Is the Non-Compete Soon to be History?

February 7, 2023 – The federal government has announced a proposed rule which would ban non-compete agreements between employers and employees, independent contractors, externs, interns, volunteers, apprentices, and even sole proprietors who provide a service to a client or customer. The Federal Trade Commission (FTC) stated the widespread use of non-competes agreements is an “often exploitative practice that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses.” Under the proposed rule, a “non-compete” clause is defined “a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.”

Although most states allow enforcement of reasonable non-competes, the increasing trend is to limit or ban their use.  In California, North Dakota, the District of Columbia, and Oklahoma, non-competes are either entirely or largely unenforceable as against public policy. Other states, including Maine, Maryland, New Hampshire, Rhode Island, and Washington, have banned non-compete agreements for low-wage workers.

In a new report, Bob Gershberg, chief executive officer and managing partner of  Wray Executive Search, raises the question of whether the FTC is overstepping its bounds, adding that it “appears as though Congressional debate might be in order.”

Mr. Gershberg cites Emily Dickens, chief of staff and head of public affairs for the Society for Human Resource Management, who said the proposed FTC rule is overly broad and could potentially harm businesses that depend on non-competes to thrive. “She cited very small, emerging industries where crucial know-how cannot be safeguarded through nondisclosure agreements alone,” said Mr. Gershberg. “Although ‘there are jobs where it makes no sense to have non-competes,’ Dickens said, ‘this kind of blanket ban is going to stifle innovation.’”

California’s Ban

He also pointed to Scott Galloway, a professor at New York University’s Stern School of Business, who emphatically believes that a  confidentiality agreement would be sufficient. “Non-compete clauses are what firms use to sequester your human capital from competitors,” said professor Galloway. “The irony of non-competes is they only serve to dampen growth. One of the few places where they’re banned is also home to the world’s most innovative tech economy: California. Job-hopping and seeding new acorns have been part of Silicon Valley since the beginning. In 1994 a Berkeley economist theorized that California’s ban on non-competes was one of the main reasons Silicon Valley existed at all, and in 2005, economists at the Federal Reserve put forward statistical evidence supporting the theory. Apple, Disney, Google, Intel, Meta, Netflix, Oracle, and Tesla were able to succeed without limiting the options of their employees.”

The proposed rule would not apply to covenants relating to the sale of business. Nor would it apply to franchisor/franchisee agreements,” said Mr. Gershberg. “This carve-out is in line with most state-based restrictive covenant laws, which are less critical of covenants incident to the sale of a business rather than to the restricted person’s employment.”

Specifically, Mr. Gershberg notes, the proposed rule would not apply to non-compete clauses:

  • entered into by a person who is selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity; or
  • by a person who is selling all or substantially all of a business entity’s operating assets, when the person restricted by the non-compete clause is a substantial owner of, or substantial member or substantial partner in, the business entity at the time the person enters into the non-compete clause.

To qualify as “substantial owner, substantial member, and substantial partner,” the person (subject to the non-compete clause) must be “an owner, member, or partner holding at least 25 percent ownership interest in a business entity.”

“FTC chair Lina Khan has maintained for years that the FTC should exercise its rulemaking in this manner,” said Mr. Gershberg. “Upon release, chair Khan stated that the rule would improve wages and working conditions, as well as ‘promote greater dynamism, innovation, and healthy competition.’”

Room for Debate

Commissioner Christine Wilson issued a dissenting statement in which she stated that the rule “represents a radical departure from hundreds of years of legal precedent that employs a fact-specific inquiry into whether a non-compete clause is unreasonable in duration and scope, given the business justification for the restriction.” She further stated that non-compete clauses are an inappropriate subject for rulemaking, noted negative consequences of suspending non-compete clauses, and criticized the lack of evidence to support the proposed rule.

“More than 50 restrictive covenant lawyers, in a letter to the White House and the FTC in the wake of President Biden’s order, addressed the misconceptions regarding the claim that non-compete clauses hurt workers and competition,” said Mr. Gershberg.

Founded in 1972, Wray Executive Search is a provider of executive search and advisory services in the restaurant, foodservice, retail, and franchise industries. Wray is a purpose-driven executive search firm and human capital advisory, specializing in C-level, senior executive and functional leadership search. The firm is headquartered in St. Petersburg, FL.

Mr. Gershberg has been a driving force behind the brand for over a decade. He specializes in searches for C-level positions, functional leadership roles, and M&A integration. Mr. Gershberg has extensive knowledge and experience in restaurant, food service, retail, and consumer industries, and has successfully completed assignments in finance, human resources, IT, supply chain, real estate, franchising, operations, and marketing.

Related: Wray Executive Search Appoints Partner

Contributed by Scott A. Scanlon, Editor-in-Chief; Dale M. Zupsansky, Managing Editor; and Stephen Sawicki, Managing Editor – Hunt Scanlon Media

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