By Bob Needham
Michigan Law
A new federal rule prohibiting companies from requiring noncompete agreements from employees may wind up reducing their use even if the rule is overturned, Professor J.J. Prescott says.
The agreements—in which the employee agrees not to go to work for a competitor or start their own business if they leave their employer—have become commonplace in recent years. The Federal Trade Commission (FTC), relying substantially on Prescott’s research, estimates that 20 percent of U.S. workers are subject to one. Under the new FTC rule, employers, in most cases, may no longer use the agreements—although court challenges to the rule are already in the works.
Prescott, the Henry King Ransom Professor of Law, has done considerable research into noncompete agreements, and the FTC extensively cited the work of Prescott and his co-authors in first proposing the new rule. Prescott—who is also co-director of the Michigan’s Empirical Legal Studies Center and co-director of the Program in Law and Economics—recently answered five questions about the issue:
1. Your research has highlighted just how prevalent noncompete agreements are—even, somewhat surprisingly, in lower-paid, lower-skill jobs. Where are they most common?
They are common in virtually all fields of employment. Although they are most prevalent where you might expect—higher-paying jobs with access to confidential information—our study found less variation between types of jobs than I believe most people would have predicted.
I personally expected to find very few noncompetes binding low-wage workers because such agreements seem likely to be more trouble than they’re worth for employers. Yet in many fast-food, seasonal, or similar types of jobs, instead of just showing up and punching a timecard, you’re now likely to find you have a bunch of paperwork to sign and an employee handbook to review on your first day. Both may contain a noncompete that you feel locked into signing.
I also expected to find that in certain high-end positions, where people have received significant training and have access to client lists, trade secrets, and other kinds of proprietary information, noncompetes would be nearly universal. But noncompetes appear to be less common in high-earning and technical fields than I would have predicted. Even so, the more technical, the more professional, the higher-paid your job, the more likely you are to be asked to sign a noncompete. In certain occupations and industries, you’re two or three times as likely to have one.
2. Do workers tend to object to, or at least to negotiate, noncompete agreements?
In the Journal of Law and Economics, my co-authors and I present evidence on this question. If noncompetes are a constraint on employee mobility, we would expect workers to demand something in return for signing one. Yet we don’t really see a lot of that, on average, at least if the employee is asked to sign a noncompete after they have already accepted their job. We also find in our survey work that very few people negotiate over noncompetes. Apparently that’s because they do not believe that refusing to agree is a realistic option and they worry that negotiating over a noncompete sends a negative message to their new employer that might harm their career.
At the same time, if you are made aware that you will be asked to sign a noncompete before you accept a job, you’re more likely to receive training and have higher wages—which suggests that having outside options at the time a noncompete is contemplated matters to an employee’s experience at that employer. Yet a lot of people do not receive notice that they will be asked to sign a noncompete in advance. They basically find out about it on day one. So you turn down all your other job offers and then show up on the first day, and the noncompete is in that bunch of papers that you have to sign. Not surprisingly, many people in that situation believe that they can’t say no and that negotiation is a nonstarter.
3. Are there issues with enforcing noncompete agreements?
Historically, noncompetes have been governed by state law. In some jurisdictions, like California, noncompetes are unenforceable in court, but they still appear regularly in employee contracts. This is surprising but part of a larger pattern. Research over the last 10 years has shown that in the context of leases, consumer contracts, and other domains, contract drafters often include provisions that they know are invalid—because the employee, renter, consumer, etc., does not know they are invalid and assumes, reasonably in my view, that if a provision appears in a contract, it must be something that can be enforced. In the case of leases, if even a small fraction of a landlord’s tenants adhere to invalid provisions that benefit the landlord, it’s probably worth it for landlords to include them.
Our latest paper, which is forthcoming in the Journal of Legal Studies, examines beliefs about the enforceability of noncompete agreements. Most people believe that noncompetes are enforceable, even when they are not. If you’re in California, for example, where noncompetes have been unenforceable for more than a century, most employees still believe that they are enforceable. When people trust that language in contracts is lawful, there is real potential for abuse by contract drafters.
We also asked people with noncompetes whether they would consider leaving their job and under what conditions. We find that even where noncompetes can’t be enforced, and even when we inform them that noncompetes are unenforceable in their jurisdiction, some people still report that their noncompete would matter to their decision to leave their employer. What we don’t know yet is why. You might comply with a noncompete because you feel like it’s a contract and it could be enforced against you, but you might also comply simply because you feel like you made a promise or because your reputation might suffer if you leave after “agreeing” not to compete.
4. Assuming that the new FTC rule holds up as it’s currently written, how broad are the effects likely to be?
The new rule has received a lot of attention, and if the courts conclude that the rule is valid, many companies will of course simply drop noncompete provisions from their employment contracts. Employers also are required to inform people who are currently bound by noncompetes that their noncompete is no longer enforceable. My guess is that the rule is going to make a pretty big difference for a lot of individuals in the economy. That said, employers are still invited to use “alternatives,” like confidentiality agreements, to protect legitimate employer interests, and innovation in the use of other types of provisions may wind up limiting the impact of the rule.
On a broader scale, one of the main takeaways of the academic literature is just a simple fact about employment contracting: Low-wage noncompetes exist even though they don’t seem to make a lot of sense, and even when the chances that an employer would sue to enforce a noncompete are very small. One very credible explanation in the low-wage setting is that noncompetes can retard wage growth by preventing people from moving to other, similar jobs where somebody is willing to pay them a higher wage. Indeed, this sort of mobility is one of the main sources of wage growth in the economy. The FTC’s rule may make it harder for employers to inhibit mobility among those in the lower part of the income distribution.
Importantly, even if the rule is ultimately overturned in court, the conversation and the rule itself may still change behavior. Employees are more likely to be aware of noncompetes and their effects. The FTC’s defense of the rule and its assembling of evidence for why noncompetes are, on balance, bad for competition might make some companies rethink how they approach post-employment covenants. Or companies may think they are at great risk in the years ahead from their state banning noncompetes even if the federal government doesn’t succeed in its defense of a national ban.
5. How likely is it that the rule will be overturned?
The consensus appears to be that the rule is quite vulnerable to being overturned by the courts. My colleague Dan Crane conducted a non-scientific survey of scholars on this question, and nearly every single person (of an admittedly small pool) who responded purported to believe that the rule will be overturned in one way or another, albeit for different reasons.
The Supreme Court has been pretty critical of agency actions in recent years, and the FTC’s noncompete rule is the sort of action that has worried the courts. It’s a broad rule that applies in lots of situations to a lot of employers. It will affect tens of millions of employment relationships.
For these reasons alone, it is certainly very possible that the FTC’s more-than-500-page defense of the rule will not be enough to convince the Supreme Court that the rule is valid.
Michigan Law
A new federal rule prohibiting companies from requiring noncompete agreements from employees may wind up reducing their use even if the rule is overturned, Professor J.J. Prescott says.
The agreements—in which the employee agrees not to go to work for a competitor or start their own business if they leave their employer—have become commonplace in recent years. The Federal Trade Commission (FTC), relying substantially on Prescott’s research, estimates that 20 percent of U.S. workers are subject to one. Under the new FTC rule, employers, in most cases, may no longer use the agreements—although court challenges to the rule are already in the works.
Prescott, the Henry King Ransom Professor of Law, has done considerable research into noncompete agreements, and the FTC extensively cited the work of Prescott and his co-authors in first proposing the new rule. Prescott—who is also co-director of the Michigan’s Empirical Legal Studies Center and co-director of the Program in Law and Economics—recently answered five questions about the issue:
1. Your research has highlighted just how prevalent noncompete agreements are—even, somewhat surprisingly, in lower-paid, lower-skill jobs. Where are they most common?
They are common in virtually all fields of employment. Although they are most prevalent where you might expect—higher-paying jobs with access to confidential information—our study found less variation between types of jobs than I believe most people would have predicted.
I personally expected to find very few noncompetes binding low-wage workers because such agreements seem likely to be more trouble than they’re worth for employers. Yet in many fast-food, seasonal, or similar types of jobs, instead of just showing up and punching a timecard, you’re now likely to find you have a bunch of paperwork to sign and an employee handbook to review on your first day. Both may contain a noncompete that you feel locked into signing.
I also expected to find that in certain high-end positions, where people have received significant training and have access to client lists, trade secrets, and other kinds of proprietary information, noncompetes would be nearly universal. But noncompetes appear to be less common in high-earning and technical fields than I would have predicted. Even so, the more technical, the more professional, the higher-paid your job, the more likely you are to be asked to sign a noncompete. In certain occupations and industries, you’re two or three times as likely to have one.
2. Do workers tend to object to, or at least to negotiate, noncompete agreements?
In the Journal of Law and Economics, my co-authors and I present evidence on this question. If noncompetes are a constraint on employee mobility, we would expect workers to demand something in return for signing one. Yet we don’t really see a lot of that, on average, at least if the employee is asked to sign a noncompete after they have already accepted their job. We also find in our survey work that very few people negotiate over noncompetes. Apparently that’s because they do not believe that refusing to agree is a realistic option and they worry that negotiating over a noncompete sends a negative message to their new employer that might harm their career.
At the same time, if you are made aware that you will be asked to sign a noncompete before you accept a job, you’re more likely to receive training and have higher wages—which suggests that having outside options at the time a noncompete is contemplated matters to an employee’s experience at that employer. Yet a lot of people do not receive notice that they will be asked to sign a noncompete in advance. They basically find out about it on day one. So you turn down all your other job offers and then show up on the first day, and the noncompete is in that bunch of papers that you have to sign. Not surprisingly, many people in that situation believe that they can’t say no and that negotiation is a nonstarter.
3. Are there issues with enforcing noncompete agreements?
Historically, noncompetes have been governed by state law. In some jurisdictions, like California, noncompetes are unenforceable in court, but they still appear regularly in employee contracts. This is surprising but part of a larger pattern. Research over the last 10 years has shown that in the context of leases, consumer contracts, and other domains, contract drafters often include provisions that they know are invalid—because the employee, renter, consumer, etc., does not know they are invalid and assumes, reasonably in my view, that if a provision appears in a contract, it must be something that can be enforced. In the case of leases, if even a small fraction of a landlord’s tenants adhere to invalid provisions that benefit the landlord, it’s probably worth it for landlords to include them.
Our latest paper, which is forthcoming in the Journal of Legal Studies, examines beliefs about the enforceability of noncompete agreements. Most people believe that noncompetes are enforceable, even when they are not. If you’re in California, for example, where noncompetes have been unenforceable for more than a century, most employees still believe that they are enforceable. When people trust that language in contracts is lawful, there is real potential for abuse by contract drafters.
We also asked people with noncompetes whether they would consider leaving their job and under what conditions. We find that even where noncompetes can’t be enforced, and even when we inform them that noncompetes are unenforceable in their jurisdiction, some people still report that their noncompete would matter to their decision to leave their employer. What we don’t know yet is why. You might comply with a noncompete because you feel like it’s a contract and it could be enforced against you, but you might also comply simply because you feel like you made a promise or because your reputation might suffer if you leave after “agreeing” not to compete.
4. Assuming that the new FTC rule holds up as it’s currently written, how broad are the effects likely to be?
The new rule has received a lot of attention, and if the courts conclude that the rule is valid, many companies will of course simply drop noncompete provisions from their employment contracts. Employers also are required to inform people who are currently bound by noncompetes that their noncompete is no longer enforceable. My guess is that the rule is going to make a pretty big difference for a lot of individuals in the economy. That said, employers are still invited to use “alternatives,” like confidentiality agreements, to protect legitimate employer interests, and innovation in the use of other types of provisions may wind up limiting the impact of the rule.
On a broader scale, one of the main takeaways of the academic literature is just a simple fact about employment contracting: Low-wage noncompetes exist even though they don’t seem to make a lot of sense, and even when the chances that an employer would sue to enforce a noncompete are very small. One very credible explanation in the low-wage setting is that noncompetes can retard wage growth by preventing people from moving to other, similar jobs where somebody is willing to pay them a higher wage. Indeed, this sort of mobility is one of the main sources of wage growth in the economy. The FTC’s rule may make it harder for employers to inhibit mobility among those in the lower part of the income distribution.
Importantly, even if the rule is ultimately overturned in court, the conversation and the rule itself may still change behavior. Employees are more likely to be aware of noncompetes and their effects. The FTC’s defense of the rule and its assembling of evidence for why noncompetes are, on balance, bad for competition might make some companies rethink how they approach post-employment covenants. Or companies may think they are at great risk in the years ahead from their state banning noncompetes even if the federal government doesn’t succeed in its defense of a national ban.
5. How likely is it that the rule will be overturned?
The consensus appears to be that the rule is quite vulnerable to being overturned by the courts. My colleague Dan Crane conducted a non-scientific survey of scholars on this question, and nearly every single person (of an admittedly small pool) who responded purported to believe that the rule will be overturned in one way or another, albeit for different reasons.
The Supreme Court has been pretty critical of agency actions in recent years, and the FTC’s noncompete rule is the sort of action that has worried the courts. It’s a broad rule that applies in lots of situations to a lot of employers. It will affect tens of millions of employment relationships.
For these reasons alone, it is certainly very possible that the FTC’s more-than-500-page defense of the rule will not be enough to convince the Supreme Court that the rule is valid.
