessary to protect businesses from trade secret misappropriation. Proving that an employee used confidential information is much more difficult and expensive than simply prohibiting an ex-employee from working for a competitor.

But the FTC believes noncompetes prevent competition in the workforce, leading to lower wages for workers. About one in five workers is subject to noncompete provisions that collectively curb earnings by hundreds of billions of dollars, according to the FTC.

The FTC also sees noncompetes as stifling to entrepreneurship and innovation. Employees who could otherwise seek new business opportunities are discouraged or delayed from doing so due to contractual obligations to their previous employers.

Are Noncompetes Necessary?

A noncompete-agreement-free workforce is hardly untested territory. Noncompetes, along with other contractual restraints on competitiveness, have been banned in California for over 100 years, and the sky hasn’t fallen. Indeed, some researchers believe that California’s ban on noncompetes stoked the innovative companies and inventions that grew out of Silicon Valley, whereas tech contemporaries on the East Coast stagnated because of noncompetes.

California employers still share proprietary information with employees and invest in their training, while finding ways to protect trade secrets by using confidentiality, nonsolicitation, and nonrecruitment agreements. Businesses can also sue for trade secret misappropriation in instances where proprietary information is stolen by former employees.

In fact, many employers are already using these remedies. According to research cited in the FTC’s analysis, 97.5% of workers with noncompetes also have nondisclosure or nonsolicitation agreements. Beyond banning universal employee noncompetes, the FTC’s proposal actually carves out room for employers to rely on such restrictive covenants to protect their intellectual property rights.

Of course, employers can also rely on the Defend Trade Secrets Act and state law remedies to litigate misappropriation. Trade secret litigation is growing across the country, even in states that allow noncompetition agreements.

Can Noncompetes Be Saved?

It’s entirely possible that the FTC will scale back its proposed rule to only ban noncompetes in certain instances, such as for lower-wage and entry-level positions. It could also decide, for instance, to tie noncompetes to specific activities that are actually competitive rather than to simply work for a competitor, or to require “garden leave” during the noncompete’s duration.

But trying to regulate noncompetes creates the potential for misuse. Some employers still use noncompetes in jurisdictions like California where they’re illegal. Even when invalid, noncompetes have a chilling effect on workers and deceive them into thinking that they have no other opportunities. If noncompetes were officially limited to high-wage earners, abuse would likely still be rampant.

Support for Noncompete Bans

The interest in regulating noncompetes isn’t unique to one political party. While some commentators like to rail against California’s progressive policies, two more states—North Dakota and Oklahoma—similarly bar employment-related noncompetes. Neither of those two states is known as a worker-friendly bastion of liberalism.

In fact, there appears to be quite a bit of common ground across the political spectrum when it comes to banning certain types of noncompetes. Sen. Marco Rubio (R-Fla.) first introduced the Freedom to Compete Act to ban noncompete agreements for entry-level and low-wage earners in 2019. Rubio’s bill has garnered bipartisan support, and at least two Democratic lawmakers are planning similar bills for this session of Congress. Several states, including Illinois, Massachusetts, and Washington, have recently passed laws to limit the scope of noncompetes.

Are Noncompetes Fair?

Why then should employers be given so much control over their former employees’ lives, especially since some states have proved that business goes on as usual when their workforces are freed from competitive restrictions?

There are a few explanations for why employers may favor noncompetes. First, employers can benefit a lot by the threat of a noncompete. These agreements decrease the costs of human capital, limit competition for labor, and provide security to employers—all without employers having to take initiative to uncover actual wrongdoing.

Second, employers can sit back while former employees wait out the terms of their noncompetes, and they don’t have to worry about whether their confidential information is being misappropriated as long as they keep tabs on where former employees are working.

While employers without noncompetes may have a higher risk that a former employee is able to secretly misappropriate valuable business information, the burden on workers who are subject to noncompetes is much higher. It demands that workers forgo paychecks and career advancement for the noncompete’s duration, start an entirely new career, or uproot their lives to a different city or state (assuming the noncompete’s scope isn’t nationwide). Of course, employers don’t owe their former employees anything—the only benefit most employees get in return is the privilege of at-will employment.

This power differential strikes many as fundamentally unfair, especially for low-wage workers, which perhaps explains why proposals to limit noncompetes enjoy political support across the aisle. Ultimately, employers don’t need this one-sided advantage, and their employees would be much better off with a level playing field.

Banning noncompetes would require employers to actually discover and allege wrongful conduct instead of benefiting from a blanket ban keeping their former employees from living freely and contributing to the workforce. But a ban would also encourage better retention practices, higher wages, and entrepreneurship.

These benefits are worth the marginal cost of ending noncompetes.

Bloomberg Law subscribers can find related content on our Practical Guidance: Restrictive Covenant page.

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