What does the future hold for restrictive covenant agreements in the U.S.?

REUTERS/Peter MacDiarmid

October 1, 2021 - Courts in most U.S. jurisdictions have long applied close scrutiny when assessing the enforceability of restrictive covenants that purport to bar employees from engaging in competitive activities with their former employers. In recent years, however, a growing number of states have taken action to further limit, or in some cases completely ban, employee restrictive covenant agreements.

Beyond these state-level developments, President Biden recently announced a renewed federal focus on increasing competitiveness in the workplace, including alluding to the possibility of the federal government taking action with respect to restrictive covenant agreements. While previous administrations have explored and studied the issue, this announcement marks the first time that federal action to limit non-competes is sought.

This article will explore recent developments surrounding non-compete and other restrictive covenant agreements, as well as where the legal landscape for such agreements might be headed in the future.

The use of restrictive covenants to limit employees from engaging in competitive activities has long been governed by state law. Because of this, a patchwork of rules has developed across the U.S. And as noted above, courts in most states have for decades tended to take a critical lens to restrictive covenant agreements. In recent years, however, state and local legislatures have placed an increased emphasis on curtailing or substantially limiting the use of such agreements.

For a long time, for instance, only California and North Dakota had prohibited most employee non-competition and non-solicitation agreements. More recently, however, Oklahoma and the District of Columbia adopted legislation to prohibit virtually all employee non-competition agreements (and in some instances even limit other employee restrictive covenants).

Likewise, a growing number of states — including Illinois, Maine, Maryland, Massachusetts, New Hampshire, Nevada, Oregon, Rhode Island, Virginia and Washington — have recently enacted legislation to prohibit employers from requiring low-wage workers to enter into non-competition agreements.

Among these states, what constitutes a "low wage" worker varies widely and may be a higher threshold than what employers may expect. For example, Virginia defines "low wage" to cover both employees and independent contractors who earn less than the average weekly wage of the commonwealth, which currently is $1,195 weekly (or $62,140 annually). Illinois recently amended its low wage restriction to now cover non-competition restrictions for employees who earn less than $75,000 and non-solicitation restrictions for employees who earn less than $45,000 per year (increasing incrementally each year). Washington State defines low-wage for purposes of its prohibition to be earnings below $100,000 per year adjusted annually for inflation.

Further, even for higher-wage employees, many of these states have enacted procedural requirements aimed at limiting the number and enforcement of employee restrictive covenants. For example, Massachusetts law now requires that non-competition agreements for higher-wage employees: expressly state that the employee has the right to consult with counsel prior to signing; be provided to the employee by the earlier of a formal offer of employment or 10 business days before the commencement of employment; be supported by "garden leave" (where the employer agrees to pay the employee during the restricted period) or other mutually agreed upon consideration; be limited to 12 months post-employment; and certain other limitations and procedural elements.

In short, the legal and legislative landscape surrounding the use of employee restrictive covenant agreements has undergone a substantial facelift in many states over the past few years, with numerous other states currently considering bills that would also affect the use of such agreements.

Amidst the changing landscape for employee restrictive covenants under state law, the Biden Administration recently announced on July 9, 2021, its intent to take certain action at a federal level to promote competitiveness and outlined 72 initiatives, including encouraging the Federal Trade Commission (FTC) to "ban or limit" non-compete agreements.

In its announcement, the White House noted that roughly half of private-sector businesses require at least some employees to sign post-employment non-compete agreements, affecting an estimated 36 to 60 million workers. In tandem with this announcement, President Biden issued an executive order to promote competition in the economy, including explicitly calling on the FTC to use its rulemaking authority "to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility."

In practice, President Biden's executive order does not impact current law regulating non-compete and similar restrictive covenant agreements, and the order itself does not require the FTC to engage in rulemaking nor specify what particular action the FTC should consider in any such rulemaking. With or without any such new regulation, the FTC (and U.S Department of Justice) could devote more resources to scrutinizing non-compete and other agreements viewed as restraining competition for workers and could potentially expand the circumstances under which such agreements are deemed anticompetitive.

Given the ongoing calls by some for the antitrust agencies to apply federal antitrust laws more broadly and rigorously to non-compete and similar restrictive covenants, the FTC and DOJ may also consider revising the Joint Antitrust Guidelines for Human Resource Professionals to directly address non-competes and other restrictive covenants in employer-employee agreements. (The guidelines currently state that they do "not address the legality of specific terms contained in contracts between an employer and an employee, including non-compete clauses.").

On the other hand, the FTC may decide to issue new regulations that directly restrict the scope and/or use of such restrictive covenants. While the FTC has not noticed any such regulatory action on the topic to date, some anticipate that the FTC may soon take some type of action. Notably, President Biden's own confirmed FTC Chair pick, Lina M. Khan, recently co-authored (with then FTC commissioner Rohit Chopra) an article in The University of Chicago Law Review exploring avenues for federal regulators to enhance competition through rulemaking, including limiting non-competes.

This most recent announcement from the Biden administration marks the most significant federal action on non-competes to date and builds on the exploratory work of the prior two administrations. In 2016, the Obama administration took initial steps to federally assess and prioritize competition in the domestic marketplace, including exploring the impact that employee non-competition agreements may play.

First, President Obama issued an executive order on April 15, 2016, directing the various federal agencies to identify specific actions to encourage competition in the U.S. economy and report such steps to the National Economic Council. Then later in 2016, the White House issued a State Call to Action on Non-Compete Agreements encouraging state action to limit non-compete agreements, particularly for low wage and other categories of workers.

During the end of the Trump administration, the FTC hosted a workshop on Jan. 9, 2020, concerning Non-Compete Clauses in the Workplace to examine the economic and legal support for rulemaking to restrict the use of employee non-competition clauses.

Overall, the future legal landscape for non-competes and other restrictive covenants is uncertain, particularly with respect to low-wage employees. Proponents for legislation or regulatory action limiting or completely barring non-competes often focus on the anti-competitive nature of such agreements, arguing that non-competes depress wages, inhibit entrepreneurship, deplete the marketplace of jobs, and limit job mobility.

Yet opponents point out that such legislation or regulatory action undercuts the ability to contract freely and also protect legitimate business interests such as confidential information and trade secrets, goodwill, customer relationships, and investments in workforce development and skills. Opponents also note that many of the same policy considerations proponents highlight are factors that courts have often looked at when determining enforceability of employee restrictive covenants, including reasonableness in duration, scope, geographic area, and the employee's ability to continue to earn a living.

While a future with outright bans on post-employment non-compete agreements is unlikely, proactive employers who utilize non-compete and similar agreements may want to re-evaluate their practices and business-protection strategies.

Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias. Westlaw Today is owned by Thomson Reuters and operates independently of Reuters News.

Mark S. Goldstein is a partner in Reed Smith's Labor & Employment Group in New York. His practice is focused on helping companies in New York and around the world manage their workplace needs, and he counsels clients on day-to-day and big-picture workplace issues. He can be reached at MGoldstein@reedsmith.com.

Noah S. Oberlander is an associate in Reed Smith's Labor & Employment Group in Richmond. His practice focuses on defending privately and publicly held for-profit companies in employment and commercial disputes in state and federal courts, and administrative proceedings. He can be reached at NOberlander@reedsmith.com.