Perspectives: Noncompete agreements: bans and battles

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“Restrictive covenants [that] prevent an employee from working for others … in the same competitive field … constitute a form of industrial peonage without redeeming virtue in the American enterprises system.”
Eutic Welding Alloys v. West, 160 N.W.2d 566, 571 (Minn. 1968)

The nationwide ban on noncompete agreements issued this spring by the Federal Trade Commission (FTC), is likely, if it ever goes into effect, to have a major impact on employers and employees alike, including here in Minnesota, where these restrictive devices were barred in large part last summer.

The FTC measure comes on the heels of legislation in Minnesota last year, Minn. Stat. § 181.988, in which the state joined an eclectic group of three others that proscribe most noncompetes. The Minnesota ban, effective from July 1, 2023, has not encountered any major judicial challenges yet.

But it didn’t take long for the FTC edict, approved by a narrow one-vote margin by the FTC on May 7 for implementation right after Labor Day, to come under legal assault. Within a day of issuance, the first of at least three legal battles was brought by the National Chamber of Commerce and other business interests, which have spread to other forums seeking to set it aside.

The competing lawsuits at the federal level raise complex procedural issues before the substantive ones can be addressed, including jurisdictional battles over which cases are to proceed in their respective jurisdictions.

Federal focus

Noncompete agreements, which restrict employees from joining competitors or starting their own competitive operations for a definite period of time, have been a focal point of the federal government since the beginning of the Biden administration. The FTC’s aggressive administrator, Lina Khan, has been a longtime foe of these devices, which she views as an unfair means of stifling employability and compensation, along with a negative impact on economic advances by individuals affected by them and hurting the economy in general.

While the FTC professes that the noncompetes can be inequitably exacted by employers with much more leverage than employees over prospective or current employment, its ban is premised largely on economic grounds.

In its edict this spring, the agency forecasts that limiting noncompetes would add approximately $524 to the average weekly wages of workers by giving them greater mobility and, therefore, increasing their leverage in negotiating with their employers, along with lowering health care costs by nearly $200 billion over the next decade. The FTC also estimates that its proscription will encourage startups of some 8,500 new businesses and will even help launch an 17,000 or more patents annually by employees who are unable to get out from under restrictive covenants and join other competitors or start their own businesses.

The effect of the FTC ban would be broad because it is estimated that some 20% of the workforce, about 30 million employees, is subject to these devices. That figure includes an estimated 300,000 in Minnesota.

Their pervasiveness is astonishing from their minimal roots, dating back to the late 19th century. The permissibility of noncompetes has been subject to legislation in some states and by common law judicial rulings in others over the years, varying from state to state.

As a general rule, Minnesota has been in the mainstream of jurisdictions, allowing them if entered into at the very outset of employment relationship or, if later, for some type of compensation or other “consideration”; are limited in scope; extend for a reasonable duration; are necessary to protect the interests of the employer; and are equitable to the interests of both employers and employee. See Friedman, E.g., Freeman v. Duluth Clinic, Ltd., 334 N.W.2d (Minn. 1983).

Fast food fuel

The rise of restrictions on noncompetes, a topic regulated only by state legislation and common law court rulings, was fueled by efforts in recent years to impose noncompetes on fast-food workers and other low-paid employees, who customarily have not been subject to these devices.

Minnesota Sen. Al Franken was in the vanguard in offering federal legislation nearly a decade ago to limit their use for low wage employees. However, it floundered in Congress. Fast forward to the Biden administration and the FTC, now with a majority of three Democrats on its five member board, devised the new ban. It was adopted on a partisan 3-2 vote, following public input that saw about 26,000 written comments, with the vast majority, about 25,000, urging restrictions or prohibitions on noncompete arrangements.

Using its acting authority under Section 5 of the enabling statute, 15 U.S. C., §§ 41-58, which authorizes an agency to curtail “unfair methods of competition,” the FTC rolled out is measure with a 500-page pronouncements in early May, 120 days before the anticipated post-Labor Day launch.

But a funny thing happened on the way to implementation. In one of the multiple Federal lawsuits that sprung up forthwith, a judge in Texas early last month enjoined the ban in Ryan v. FTC, 2024 WL 3297524 (N.D. Tex. July 3, 2024) viewing it as “unreasonably overbroad,” lacking a “reasonable explanation” by the agency, and being “arbitrary and capricious.”

But less than three weeks later, a Pennsylvania jurist reached an opposite result and declined to halt its implementation in ATS Tree Services, LLC v. FTC, 2024 WL 3511630 (E.D. Pa. July 23, 2024). That ruling regarded the measure as a permissible exercise of agency authority.

The dual duels are likely to keep the pot boiling for quite a while, possibly leading to the Supreme Court, which may have the opportunity to deploy its new outlook on administrative regulations following its ruling at the end of this past term knocking out the long-standing deference to agency actions under the Chevron doctrine in Loper Bright Enterprises v. Raimondo, 144 S.Ct. 2244 (2024).

Minnesota measure

The Minnesota measure came about as a result of the DFL last year gaining a slender majorities in the Legislature and continues its hold on the governor’s office. The enactment joins an eclectic trio of other states that have largely banned these arrangements.

But the Minnesota law was not as broad as some proponents sought. It applies to noncompete agreements entered into between employers and employees on or after July 1, 2023. However, it does not affect noncompete arrangements entered into in connection with the sale of a business, which generally is acceptable because these arrangements usually are arm-length transactions, devoid of the disparate bargaining power between employers and employees in the workplace.

The Minnesota law does not apply retroactively to agreements signed before last July 1, although many of those measures have expired or soon will evaporate by their terms anyway.

But one major shortcoming viewed by many, at least from the standpoint of employees, is that the measure does not prohibit non-solicitation clause agreements, which can be nearly as onerous as noncompete agreements because as a back door to restrict individuals who have developed valuable relationships with a customer base.

The permissibility of non-solicitation clauses affects a broad swath of employees, such as sales personnel, financial advisers, insurance agents and many professionals who have direct customer contact and would be barred from capitalizing on those relationships under non-solicitation clauses. But those individuals looking for work elsewhere or thinking of beginning a startup, saddled with a non-solicitation clause can be almost as onerous as a noncompete agreement by barring contact with past and existing customers. Lawyers, incidentally, are not subject to noncompete agreements, as proscribed by Rule 5.6 of the Minnesota Rules of Professional Conduct.

A portion of that concern was alleviated this year when the solons in St. Paul added a new measure, Minn. Stat. § 181.9881 barring non-solicitation clauses in arrangements with independent contractors or in hiring service workers.

The specter of non-solicitation clause is present, but perhaps less pronounced, under the FTC proscription. While the proposed federal ban does not expressly reference non-solicitation agreements at all, it states that arrangements besides traditional noncompetes may be deemed invalid if they have a similar restrictive effect, a characterization that may be applicable to many non-solicitation clauses that are allowable under last year’s Minnesota law.

The federal measure is not all-encompassing, either. Like the Minnesota proscription, it does not address business transactions in which they may be valid.

But the FTC edict is also more narrow than the Minnesota proscription insofar as it does allow noncompete agreements for high level “executives,” described as those who make more than $151,164 per year, and occupy “policy-making” positions.

That should not worry too many fast food workers.

But a major distinction between the federal and Minnesota prohibitions is that the federal one bars “enforcement” of any noncompetes, regardless of where they are entered into, making it retroactive — unlike the Minnesota law, which applies only to those agreements entered into on or after last July. Thus, under the federal measure, employers cannot enforce noncompete agreements, even if they are entered into before the FTC edict goes into effect, which due to the pending litigation, probably will be delayed for many more months, if not years.

Two tussles

Meanwhile, the 8th U.S. Circuit Court of Appeals within the past two months has adjudicated two noncompete tussles reaching rival results: one affirming an injunction and the other dismissing the lawsuit.

In Cigna Corp. v. Bricker, 103 F.4th 1336 (8th Cir. June 5, 2024), the court affirmed a lower court injunction barring an executive with a two-year noncompete with a large pharmaceutical corporation from working for its largest competitor. Upholding the lower court bar, the court held that the “highly talented and sought after corporate executive” could be temporarily restrained from jumping to the health care corporation on grounds that her former employer’s “interests are substantial and numerous” and a “fair chance” exists that the agreement, although “broad,” is “reasonable and enforceable” and “not broader than necessary to protect [the company’s] legitimate interests.”

But a similar North Dakota noncompete lawsuit was dismissed by the 8th Circuit in Jacam Chemical Company 2013, LLC v. Shepard, 101 F.4th 954 (8th Cir. May 17, 2024). Affirming a lower court ruling, the panel, which included Judge David Stras of Minnesota, held that an exiting executive with a chemical company could not be prevented from joining a competitor because he “owed no contractual obligation to his former employer.”

While noncompete agreements are barred under North Dakota law, the employer sought to enforce nondisclosure and non-solicitation clauses in the employment agreement. But that contract did not apply under applicable state law due to “failure-of-consideration” when the employment agreement was renewed. Nor was a handbook applicable because it was not “entered into as a contract and there was no “other consideration.”

Impact intrigue

If the FTC noncompete edict is restricted or extinguished, the Minnesota bar will still remain in effect.

But challenges to that measure may be forthcoming, and an adverse high court ruling on the FTC ban could furnish momentum to attack certain portions of Minnesota law, too, perhaps albeit on different grounds since it was the product of legislation, rather than administrative action.

It is intriguing to anticipate whether the federal ban or its Minnesota counterpart will stand and how either or both may impact workplaces in Minnesota and elsewhere.

PERSPECTIVES POINTERS 

States with laws barring noncompetes

California

North Dakota

Oklahoma

Minnesota

Marshall H. Tanick is an attorney with the Twin Cities law firm of Meyer Njus Tanick.