Regulating Non-Compete Agreements

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Governments should place limits on non-compete agreements that apply to low-wage workers.

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Jimmy John’s, a well-known sandwich chain, made national news in 2014 for requiring its sandwich makers to sign non-compete agreements as a condition of employment. The Jimmy John’s non-compete agreement prohibited employees for two years from working at companies that derived at least 10 percent of sales from selling sandwiches and operated within two miles of a Jimmy John’s store. This news item brought the issue of non-competes covering workers in low-wage industries into the national conversation and it has not left.

Due to the clear negative effect of these agreements that this coverage helped bring to light, state and federal legislators should endeavor to enact laws to ban entirely or severely limit the usage of non-compete agreements. In those states that have already banned or limited these agreements, states should attempt to increase enforcement in order to reduce their continuing usage with a special emphasis on assisting workers in low wage industries.

Since Jimmy John’s made headlines, there have been a number of responses to the issue, including governmental and scholarly studies on the issue of non-compete agreements and their increasing usage. These studies have shown that usage of such agreements has increased and that they are no longer limited to workers at the highest echelons of their companies. Instead, non-compete agreements are applied to anyone who the employer thinks may have access to proprietary information. Studies have shown that nearly 40 percent of workers have been covered by non-competes at some time.

Economists and antitrust experts have also written about non-compete agreements and how they connect to the concept of monopsony. Monopsony in this context means that employers have outsized power over wages, which results in wages remaining stagnant. Experts have theorized that the increasing usage of non-competes has contributed to the increase in wage inequality by tipping the hiring process in favor of employers and thereby consolidating employer power. The Brookings Institution released a paper describing the phenomenon and stated, “Labor market collusion or monopsonization—the exercise of employer market power in labor markets—may contribute to wage stagnation, rising inequality, and declining productivity in the American economy, trends which have hit low-income workers especially hard.”

To put it in plainer terms, non-compete agreements diminish a worker’s power to change jobs and bargain for higher wages by stopping workers from moving between jobs. This phenomenon is especially prevalent in low-wage and minimum-wage industries. A study by the U.S. Department of the Treasury even showed an association between stricter non-compete enforcement, lower wage growth, and lower initial wages.

Due to the detrimental effect of these agreements on workers and the way that they lead to a decrease in worker power, there is a need for more innovative legislative proposals, ones that decrease the number of workers affected by these agreements and also allow for greater enforcement mechanisms.

Change is on the horizon at the state level. The most significant result of public scrutiny and academic research has been state proposals and legislation to tackle the issue of non-compete agreements.

But some of these proposals have fallen short of what is needed to protect workers because the proposed policies do not incorporate a clear understanding of how non-compete agreements are enforced. Companies can use both litigation and other negotiation tactics that take advantage of their power differential over employees.

Management lawyers recommend “informal” methods of enforcing non-compete agreements, including sending letters to workers and contacting their new employers to avoid litigation. Such tactics effectively force workers to resign from their new jobs or change fields to avoid detection. Companies using these tactics force workers to attempt to get out of non-competes using formal methods such as legal appeals to the unconscionability of the contract and declaratory judgments.

The Illinois Freedom to Work Act of 2016 is just one example of a state proposal that was important in the movement to protect workers in low wage industries from non-competes, but that did not go far enough. The Illinois Act followed a significant state appellate court decision that held that continued at-will employment was insufficient consideration to support a non-compete under Illinois law. The case probably assisted substantially with the push for legislative action in Illinois.

In its Act, the Illinois legislature prohibited private-sector employers from entering into a covenant not to compete with any of their low-wage employees. It directly targeted workers in low-wage industries for protection and included a clear prohibition of non-competes. The Illinois Act, however, only addressed minimum-wage workers and did not provide a private right of action or attorney’s fees, two items that are crucial to get private attorneys to take on cases in this arena.

Other states have begun to pass legislation as well. Oregon passed a law limiting non-competes to 18 months in duration, requiring notice and consideration beyond continued employment for some agreements. New Mexico restricted the use of non-competes among health care workers. Nevada passed a law requiring valuable consideration for non-competes among other restraints on the agreements. Hawaii prohibited the usage of non-competes in the technology industry.

Massachusetts is the newest law on the books, and that law includes substantial protections. It clearly defines non-compete agreements and sets forth eight requirements that must be met for such an agreement to be valid and enforceable in the state.

Notably, the Center for American Progress recently released a report suggesting that new non-compete legislation must give workers and enforcement agencies the tools to enforce these rights. The report’s proposals include many of the items in the Massachusetts law, such as disclosure of non-competes at the outset of employment and consideration. A focus on providing these remedies can only serve to increase worker power in this arena.

Including other items, such as an affirmative private right of action, will make state legislation more effective at protecting workers from overreaching non-compete agreements. States can also encourage state agencies to investigate the unlawful usage of non-competes. Currently only the Illinois and New York State Attorneys General have undertaken enforcement efforts in this area. The related area of no-poaching—where companies prohibit their franchisees from hiring workers from one another—has galvanized more state enforcers, such as Washington State.

As states continue to draft new proposals, policymakers should expand the reach of non-compete legislation beyond minimum-wage workers, including in such legislation a private right of action, penalties, or both to encourage more workers to come forward and challenge unlawful non-competes, and encourage government intervention where possible so that workers do not have to come forward individually and litigate these agreements.

By focusing on these concrete steps, the damaging effects of non-compete agreements can be reduced in the workplace, with the ultimate goal of allowing workers the flexibility to move freely in the workforce.

Najah A. Farley

Najah A. Farley is a senior staff attorney at the National Employment Law Project.

This essay is part of a nine-part series, entitled The Future of Workplace Regulation.