By Herbert Hovenkamp, University of Pennsylvania
The Federal Trade Commission (FTC) has proposed a rule that would ban nearly all employee noncompetition agreements as unfair methods of competition. These agreements prevent an employee from taking a new job in a competing business for a certain period after his or her employment ends. The duration and geographic scope of the agreements varies.
Today, purely vertical noncompete agreements are analyzed under antitrust’s rule of reason and most are lawful under federal law. Several states have enacted stronger laws. The FTC’s proposed rule would apply the FTC Act, a statute that reaches further than the Sherman Antitrust Act but cannot be enforced by private parties.
This essay does not consider the FTC’s power to make and enforce a rule like the one proposed, but rather it addresses the wisdom of the proposed rule itself. Should employee noncompete agreements be invariably unlawful or should the law reach only a subset? If the latter, how should the law distinguish between different agreements?
The effects of employee noncompete agreements vary with the type of job. Recent attention has turned to noncompete agreements covering lower-wage employees in industries such as fast food. These are unjustified and anticompetitive, and there is growing support for prohibiting them. In these situations, employers have not invested a great deal in specific employees. Most of their employment is “at will,” which means that either employer or employee can ordinarily terminate employment on reasonable notice. A noncompete agreement in such situations is nothing more than an anticompetitive restraint on employee mobility, limiting an employee’s right to seek a better job by moving or threatening to move elsewhere.
Other employees are different. They may receive specialized training that is costly to their employer and “portable” in the sense that the training can be carried to a different employer. They might also hold confidential information, trade secrets, customer lists, or other knowledge that would be of value to a different employer. For many of these employees, a noncompete agreement is the only effective way an employer can protect its investment from the risk of “free riding,” which occurs when one person is able to commandeer another person’s investment. For example, although an employer may be able to prohibit an employee from purloining a trade secret, there is no way to prohibit a former employee from using skills provided by the first employer in a second employer’s business. Here, noncompete agreements are socially valuable, provided that they are reasonable in scope and duration. Workers who sign such agreements often receive higher wages than those who do not, because the noncompete agreement protects the employer’s investment. A rule categorically banning them would harm these workers as well as their employers.