As One Door Closes, Another Opens

As expected, a United States District Court in late August imposed a nationwide injunction on the enforcement of the Federal Trade Commission (FTC) rule that would have banned most employee non-compete agreements.

Judge Ada Brown of the Northern District of Texas ruled that the FTC’s actions in developing and proposing the rule were arbitrary and capricious. Although the FTC is expected to appeal the decision, we do not expect the rule to be revived.

That’s the good news. Non-compete agreements, however, remain under attack. As previously noted, four states— California, North Dakota, Oklahoma, and (most recently) Minnesota—completely bar the use of such agreements (although all four states exempt from the bans non-compete provisions negotiated with a business owner as part of the sale of their business). New York’s recent effort to impose a similar ban died on Gov. Kathy Hochul’s desk because it did not include a sales carve-out, but the state legislature likely will revisit the matter when it reconvenes next year. Another 12 states and the District of Columbia generally ban the use of non-compete restrictions for hourly and/or other employees who make less than a specified amount per year.

Neither the FTC nor any of the states that restrict the use of non-compete agreements have extended their restrictions to “non-solicitation” agreements. The FTC specifically distinguishes “non-solicitation” agreements that would bar a former employee from soliciting business from the former employer’s clients from “non-compete” agreements that prohibit a former employee from working for a competitor of the former employer.

A second flavor of “non-solicitation” agreement, however—no-poach deals made between employers agreeing to not solicit the other’s workers for employment—already faces scrutiny from the Department of Justice (DOJ). The department is likely to ramp up that focus going forward.

A no-poach agreement is an arrangement between two companies not to hire each other’s employees. For your firms and your clients, such provisions are routinely used in vendor and customer contracts. A typical example reads like this:

Non-Solicitation—Company A agrees that it will not offer employment to or seek to employ any current employee of Company B for a period of 12 months, commencing with the completion of the services provided hereunder.

A 2023 federal court of appeals decision found that such no-poach terms in otherwise lawful agreements are often illegal because they restrict competition—in this case in the labor market—without any countervailing procompetitive benefit for that market. The agreement doesn’t have to be absolute; even a commitment not to solicit each other’s employees under certain circumstances still violates the antitrust laws.

These violations can result in DOJ criminal prosecutions or civil class action lawsuits. To protect your firm and your clients, it is critical to understand what a no-poach agreement is and how to identify those agreements to avoid entering into them, to adequately evaluate the risk of maintaining any such agreements, and to undertake appropriate remediation if necessary.

Recent Developments

In 2016, after filing a series of lawsuits against Silicon Valley companies that had agreed not to hire each other’s employees, the Department of Justice announced that it would from that point prosecute no-poach agreements as criminal antitrust violations.

During the Biden administration, the DOJ has brought multiple prosecutions for no-poach agreements. Entering into a no-poach agreement can result in fines for companies and jail time for the individuals involved. Such a deal does not have to create actual harm to violate the law—just entering into the agreement can be a criminal violation.

A number of civil class action lawsuits challenging the use of no-poach agreements also have been litigated. In Deslandes v. McDonald’s, for example, McDonald’s employees accused the fast-food giant of having a no-poach term in its franchise agreements: no franchisee can hire an employee from another McDonald’s franchise or the parent corporation.

McDonald’s argued that its no-poach language was not anticompetitive, because it helped franchisees open new stores with confidence that other franchisees would not hire away their employees, and new stores meant more hamburger output. Judge Frank Easterbrook, writing for the United States Court of Appeals for the Seventh Circuit, rejected this argument, finding that to be lawful, the no-poach term must support a procompetitive effect in the labor market, not just in any market.

Unstated but implied is that it is unlikely that the no-poach term in the McDonald’s franchise agreement had any procompetitive effect in the labor market. And under the McDonald’s decision, such terms in otherwise lawful contracts can be “per se” illegal, meaning that they can be prosecuted criminally and that to prevail class-action plaintiffs do not have to show that the term had an anticompetitive effect.

All of that said, we are in the early throes of this debate, and it is unclear the extent to which DOJ or private litigants will challenge the use of no-poach agreements in areas that have not yet faced scrutiny, such as terms in service provider or vendor contracts, or in merger agreements.

Identifying the Risks

As a first step to minimizing potential legal exposure, companies should determine which if any of their contracts contain no-poach clauses or agreements.

Many companies have no-poach terms in legacy contracts and master services agreements. These contracts are often renewed without anyone reviewing the “standard terms,” which include the no-poach language. Indeed, employers and employees may not even remember that those terms are in the contracts. Nonetheless, even if never acted upon, the very existence of a no-poach clause or agreement can violate antitrust laws.

No-poach agreements that exist outside of formal written contracts, such as gentlemen’s agreements, also can trigger liability. These agreements may exist where companies are already working closely together, or they may arise in countries where agreements regarding labor are not generally considered an antitrust violation under the local laws (such as in countries in East Asia) but have effects in the United States, which then could give rise to liability.

Moreover, no-poach agreements that apply to independent contractors also may be unlawful. And while no-poach agreements are often applied to highly skilled or certified employees like nurses and engineers, recent cases have focused on fast food and retail workers as well.

Evaluate and, if Necessary, Ameliorate the Risks

Next, companies should consider the following.

• Eliminate no-poach terms from any new contract or contract renewal, unless in-house counsel approves it as supporting a procompetitive effect in a labor market. No-poach agreements that are closely tied to recouping training costs or that allow the effectuation of service agreements may not, for example, receive the same level of scrutiny if a reasonably procompetitive justification can be demonstrated.
• Implement an internal policy that the no-poach terms in any existing agreement will not be enforced, threatened, nor abided by, and that employees should immediately identify to in-house counsel any instance in which a counterparty enforces, threatens to enforce, or discusses the no-poach term.
• Identify those existing contracts that are high-risk and may require immediate remediation, as opposed to waiting for a renewal or termination. For example, a high-risk contract could be with a counterparty in a closely related industry or one where employees could easily move to the counterparty without the no-poach term. Also, any contract that may make its way into the hands of a government agency should be considered high-risk.
• Determine whether the company has ever enforced or threatened to enforce any no-poach term. The company should consider specific risk assessment and potential remediation in such circumstances.
• Update antitrust training programs to include a focus on no-poach agreements, including as terms in contracts.

The risks no-poach clauses pose in light of DOJ’s posture should be taken seriously. Companies should evaluate and remediate their exposure now before it becomes a problem.