By Aparajita Lath
In January, the Federal Trade Commission (FTC) released a new draft rule that would categorically ban non-compete clauses — contractual terms between an employer and an employee that prevent subsequent employment at a competing firm — across the country.
Banning non-compete clauses may help to promote competition and innovation in biotechnology and health care.
Currently, there is a high degree of knowledge concentration in new and evolving technologies in the biotechnology sector. For instance, as revealed in the ongoing litigation between HDT and Emcure over saRNA technology, knowledge and know-how related to this new technology is limited to a ‘tiny community’ of highly specialized and experienced alphavirologists. If the members of this tiny community of experts are subject to non-compete agreements or very broad non-disclosure agreements, they may not be able to start new businesses in this field or work for competitors.
In other words, the concentration of knowledge in the hands of a few major players can impact competition, innovation, and prices.
Overview of non-compete clauses
Based on available evidence, the FTC estimates that approximately one in five American workers, or approximately 30 million workers, are bound by a non-compete clause.
Currently, the enforceability of non-compete terms depends on applicable state law. State laws vary, but all 50 states restrict non-compete clauses to some degree, either based on occupation, earnings, or other such conditions. Only three states – California, North Dakota and Oklahoma have laws that render non-compete clauses void for nearly all workers.
The FTC now proposes a ban on non-compete clauses, post-employment, across all states (subject to limitations, such as contracts between a buyer and a seller of a business). The rule will contain an express preemption provision and will establish a nationwide regulatory floor.
The ban on non-compete clauses could result in substantial benefits, including an increase in worker’s earnings by $250-$296 billion annually, decreased health care prices, and increased innovation and competition. On the flip side, the FTC estimates that the proposed rule could result in a decrease in spending on worker training and investment in capital assets.
Innovation, non-competes, and non-disclosure agreements
The FTC proposal cites studies that show non-compete clauses can tie up industry expertise and experience, which can adversely impact innovation. Lifting non-compete barriers could consequently increase knowledge-sharing and innovation. The FTC cites studies that have tried to quantify this effect through studying patenting activity.
California, a poster child for technological innovation and success, has long had a statute that renders non-compete clauses void. In states like California, where employers cannot enforce non-compete clauses, investments are protected through trade secrecy laws and non-disclosure agreements. Trade secrecy protection is recognized as a legitimate interest of an employer and nearly all states protect this interest. Some states go further by granting protection to confidential information that are not trade secrets.
The FTC finds these alternatives to be more appropriate since they are narrowly tailored compared to blanket non-compete clauses. Such agreements do not prevent employees from joining competitors or starting a new business, but prevent them from using certain information that is identifiable and commercially valuable in their new employment. Employees therefore “remain free to work for whomever they wish, wherever they wish, and at whatever they wish,” subject only to restrictions on the disclosure and use of certain information.
While the use of non-disclosure agreements is generally recognized as a legitimate means of protecting commercially valuable information, concerns exist regarding the breadth of these agreements. Non-disclosure agreements can be very broad and can effectively prevent workers from working in a particular industry. The FTC notes that very broad non-disclosure agreements, that operate like non-compete clauses, will fall within the scope of the proposed ban.
For example, an unusually broad non-disclosure agreement that defined ‘confidential information’ as any information that is ‘usable in’ or ‘relates to’ the securities industry was held to be too broad, as it effectively prevents a worker from ever working in securities trading (Brown v. TGS Mgmt. Co., LLC). Similarly, prohibitively large liquidated damages can also operate as de facto non-compete clauses (Wegmann v. London).
The FTC first began focusing on non-compete clauses in 2010, and this proposal represents a culmination of several years of evidence gathering, empirical research, public comments, and engagement on the effects of non-compete clauses on competition in the labor and product and services market.
However, one FTC Commissioner has dissented, citing a lack of evidence and lack of authority to support the new rule. This was the only dissenting opinion in the 3-1 vote to the published proposal.
The FTC has invited public comments on this proposed rule and the due date for submission of comments is March 20, 2023.