The HR Professional’s Guide To The End of The Non-Compete Era
Key Takeaways
ARTICLE | The HR Professional’s Guide To The End of The Non-Compete Era
Last month, the Federal Trade Commission issued a new rule that invalidates non-compete agreements for the vast majority of employment contracts, reducing the percentage of the employees subject to non-compete agreements from almost 20% of the workforce to less than 1%.
For human resource professionals, executives, and organizational leadership, the impacts of these changes will be considerable - from talent acquisition and retention to employee health outcomes - and may be worth considering in advance of when the new rule is set to take effect this coming fall.
To be clear, it’s very possible if not more likely than not that at least one of the pending/forthcoming lawsuits challenging the new rule will succeed on some level, but the FTC makes a fairly compelling case - both against non-compete agreements and for the agency’s ability to regulate them - that is unlikely to go away even if the new rule in its current form doesn’t survive judicial review unscathed.
In the event that the current era of non-competes truly does come to an end, whether sooner or later, more than a few common business practices for managing talent retention, intellectual property protection, and limiting competition will have to be rethought and reconfigured from the ground up, which will provide both significant challenges and meaningful opportunities.
How HR professionals and organizations in general respond to those challenges and adapt their way of doing business to the new non-compete normal, and more importantly how effective their adjustments prove to be, will likely reshape human resources management practices and business organizational structuring for decades to come.
Non-Compete Agreements In US Before New Rule
Non-Compete Agreements In US After New Rule
What Happens Next?
The first thing that employers must do is notify all employees who will be affected by the new rule and inform them that their non-compete agreement will no longer be in effect as of September 4th (or whatever date in advance of September 4, 2024 that the company may choose). The FTC has provided model language to assist in the process that can be found on the agency website.
The next step must be quickly adjusting course in line with the new reality that non-compete agreements may soon be a relic of the past.
To understand how the absence of non-compete agreements will affect business operations, it’s important to start with the main goals that non-compete clauses are typically utilized to meet - retaining talent, protecting IP/ trade secrets, and limiting competition.
These goals can all be pursued via a combination of other efforts, of course, but those efforts will not necessarily all be as effective as non-competes had been, nor will they all be equally effective for every employer that puts them to use.
While it remains to be seen what methods will and won’t be effective for a given employer/industry/goal, that process of trial and error in discovering what works and what doesn’t will likely have major consequences that will be felt across the labor market and economy as a whole in terms of how business is conducted going forward relative to the status quo.
IP Protection:
Non-compete agreements have often been employed in order to ensure that in-house know-how and trade secrets stayed in-house.Perhaps the most relatable of the justifications for restricting the free movement of employees within a market is the understandable desire for organizations to keep some information out of the hands of competitors, would-be market entrants, and others who may inhibit the ability of the business to grow and succeed.
To those ends, non-compete agreements were fairly effective, which is partly responsible for the widespread practice of routinely including non-compete agreements in employment contracts.
In a post-non-compete world, one concrete measure organizations can undertake to better protect intellectual property and trade secrets is putting in place more clear and restrictive policies and procedures for using company equipment and for accessing, downloading, storing, and utilizing company data and work product.
These efforts can decrease the likelihood that confidential information gets outside of the building in the first place, in addition to potentially helping to determine if, when, how, and by whom that information was improperly accessed or disclosed in the event of a breach.
While laws that allow for the protection of trade secrets and IP remain in place even absent non-compete agreements, however, in practice it can be much more difficult to prove infractions than to prevent them.
As a result, to better reduce the leaking of valuable information without non-compete agreements to limit in-house knowledge from benefiting competitors, employers are likely to redouble their talent retention-efforts, especially for specialized roles with specific insight into the organization’s competitive advantages.
Regardless of the efforts taken to retain talent, however, some employees with access to trade secrets and valuable organizational knowledge will inevitably move on to work for another employer, in which case tighter, and more specific non-disclosure agreements with heightened penalties for violations may be the best tools available for ensuring departing employees know both what information should not be revealed as well as the legal repercussions they may face if they do so.
Talent Retention:
Once non-compete restrictions are lifted, employees will be able to more directly test the market value of their labor by offering it to competitors.
At first, this newfound employee freedom of movement may lead to both increased turnover and increased wages/labor expenses. While some employees will take the opportunity to open their own business, the majority of the influx of talent on the market will likely look to move on and/or move up resulting in an industry-wide game of musical chairs.
As a growing number of companies begin adopting alternative means for achieving the goals they had previously pursued via non-compete agreements, however, that churn is likely to settle and may ultimately lead to a lower turnover rate overall.
For example, while non-competes provided a serviceable ‘stick’ to limit employees’ ability to leave their jobs, the absence of non-compete agreements suddenly makes the various ‘carrots’ that serve a complementary purpose all the more crucial.
While some other retention-aiding ‘sticks’ can still be put to use toward improved retention, including Training Repayment Assistance Programs (TRAPS) so long as those programs are not so severe as to constitute de facto non-compete agreements, ‘carrots’ like escalating bonus schedules, accumulating benefits, and longer vesting periods for stock options will have an increasingly important function in keeping top talent on board.
Inhibiting Competition:
The threat of increased competition is two-fold when employees are suddenly more capable of either putting their skills to use for a rival organization or starting their own operation in the space.
In either case, non-solicit agreements can be effective in limiting that exposure by limiting the ability of employees to poach clients on their way out the door and for a period of time following their employment. Non-solicit agreements should also be put in place to restrict former employees from hiring your organization’s current staff, agents, and sales people for a set period of time following the former employee’s term of employment.
Non-disparagement and non-interference agreements may also be useful in similar situations with similar goals by preventing former employees from disparaging, disrupting, damaging, or otherwise interfering with their former employer’s business.
As for inhibiting competition from existing industry counterparts who benefit from talent your organization developed in-house, the best defense is to shore up your IP protection alongside reinforced talent longevity and retention efforts.
The best offense, on the other hand, may be to bolster your own organization’s ranks with some of the new talent who will be making their services available on the market in the near future.
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Exceptions To The Rule:
Beginning September 4th, 2024 most non-compete clauses will be banned going forward, but not all.
Non-compete agreements involving the sale of a business will remain valid for both past and future business sales so that buyers can remain protected from competition from the seller.
Importantly, this exception applies to any bona fide good faith sale in which the seller has an ownership stake regardless of the size of that stake - which is a departure from the proposed rule which required a minimum 25% ownership stake for non-compete clauses to be valid. Though the final rule is an expansion of the exception form the proposed rule, the FTC is clearly aware of the potential abuse of this exception.
Further, the FTC notes that the invalidation of existing non-compete agreements isn’t retroactive, so violations of existing non-competes can still result in viable legal action if the violations or conditions enabling the violations occurred prior to the new rule taking effect.
Most existing non-compete agreements that don’t meet the business sale exception will also be invalidated as of September 4th, 2024, but there is an exception for existing non-compete agreements involving ‘senior executives’ - defined in the rule as employees who earned at least $151,164 in the last year and who have final authority to make policy-setting decisions that affect significant aspects of the business.
Non-profit organizations are also outside the scope of the new rule as beyond the purview of the FTC, but regulators note that they do retain jurisdiction over organizations who may be non-profit in name, designation, and/or tax status, but nonetheless operate as for-profit entities and/or primarily for the benefit of their operators, in which case the new rule will be applicable.
Healthcare-Specific Impacts of Banning Non-Compete Agreements
Given the prominent role that healthcare plays in workforce management, benefits administration, and worker productivity, human resources professionals should also be mindful of some of the healthcare-related changes that may result from banning non-compete agreements.
The two primary negative impacts that non-compete restrictions can have on the healthcare industry according to public commentary highlighted by regulators can be boiled down to reduced access to care and reduced quality of care.
While reduced quality or access to a product or service is generally considered a problem across most industries, the stakes are often significantly higher when health is involved, which is one reason that the FTC paid special attention to address some healthcare related issues and objections related to banning non-competes.
Further, the healthcare industry will be critically impacted by the new rule as a result of the large number of physicians currently subject to non-compete agreements, with as much as 45% of physicians at for-profit hospitals are currently constrained by non-compete agreements.
While the new rule has the support of the American Medical Association, there are still plenty of agents and organizations within the healthcare industry who are of the opinion that the rule will ultimately have a net negative impact.
In responding to those who oppose the new rule, regulators make it clear that they are very much aware of the relevant concerns held by some within the healthcare industry about how the new rule will affect their operations - including that the rule would worsen the existing healthcare worker shortage problem and would drive up healthcare worker wages and health care costs in general as a result - but the FTC largely dismisses those concerns as unsupported by the data.
It is not entirely clear whether or not regulators found those concerns to be without merit, however, or if the evidence in support of those propositions was simply insufficient while they found the data and commentary in opposition to non-compete clauses more compelling.
For example, a significant number of physicians commented that non-competes negatively impact the quality of care they can provide by forcing them to accept care-impacting decisions made by administrators at the institution with which they are contracted while depriving them of the opportunity to offer their skills and experience to a competing institution instead, which can ultimately lower the overall quality of care for both healthcare institutions in the example.
Further, while regulators conceded that tax-exempt organizations in general operate outside the realm of the FTC, they do notably claim jurisdiction over (and fired a shot across the bow of) the many nominally non-profit hospitals and healthcare organizations that nonetheless pay executives exorbitant salaries and contribute less to their communities than the value of the tax breaks they get as a result of their non-profit structure.
What will be the overall impact on healthcare? The FTC claims the new rule will lower healthcare expenses by an average of $20 billion per year over the next decade in addition to creating more competition and offerings to better meet patient needs/demand, while opponents believe freedom of movement for healthcare workers will result in higher wages that drive the cost of healthcare up.
Whatever the end result, there will almost certainly be healthcare-related confusions and complications that arise as the industry adapts to the changing environment, which will likely cause employees to lean on their employers further for guidance and help navigating the evolving healthcare landscape.
Economic Impacts of Banning Non-Compete Agreements
The Case Against Non-Compete Agreements
According to the Federal Trade Commission (FTC), about 30 million workers are currently subject to non-compete agreements, which means any problems that non-compete agreements may be causing or exacerbating are going to be felt economy wide.
Despite the widespread adoption and long history of non-compete clauses in employment contracts, the practice has long been the subject of controversy, with data analysis increasingly seeming to confirm some of the most common critiques of non-compete agreements, including that they are economically inefficient, lead to higher costs, result in worse quality product/service offerings, and stifle innovation.
One of the biggest arguments against non-competes embraced by the FTC is that they unnaturally inhibit free market forces that could potentially distribute labor more efficiently if non-competes weren’t restricting the free movement of talent within a market/geographic region.
Those restrictions affect not only the movement of labor and ideas among existing competitors within a given market, which affects the value of that labor in turn (i.e. wage suppression), but non-compete agreements also inhibit new entrants from accessing the market, which has a chilling effect on innovation by limiting the availability of expertise and experience to would-be innovators and their organizations, whether preexisting or brand new.
Interestingly, data indicates that non-competes not only depress wages and earnings for workers whose contracts contain non-compete clauses, but also for workers who aren’t directly subject to non-compete clauses, as well, by lowering wages across the entire category.
Quality of product and service offerings is another victim of non-compete agreements highlighted by the FTC, noting that employees who are unable to take their services elsewhere are less capable of pushing back against excessive workload, job requirements, or cost-saving measures that are likely to result in a lower quality of work output.
Given these findings, it is no surprise why the FTC decided that the use of these kinds of restrictions should be banned.
Not everyone agrees, however, with opponents challenging both the wisdom of the new rule and the FTC’s authority to issue it, which is a position supported by many stakeholders across a range of industries who believe that regulators at the FTC have overstepped their regulatory bounds with the new rule and grossly misunderstood and/or mischaracterized the potential effects that banning non-compete agreements may have.
Legal Challenges To The New Rule
As of this writing, there are at least 2 separate lawsuits that have been filed against the FTC with regard to this rule.
The most prominent plaintiff thus far is the US Chamber of Commerce, which claims that the FTC lacked the authority to issue such a broadly-sweeping rule, amongst other claims. The suit was filed in the US District Court for the Eastern District of Texas, which the Chamber presumably believes to be a district friendly to the cause and somewhat increases the chances that the challenge will be heard favorably, at least in the short-term.
In making its case, the Chamber specifically pointed to the substantial costs that companies would have to undertake to protect their investments in terms of both developing talent and safeguarding intellectual property if non-competes are no longer permissible.
The FTC counters those complaints by claiming that the agency is specifically mandated to regulate unfair methods of competition, which they have concluded includes non-compete agreements.
The Chamber has not yet said whether it will move for a temporary injunction blocking the enforcement of the rule pending their legal challenge, but as September approaches, that motion for injunction becomes increasingly likely unless another legal challenger to the new rule (of which many more are anticipated) takes that action first.
Mployer Advisor’s Take
Despite having the final rule in hand and just a few months before it is scheduled to take effect, the general consensus is that legal challenges to both the rule banning non-competes and the FTCs right to enact the rule will succeed in delaying implementation at the very least.
How those cases play out remains to be seen for the time being, but given the current makeup of the federal judiciary, substantial changes to the rule if not a de facto gutting of it seem more likely than not prior to the rule taking effect.
Even if the non-compete ban is severely diminished if not invalidated by the time it has been terminally adjudicated, given the clarity of the case they present and the resolution in their actions, regulators at the FTC may very well attempt to achieve the same ends via different, more judicially palatable means should they still be in position to do so next year following the elections this fall.
One way or another, the spotlight has been shone on non-compete clauses, and a return to the era of widespread, default non-compete agreement use is unlikely to happen regardless of the fate of the current legal challenges to the new rule.
In justifying the ban, the FTC noted that there were a number of less-intrusive ways for employers to achieve the benefits they’ve come to expect from non-compete agreements including talent retention and IP protection, including some of those discussed above.
Further, the FTC pointed to the experience of several early adopter states like California and Oklahoma that paved the way for the new rule via heightened non-compete regulation above and beyond the national standards at the time.
Those early adopter states not only provide evidence that banning non-competes won’t result in the worst outcomes predicted by those opposed to the new rule, but they are also home to thousands of companies that can serve as case studies that can benefit out-of-state companies addressing these issues for the first time with how best to adapt to the new, more competitive environment.
Forward-thinking organizations might be wise to begin looking toward those models, exploring their options, and making the transition away from relying on non-compete agreements before being directly faced with a swiftly approaching the legal deadline for doing so, whether that deadline ends up being this coming September or a little farther down the road.