States Outlaw Noncompete Agreements
A growing number of states have banned noncompete agreements, leaving employers to grapple with a patchwork of different state-level requirements and federal actions.
“We are seeing a very clear trend of increasing hostility to the use of noncompete agreements,” said Daniel Kadish, an attorney with Morgan Lewis in New York. “It has been a significantly growing trend over the last 4 or 5 years. We have seen this pick up speed.”
Noncompetes prohibit employees from working for corporate competitors or opening their own competing business within a geographic area for a certain period of time after they leave a company. Traditionally, employers have used noncompete agreements to stop employees from taking trade secrets and proprietary information to a competitor. Noncompete agreements may boost an employer’s retention rate if they prevent workers from seeking similar jobs at competitors.
The trend of banning noncompetes is likely to spread to more states in the near future, said Dan Prokott, an attorney with Faegre Drinker in Minneapolis.
States tend to follow each other, and “it becomes a bit of a bandwagon effect,” said Julie Werner, an attorney with Lowenstein Sandler in New York.
Four states—California, Minnesota, North Dakota, and Oklahoma1—have banned noncompete agreements entirely, and many other states have enacted restrictions, such as setting a compensation threshold or requiring advance notice.
The New York Legislature recently passed a bill2 that would ban noncompete agreements, but Governor Kathy Hochul has not signed it yet. The legislation’s “scope is very broad, and its details are very little,” said Larry Del Rossi, an attorney with Faegre Drinker in Florham Park, New Jersey. If enacted, it might make companies think twice about having their chief executives based in New York, Werner said.
The state laws primarily targeted noncompete agreements that apply to low-wage workers. “It is an effort to solve for those situations,” Werner said.
Some state laws allow noncompete agreements for employees whose salary is above a certain threshold, and others do not. Some state laws permit noncompete agreements in connection with the sale of a business, and others do not.
Some states also stipulate that you cannot have a noncompete in certain professions, like medicine or law, Del Rossi said.
The state laws do not clearly define what a business competitor is, which can make things confusing for employers that use noncompetes, Prokott said.
The variation in state laws “creates difficulties for organizations that have to comply with different rules in different places,” Kadish said.
“The trend is that every state is handling these things differently. The idea of just using a standard template form does not work anymore,” Werner said.
The Federal Trade Commission (FTC) released a proposal on January 5, 2023, to prohibit
noncompetes. The FTC said noncompetes constitute an unfair method of competition and
therefore violate Section 5 of the Federal Trade Commission Act. It concluded that noncompetes suppress wages, stifle innovation, and make it harder for entrepreneurs to start new businesses. The agency has not released a final rule yet.
“We still suspect there will be some final rule by roughly April or May 2024 from the FTC,” Kadish said.
Corporations are likely to challenge any state or federal bans in the next year or two. “Inevitably, there is going to be legal challenges in the courts,” said Mark Goldstein, an attorney with Reed Smith in New York. “Employers need to brace for some uncertainty on this front.”
In a memo3 released on May 30, 2023, National Labor Relations Board General Counsel Jennifer Abruzzo announced that some noncompete agreements violate the National Labor Relations Act 5. The announcement, which applies to nonunionized and unionized employers, may result in unfair labor practice charges for employers that use noncompetes.
The Society for Human Resources Management (SHRM) urged4 the FTC to allow employers to continue using noncompete agreements with certain employees.
In comments to the FTC, Emily M. Dickens, Chief of Staff and head of government affairs at SHRM, said the FTC’s proposal would “impede SHRM members’ ability to balance the needs of workers and employers and will reduce the contractual capabilities of reasonable and consenting parties. The sweeping proposal significantly complicates HR professionals’ responsibility to protect their workforces’ intellectual property.”
Tips for Employers
Human resources professionals should stay up-to-date on state laws around noncompete agreements and have accurate records of where their employees work, Del Rossi said.
“It makes sense for organizations to review their current noncompete agreement and see if the way they are using those agreements are still aligned with their business goals,” Kadish said. For example, companies could consider tailoring the noncompete agreement to the job, adjusting the duration of the agreement, or tightening the scope of new hires who are required to sign a noncompete.
Noncompete agreements often name the state where the contract applies, based on where the business is incorporated, where the employee lives, or where the work takes place. Employers should “be thoughtful” about this choice, Werner said, and “use the right agreements for the right people,” which can include not giving noncompetes to junior employees.
In the meantime, businesses should “start planning for alternatives to noncompetes,” such as nondisclosure and nonsolicitation agreements, which can protect trade secrets, said John Siegal, an attorney with BakerHostetler in New York. “Be more flexible and creatively use less restrictive employee agreements, including customer nonsolicitation agreements and notice or garden leave provisions,” where employees are instructed to stay away from work during the notice period while still remaining on the payroll.
In a tight labor market, state prohibitions on noncompetes might make it easier for some businesses when they need to attract certain types of workers who were previously under noncompetes, said Rob Whitman, an attorney at Seyfarth in New York.
Eighteen percent of U.S. workers are subject to noncompete agreements now, and 38% of workers have been subject to noncompete agreements at some time in their careers, according to a new report5 from the U.S. Government Accountability Office. About 55% of employers said they used noncompete agreements.
“Few workers who sign noncompete agreements negotiate the terms because they are unaware of what noncompete agreements are, they want the job regardless, or the noncompete agreement is introduced after a job is accepted,” the report stated. Noncompete agreements have particularly high use in the health-care, financial services, and IT industries, according to Prokott.