The Federal Trade Commission has enacted a rule banning most employment related non-compete agreements. This rule is scheduled to become effective on September 4, 2024, and could be a win for Hawaii employers. Why?
First, the FTC makes a strong case that non-competes are bad for everyone. Not just workers and consumers, but also businesses denied access to workers they need and even businesses that rely on non-competes to ignore consumer needs.
After the FTC issued its Notice of Proposed Rulemaking last year, it received 26,000 comments. Of those, 25,000 were in support of the proposed ban on non-competes.
The 570-page announcement of the FTC’s final rule includes some of the comments. Many comments illustrate how non-competes negatively affect workers, as these agreements are often not negotiated and can come as a surprise. New employees frequently sign them to secure a job with little thought to future impacts. They later find their careers derailed or new business opportunities impossible when it is time to move on:
“I was laid off from my company in 2008 due to the economy; not to any fault of my own. However, when I was offered a job at another company, my former company threatened them and my offer was rescinded. I was unable to find gainful employment for months, despite opportunities in my field, and had to utilize unemployment when I otherwise would not have needed it. To find work, I ultimately had to switch fields, start part time somewhere, and just continue to work my way up. All of this because I was laid off to no fault of my own.”
Other comments show how non-competes can harm consumers, such as by keeping patients from seeing the health care provider of their choice:
“I was terminated by a large hospital organization suddenly with a thriving, full Pediatric practice. … My lawyer and I believe the non-compete does not apply in my circumstances and that the noncompete is overly broad, restrictive, and harmful to the public (my patients). I started seeing my patients mostly gratuitously in their homes so they would not go without the care they wanted and needed. … The judge awarded the order and I was told I cannot [have any contact with my patients or] provide any pediatric care within my non-compete area. Patients are angry and panicked. I’m worried every day about my patients and how I can continue to care for them. … Patients have a right to choose and keep their doctor. The trust built between a patient and [their] doctor is crucial to keeping a patient healthy. It’s not a relationship that can or should be replaced. … Patients should always come first and that is not happening.”[1]
Comments also illustrate how non-competes can be bad for industries that rely on skilled workers:
“I am the owner of a small-midsize freight brokerage, and non-competes of large brokerages have time and time again constrained talent from my business. Countless employees of [a] mega brokerage … have left and applied for our company and we must turn them away. These are skilled brokers that are serving the market and their clients well due to their skill sets. … These non-competes affect not just me but the clients they work with, as these skilled brokers are forced out of the entire logistics market for an entire year and possibly a lifetime when they pick up a new career in a different field because of these aggressive non-competes.”
Comments also address how non-competes can be bad for employers that rely on them. When non-competes disable competitive labor markets, businesses stagnate and fail to adapt to the needs of customers and employees alike:
“Non-competes serve little more purpose than to codify and entrench inefficiencies. I have seen this firsthand in the context of a sophisticated management consulting environment where company owners provided ever less support in terms of contributing to projects or even to sales of new business while still feeling secure through agreements that substantially limited anyone from working in the relevant industry for two years on a global basis after leaving. … The reality is that there are innumerable retention mechanisms (such as good working conditions, compensation, culture, management, growth trajectory and/or strategy) that can contribute to loyal employees without the need for non-competes.”
And this can lead employees to recognize opportunities to fairly compete that will become increasingly difficult to prevent as the legal environment shifts away from enforcement of non-competes:
“I currently work in sales for an asphalt company in Michigan. The company had me sign a two year non-compete agreement to not work for any other asphalt company within 50 miles if I decide to resign. After two years with the company I have been disheartened at how poorly customers are being treated and how often product quality is sub-par. I would love to start my own business because I see this as an opportunity to provide a better service at a lower cost. However, the non-compete agreement stands in the way even though there are no trade secrets and too many customers in this market.”
Second, the FTC rule would benefit Hawaii employers by providing certainty. Many businesses may worry that the FTC would be taking away a critical tool in protecting their business — but in Hawaii, the benefits of a non-compete are not well defined and are often illusory.
In the case of Prudential Locations, LLC vs. Lorna Gagnon (2022), an Oahu real estate brokerage tried to enforce a non-compete to stop one of its employees from opening her own competing brokerage. The Hawaii Supreme Court noted the trends toward restricting the enforceability of non-compete agreements and that some states have banned all or specific types of non-competes,[2] but declined to take that step.
Non-competes must be supported by some legitimate business purpose, like protecting trade secrets or customer relationships. Preventing competition is not a legitimate purpose. But every business fears, and would on some level love to eliminate, its competition. And it can be difficult for a business witness to avoid acknowledging this fact, such as in this exchange quoted in the Gagnon decision:
“Tabori stated during his deposition that preventing competition from new firms was a purpose of the non-compete agreement:
Q. You said that the rationale for having a noncompete that prevents someone from forming a new entity such as Ms. Gagnon’s restrictive covenant is that you don’t want someone to start up a new competing enterprise against you, essentially with your stuff. Fair?
A. That would be the reason to put that language into the noncompete that Lorna Gagnon signed, fair.”
For the Hawaii Supreme Court, this was enough to invalidate the enforcement attempt, on the basis of an improper purpose: trying to prevent competition. Yet, the question posed to the witness includes the phrase, “…with your stuff,” presumably meaning to prevent unfair competition by competing with the benefit of the employer’s confidential information. The Court appears to ignore this important qualification. After nine years of litigation, the employer’s case seems to have been sunk by one misconstrued deposition answer.
And there’s more potential bad news in the Gagnon opinion. The Court set a very high bar for non-competes that seek to protect trade secrets and confidential information. Employers will need to be scrupulously consistent in implementing their non-competes. If they are not, they expose themselves to a ruling that the information they sought to protect is not actually confidential:
“. . . the information that Locations asserts constitutes a protectible legitimate purpose was not actually ‘confidential.’ As noted by the circuit court, other Locations employees and managers with similar or more access to the allegedly confidential information were not restricted by non-compete agreements. For example, only some of the 18 sales coaches employed by Locations were subject to non-compete agreements. Further, despite Locations’ purported confidentiality concerns, the non-compete clause only prohibited Gagnon from starting her own firm, but permitted her to work for an existing brokerage firm even within one year of leaving Locations. In addition, Locations did not produce any evidence of and did not dispute that there was no trade secret violation.”
The underlined language above is a Catch-22 for employers. It seemingly requires that all employees with access to confidential information be bound to a non-compete. For example, an executive and their secretary often have access to the same information. Should the secretary have the same non-compete as the executive? Before the Gagnon case, most Hawaii employment attorneys would have said that because the secretary is not a competitive threat, a non-disclosure agreement is what’s warranted for the secretary; not a non-compete. Yet, requiring a secretary (or an entire workforce) to enter a non-compete is just the sort of overreach other courts take as an indication the employer is using non-competes for the improper purpose of preventing competition. [3]
Hawaii also has a non-compete-specific attorneys’ fee statute that requires a court to award attorneys’ fees to a former employee who successfully defends an attempt to enforce a non-compete.
In this legal environment, the FTC rule would be doing Hawaii employers a favor by eliminating the legal uncertainty under current case law.
But will the new rule be allowed to take effect? Not likely. It is already subject to multiple legal challenges, including in Texas, where opponents of federal regulations have had success in challenging them, including in the employment arena.
But Hawaii employers should not wait for the FTC rule to take effect to assess their use of non-compete agreements. Most are worth little more than an opportunity to bully a former employee unable to afford legal counsel out of a job no court would make them give up. If their new employer is willing to hire counsel, that push back will likely be enough to demonstrate the actual weakness of the agreement. The FTC’s rule, even if enjoined, will bolster the arguments against non-competes, as well as the general perception of their harmfulness and unenforceability. The more an employer pursues enforcement, the more money is spent on attorneys rather than business improvements and employee retention.
Hawaii employers might be better served to consider non-solicitation agreements. These are typically far more defensible, and do not require an employer to ask a court to put someone out of a job.
Labor is a competitive market. Hawaii businesses compete to keep employees every day. Non-competes may make it difficult for employees to leave, but employees certainly won’t be happy if they feel stuck — and employers can’t expect workers to do their best for the business if they feel like hostages in the workplace.
[1] Health care non-competes are particularly harmful in places like Hawaii where there are shortages of health care professionals. See Non-Compete Clauses in Physician Employment Contracts are Bad for our Health, Hazel G. Beh and Ramsey Ross, Hawaii Bar Journal, Vol. 14, No. 13 (July, 2011).
[2] Hawaii has already banned non-competes for “technology businesses” (think software developers) to promote market benefits similar to reasons articulated in the FTC rule.
[3] Requiring a secretary to enter a non-compete could also prompt an unfair labor practice charge with the National Labor Relations Board, as the NLRB General Counsel last year opined that most non-competes with non-supervisory employees violate the National Labor Relations Act. https://www.nlrb.gov/news-outreach/news-story/nlrb-general-counsel-issues-memo-on-non-competes-violating-the-national