Non-compete agreements have been around for hundreds of years protecting businesses from intellectual property theft and unauthorized disclosure of confidential business information by executives or employees who leave their positions for a competitor or to start a competing business. Their enforceability to date has been for the most part dependent upon geographic and time limits and the type and location of the business and its legitimate business needs. However, they have also been subject to changing directives of the Executive and Legislative branches of government and currently, are clearly disfavored by the present administration and are being battered about as a result.
The Biden administration has been critical of non-compete agreements as inhibiting employee mobility and competition and thereby lowering working conditions and wages. On July 9, 2021, President Biden signed the 2021 Executive Order Promoting Competition in the American Economy, 86 Federal Register 36987 (July 14, 2021). The Order states that it serves to establish a “whole of government effort to promote competition in the American economy by encouraging stronger enforcement of antitrust laws.” In direct response to President Biden’s 2021 Executive Order on Promoting Competition in the American Economy, we have seen a relatively new federal and state focus on banning and restricting non-compete agreements. Starting in late 2021 and into 2022, a number of states, Colorado, Illinois, Massachusetts, Nevada, Oregon and the District of Columbia promulgated legislation either banning or further restricting the use of non-compete agreements in employment. Then in 2023, we have seen an increased emphasis on federal rule making as well as state legislation aimed at complete prohibitions on non-compete agreements. Thus, employers are faced with enforcement action by the federal government in the nature of antitrust violations while simultaneously, states are enacting legislation which creates private causes of action at the state level.
At the federal level, on January 4, 2023, the Federal Trade Commission (FTC) released a press release announcing three FTC enforcement actions against two affiliated Michigan based companies and a glass manufacturer, based on claims the non-compete provisions required of employees constituted an unfair method of competition affecting commerce under Section 5(a) of the Federal Trade Commission Act, 15 U.S.C. Sec. 45(a). All three proceedings resulted in consent agreements. These enforcement actions were the first of this kind by the FTC, but likely indicate an upcoming wave similar to the strategy taken by the Department of Justice in 2021 and 2022, pursuing claims of naked restraint/antitrust violations involving non-solicitation provisions between staffing companies and their clients.
Two days later, on January 6, 2023, pursuant to 15 U.S. C. 45 and 46(g), the Federal Trade Commission (FTC) issued a proposed new rule that would certainly impact, if not outright prohibit, non-compete agreements. The proposed rule would add a new subchapter J, consisting of part 910, to chapter 1 in Title 16 of the Code of Federal Regulations and declare it to be an unfair method of competition for an employer to enter into, or attempt to enter into a non-compete clause with a worker, maintain a worker in a non-compete clause or represent to a worker that he/she is subject to a non-compete clause. The rule is quite broad, although because the FTC’s jurisdiction under Section 5 is not unlimited, certain industries are exempt: banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers, meatpackers and poultry dealers. The proposed rule would supersede (preempt) all contrary state laws, will require employers which use any agreement containing a non-compete clause (or any clause which is deemed to be a non-compete clause pursuant to the definition in the proposed rule) to rescind the non-compete clause. The rescission will not require any monies paid in exchange for the non-compete to be returned and requires a written communication of rescission. There is a sale of business exception that applies to individuals who have at least a 25% stake in the business. The proposed rule was subject to public comment through March 2023.
However, the FTC proposed ban on non-competes has triggered criticism from Republicans, the Chamber of Commerce and the business community arguing they are critical in furthering legitimate business interests to protect trade secrets as well as challenging the FTC’s authority to make such a rule. A May 10, 2023 report from Bloomberg Law indicated that the FTC received over 27,000 comments and as a result, will likely not vote on the rule until April 2024. It should be noted that even if passed, the rule will be subject to legal challenges as to its enforceability. Regardless, the passage of the rule sends a clear message to employers and employees as to where the FTC stands on this issue.
In addition to the FTC action, on May 30, 2023, the National Labor Relations Board General Counsel issued a memo to all NLRB regional directors, officers in charge and resident officers, that the proffer, maintenance, and enforcement of non-compete agreements in employment contracts and severance agreements violate the National Labor Relations Act. Generally, the memo states that non-compete provisions chill employees in their exercise of Section 7 rights and interfere with employment opportunities. There are some exceptions such as the sale of business and true independent contractor relationships. While the NLRB General Counsel’s memo is not binding or precedential law or authority, it does direct the Regional Directors to submit cases involving unlawful non-compete agreements to the NLRB’s Division of Advice. It is not clear if the NLRB will move ahead with enforcement action. Although if an opportunity arises to challenge an overbroad non-compete agreement, it is likely the NLRB will take that opportunity.
Similarly, on the state front, two states either passed or have pending legislation to prohibit non-competes. On May 16, 2023, Minnesota enacted a near-total ban on the use of covenants not to compete, Article 6 of the Labor Omnibus Budget Bill, SF3035. The legislation contains choice of law and venue provisions prohibiting an employer from requiring an employee who primarily resides and works in Minnesota to agree to any provision that requires a claim or controversy arising in Minnesota to be adjudicated outside of Minnesota or deprive an employee of protections in Minnesota. The legislation bans non-compete agreements but excludes non-disclosure agreements, agreements which protect trade secrets, confidential information and non-solicitation of clients. The law took effect on July 1, 2023, although agreements entered into before July 1, 2023, are not affected. In litigation, where courts asked to enforce preexisting agreements, the courts can take into account the law and attorney’s fees can be awarded if there is a violation.
Then in New York, on June 7, 2023, the New York Senate and on June 20, the New York Assembly passed a law, Bill No. S3100A, which, as written bans the use of non-compete agreements. The law, an amendment to New York Labor Law 191, prohibits an employer or its agent or the officer or agent of a corporation, from seeking, requiring demanding or accepting a non-compete agreement from a covered individual, as defined therein. It creates a private cause of action, with an attorney fee provision and appears to mandate an award of liquidated damages in the amount of $10,000 per violation. While the bill has passed in the Senate and Assembly, it has not been presented to the Governor yet and remains in this interim time period. Once it is presented to the Governor, she will have 30 days to sign it, veto it or do nothing.
Needless to say, a complete ban on non-compete agreements as well as the creation of a private cause of action, with liquidated damages and attorney’s fees, in a state such as New York, will have a significant impact on businesses in the US. Employers will therefore continue to face individual, as well as class litigation challenging existing agreements in addition to potentially being subject to increased government investigations and possible enforcement actions. In all of this litigation, questions as to the validity of non-compete agreements, and anti-competitive nature of the activities will be questions of fact to be decided by a jury, not a Court.
We often receive questions concerning insurance coverage for claims that arise when restrictive covenants, such as non-compete agreements and confidentiality agreements, are at issue. Coverage for such claims depends upon the facts of the underlying claim, the parties to the claim, the causes of action alleged, the Policy terms and conditions, and applicable laws. A good place to start is reviewing your Directors & Officers Policy for potential coverage.
In this context, claims can be brought by the government, competitors, and individuals against the company and its executives, directors and officers and its employees for allegedly engaging in anti-competitive behavior, unfair competition and/or unfair business practices violations. In the case of when a company hires an executive and/or employee from a competitor, the competitor can allege breach of the various agreements with the individual, tortious and/or intentional interference with the competitor’s business, misappropriation of trade secrets or other confidential company information, breach of the duty of loyalty and/or aiding and abetting breach of loyalty, computer fraud and abuse, and even conspiracy. In addition to sizable settlements, such claims are very costly to defend and can damage a company’s brand and can even lead to further litigation from shareholders.
Coverage for the company (entity coverage) will generally turn on whether the D&O policy is written on a public or private form. If a public form, entity coverage is limited to Securities Claims and therefore coverage is unlikely when a company is sued by a competitor. Under a private D&O form however, depending upon what is alleged, coverage for the entity may be available but could be limited by various exclusions including breach of contract; antitrust/unfair and deceptive trade practices/violations of the FTCA/restraint of trade; intellectual property/misappropriation of trade secrets; unauthorized disclosure of proprietary business information; and uninsurability for disgorgement of profits for example. How the exclusions apply will depend upon the specific policy wording which varies by carrier. It will be important to review Policy exclusions and endorsements, as some carriers provide defense cost coverage for contract claims and limited coverage for antitrust claims subject to sub-limits, a higher retention or defense costs. In addition, despite these exclusions, there may be coverage for tortious interference and aiding and abetting claims against the entity.
Coverage for claims against the individual, which may specifically include breach of the non-compete and/or non-disclosure agreements, breach of loyalty, and disclosure of confidential business information, will likely be limited by a “capacity” defense. In D&O Policies, coverage is available for the executive and employees of the company but only when acting in his or her capacity for the company. In this context, such allegations against the executive and/or employee, if based on duties owed to the former employer/competitor, as opposed to the company, would be subject to such a defense.
Also, an additional layer of complexity is added when the individual files a counterclaim against his former employer claiming that the non-compete is unenforceable, and/or invasion of privacy, defamation or tortious interference, triggering a coverage review under the competitor’s Employment Practices Liability Policy. Most D&O and EPL Policies contain allocation provisions and, based on the coverage issues, if coverage is triggered, one should expect that carriers will seek to allocate defense costs as well as indemnity coverage which will depend upon the covered and uncovered claims and parties.
As you can see, this area is complex not only from an underlying claim perspective but also from a coverage perspective. Depending upon what is pled and the policy language, there may be coverage for the company and/or the individuals, but such claims require a close review of the claim and policy terms and conditions and applicable endorsements which may broaden coverage.
Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed entities, including Willis Towers Watson Northeast, Inc. (in the United States) and Willis Canada Inc. (in Canada).
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