Non-compete clause

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In contract law, a non-compete clause (often NCC), restrictive covenant, or covenant not to compete (CNC), is a clause under which one party (usually an employee) agrees not to enter into or start a similar profession or trade in competition against another party (usually the employer). In the labor market, these agreements prevent workers from freely moving across employers, and weaken the bargaining leverage of workers. [1]

Contents

Non-compete agreements are rooted in the medieval system of apprenticeship whereby an older master craftsman took on a younger apprentice, trained the apprentice, and in some cases entered into an agreement whereby the apprentice could not compete with the master after the apprenticeship. [2] Modern uses of non-compete agreements are generally premised on preventing high-skilled workers from transferring trade secrets or a customer list from one firm to a competing firm, thus giving the competing firm a competitive advantage. [1] [2] However, many non-compete clauses apply to low-wage workers or individuals who do not possess transferable trade secrets. [2]

The extent to which non-compete clauses are legally allowed and enforced varies under different jurisdictions. Some localities and states ban non-compete clauses or highly restrict their applicability. In jurisdictions where non-compete agreements are legal, courts tend to evaluate whether a non-compete agreement covers a worker's move to a relevant industry and reasonable geographic area, as well as whether the former is still bound by the agreement over a reasonable time period. An employer bringing a lawsuit may also be asked to identify a protectable business interest that was harmed by the employee's move to a different firm. [2]

Research shows that non-compete agreements make labor markets less competitive, reduce wages and reduce labor mobility. [3] [1] While non-compete agreements may incentivize company investment into their workers and research, they may also reduce innovation and productivity by employees who may be forced to leave a sector when they leave a firm. [4] [5] The labor movement tends to advocate for restrictions on non-compete agreements while support for non-compete agreements is common among some employers and business associations.

History

As far back as Dyer's Case in 1414, English common law chose not to enforce non-compete agreements because of their nature as restraints on trade. [6] That ban remained unchanged until 1621, when a restriction that was limited to a specific geographic location was found to be an enforceable exception to the previously absolute rule. Almost a hundred years later, the exception became the rule with the 1711 watershed case of Mitchel v Reynolds [7] which established the modern framework for the analysis of the enforceability of non-compete agreements. [8]

Traditionally, non-competes were used to prevent high-skilled workers from transferring trade secrets or a customer list from one firm to a competing firm. [1] [2] However, such clauses can frequently be found in the contracts of low-wage workers and other workers who are unlikely to be in a position to share trade secrets. [2]

When courts consider the enforceability of non-compete agreements, they usually ask the employer to identify a protectable business interest that was harmed by the employee's move to a different firm. Courts consider whether the non-compete covers a relevant industry (does the worker do work for a firm in the same industry?), reasonable geographic area, and reasonable time period. [2]

University of Chicago Law School Professor Eric A. Posner has argued that since non-competes have an adverse impact on competition, they should be covered under a strong anti-trust regime, and the "law should treat noncompetes as presumptively illegal, allowing employers to rebut the presumption if they can prove that the noncompetes they use will benefit rather than harm their workers." [2]

In April, 2024, the Federal Trade Commission (FTC) banned all non compete agreements in the United States. [9] Within a few days, business groups including the U.S. Chamber of Commerce sued to block the new rule. [10]

Impact

Studies show that non-compete agreements make labor markets less competitive, reduce wages and reduce labor mobility. [3] [1] Existing evidence suggests that the wage suppressing effects of non-competes are disproportionately concentrated on lower-income workers. [1] Non-compete agreements can incentivize firms to increase investment into worker training and research, as those workers are less likely to leave the firm. [1] Non-competes may reduce overall hiring costs and employee turnover for companies, which may result in savings that could in theory be passed on to customers in the form of lower prices and to investors as higher returns. [2]

Non-competes are more common for technical, high-wage workers and more likely to be enforced for those workers. However, even when non-compete agreements are unlikely to be enforced (such as for individual low-wage workers or in states that do not enforce these agreements), the agreements may still have an intimidating impact on those workers. [3] [11]

A 2021 study of the U.S. health care sector from 1996–2007 found that noncompete agreements in this sector led to higher prices for physicians, smaller medical practices and greater medical firm concentration. [12]

A 2021 study found that noncompete agreements for low-wage workers have been shown to lower wages; a study determined that the 2008 Oregon ban on noncompete agreements for workers paid by the hour "increased hourly wages by 2%–3% on average." [13] The study also showed that the Oregon ban on noncompete agreements for low-wage workers "improved average occupational status in Oregon, raised job-to-job mobility, and increased the proportion of salaried workers without affecting hours worked." [13]

Studies have found that non-compete agreements can prompt technical workers to involuntarily leave their technical field to avoid a potential lawsuit from their former employer. [4] [5] For this reason, non-compete agreements have been linked to less innovation and lower productivity as inventors switch fields in order to avoid violating non-competes. [5]

By country

Belgium

In Belgium, CNCs are restricted to new employments within Belgium and for no more than one year. The employer must pay financial compensation for the duration of the CNC, amounting at least half of the gross salary for the corresponding period. [14]

Canada

Canadian courts will enforce non-competition and non-solicitation agreements; however, the agreement must be limited in time frame, business scope, and geographic scope to what is reasonably required to protect the company's proprietary rights, such as confidential marketing information or client relations [15] and the scope of the agreement must be unambiguously defined. The 2009 Supreme Court of Canada case Shafron v. KRG Insurance Brokers (Western) Inc. 2009 SCC 6 held a non-compete agreement to be invalid due to the term "Metropolitan City of Vancouver" not being legally defined. [16]

In 2021, employees in Ontario may no longer enter into non-compete agreements. There are exceptions for when a business is sold, and for chief officers (such as CEOs, CFOs, etc.). [17]

France

In France, CNCs must be limited in time to a maximum of two years and to a region where the employee's new work can reasonably be seen as competitive. The region can be a city or the whole country, depending on the circumstances. The employer must pay financial compensation, typically 30 percent of the previous salary. [18] A CNC may not unreasonably limit the possibilities of the employee to find new employment.

Germany

In Germany, CNCs are allowed for a term up to two years. The employer must provide financial compensation for the duration of the CNC amounting to at least half the gross salary. [19] Unreasonable clauses – for example, excluding similar jobs throughout the whole of Germany – can be invalidated.

India

Section 27 of the Indian Contract Act has a general bar on any agreement that puts a restriction on trade. [20] The Supreme Court of India has clarified that some non-compete clauses—specifically, those backed by a clear objective that is considered to be in advantage of trade and commerce—are not barred by Section 27 of the Contract Act, and therefore valid in India. [21]

Italy

Non-compete agreements are prevalent in Italy. [22] In Italy, CNCs are regulated by articles 2125, 2596, and 1751 bis of the civil code.

Netherlands

In the Netherlands, non-compete clauses (non-concurrentiebeding or concurrentiebeding) are allowed regarding issues such as moving to a new employer and approaching customers of the old company. Unreasonable clauses can be invalidated in court. [23]

Pakistan

According to Section 27 of the Contract Act, 1872, any agreement that restrains a person from exercising a lawful profession, trade or business is void. [24] However, courts of Pakistan have made decisions in the past in favour of such restrictive clauses given that the restrictions are "reasonable". [25] The definition of "reasonable" depends on the time-period, geographical location and the designation of employee. In the case of Exide Pakistan Limited vs. Abdul Wadood, 2008 CLD 1258 (Karachi), the High Court of Sindh stated that reasonableness of the clause will vary from case to case and depends mainly on duration and extent of geographical territory [26]

Portugal

In Portugal, CNCs are regulated by article 136 of the labor code and restricted to two years extendible to three years in cases of access to particularly sensitive information. The employer must pay financial compensation for the duration of the CNC, but the law does not specify anything regarding the amount of the compensation. [27]

Romania

In Romania, CNCs are regulated by articles 21–24 of the labor code and restricted to two years. The employer must pay financial compensation for the duration of the CNC, amounting to at least 50 percent of the last 6 months salary.

Spain

In Spain, CNCs are regulated by article 21 of the labor law. CNCs are allowed up to two years for technical professions and six months for other professions, given that adequate compensation is given.

United Kingdom

In the United Kingdom, CNCs are often called restraint of trade or restrictive covenant clauses, and may be used only if the employer can prove a legitimate business interest to protect in entering the clause into the contract. Mere competition will not amount to a legitimate business interest. [28] The UK's regulator, the Competition and Markets Authority, advises that non-compete clauses are a form of employer collusion and are a form of a business cartel. [29]

Restrictions are normally limited in duration, geographical area (an "area covenant"), [30] and content. [31]

In the Crown dependencies, many financial and other institutions require employees to sign 10-year or longer CNCs which could be seen to apply even if they leave the country or enter an unrelated field of work.[ citation needed ]

In May 2023, the UK Government announced plans to limit non-compete clauses to a maximum of three months. [32]

United States

Prevalence and status

The majority of American states recognize and enforce various forms of non-compete agreements. A few states, such as California, North Dakota, and Oklahoma, totally ban noncompete agreements for employees, or prohibit all noncompete agreements except in limited circumstances. [33]

Data from 2018 indicates that non-compete clauses cover 18 percent of American labor force participants. [34] A 2023 petition to the FTC to ban non-compete agreements estimated that about 30 million workers (about 20% of all U.S. workers) were subject to a noncompete clause. [35] While higher-wage workers are comparatively more likely to be covered by non-compete clauses, non-competes covered 14 percent of workers without college degrees in 2018. [36] By some estimates, nearly half of all technical workers are covered by non-compete agreements. [4]

Federal law

In March 2019, Democratic officials, labor unions, and workers' advocacy groups urged the U.S. FTC to ban non-compete clauses. A petition to the FTC, seeking a ban on noncompete clauses, was submitted by the AFL-CIO, SEIU, and Public Citizen. [35] In July 2021, President Joe Biden signed Executive Order 14036, directing the FTC (whose chair, Lina Khan, he had recently appointed), as well as other federal agencies, to "curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility". On January 5, 2023, the FTC proposed a rule banning non-compete agreements. [37]

The U.S. Chamber of Commerce has lobbied against bans on non-compete agreements; in 2023, it threatened to sue the FTC if it bans non-compete agreements. [38] The Chamber argued that "noncompete agreements are an important tool in fostering innovation and preserving competition". [38]

Federal Trade Commission

On April 23, 2024, the Federal Trade Commission (FTC) issued a ban on nearly all non-compete agreements. [39] [40] The rule was published on the Federal Register on May 7 and the ban will go into effect on September 4, 2024. [41]

The FTC found as shown the use of non-compete clauses by employers has negatively affected competition in labor markets, resulting in reduced wages for workers across the labor force—including workers not bound by non-compete clauses and that by suppressing labor mobility, non-compete clauses have negatively affected competition in product and service markets in several ways. [42] The commission noted that the existing legal frameworks governing non-compete clauses—formed decades ago, without the benefit of this evidence—allow serious anticompetitive harm to labor, product, and service markets to go unchecked. [42] The Commission noted "that instead of using noncompetes to lock in workers, employers that wish to retain employees can compete on the merits for the worker's labor services by improving wages and working conditions." [43] In 2024, approximately one in five American workers, or about 30 million people, are subject to noncompetes. [43]

While CNCs are one of the most common types of restrictive covenants, there are many others. Each serves a specific purpose and provides specific rights and remedies. The most common types of restrictive covenants are as follows:

The enforceability of these agreements depends on the law of the particular state. As a general rule, however, with the exception of invention assignment agreements, they are subject to the same analysis as other CNCs. [44]

No-poaching agreements between employers are typically considered illegal anti-competitive collusion. (See for example High-Tech Employee Antitrust Litigation concerning Silicon Valley employers in the 2000s.)

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  41. ↑ "Non-Compete Clause Rule". Federal Register. 89 (89): 38342–38506. May 7, 2024. 89 FR 38342.
  42. 1 2 "Non-Compete Clause Rule". Federal Register. 88 (12): 3482–3546. January 19, 2023. RIN   3084-AB74, 16 CFR 910, 88 FR 3482. Retrieved 26 April 2024.PD-icon.svg This article incorporates text from this source, which is in the public domain .
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Works cited

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