By Jazmine King
1. Noncompete Agreements & Their Effect on the U.S. Labor Markets
It is not taboo to hear that companies involved in competitive job markets require their employees to sign a noncompete agreement after an employee has accepted an offer for employment. A noncompete agreement, also referred to as a restrictive covenant, is a contractual term between an employer and its employee that prohibits the employee from working for a competing company, and/or starting a competing business.[1] Typically, these agreements include restrictions within a certain geographic area and a period of time when the employee may re-enter the workforce after the employee’s employment ends.[2] From an employer’s standpoint, noncompete agreements are vital to the growth and sustainability of many companies because, when properly drafted, these agreements provide significant protection for companies’ business interests.[3] In fact, many companies have utilized this contractual clause not only to prevent employees from working with their competitors, but have also used noncompete agreements to prevent former employees from revealing confidential information or trade secrets.[4]
Nevertheless, the use of these agreements have been subject to grave scrutiny. For many years, both workers and public interest groups have argued that noncompete agreements negatively impact the labor markets.[5] For instance, the National Employment Project has argued that noncompete agreements restrict job mobility by making it more difficult for workers to leave their current employers for better and higher-paying jobs,[6] which in fact disproportionality affects women and people of color.[7]
Since entering office, President Joe Biden has also condemned employers’ use of noncompete agreements and has stated that “[o]ne way companies stifle competition [in the labor markets] is with non-compete clauses.”[8] Then on July 9, 2021, President Biden signed an executive order that focused on promoting competition in the American economy.[9] Indicated in the executive order, President Biden encouraged the Federal Trade Commission (“FTC”) to regulate noncompete clauses.[10]
Furthermore, President Biden’s call for change did not go unnoticed by the FTC. On January 5, 2023, the FTC released a Notice of Proposed Rulemaking to prohibit employers from imposing noncompete clauses on workers.[11] Included in its proposal, the FTC argued that noncompete clauses or agreements are an unfair method of competition that inflict many burdens on workers and business practices in the country.[12] Besides restricting workers from moving freely from one competing company to another, the FTC also stated that “[e]xisting evidence show[ed] that noncompete clauses hinder innovation in several ways – from preventing would-be entrepreneurs from forming new business, to inhibiting workers from bringing innovative ideas to new companies.”[13] Moreover, with one in five American workers – approximately thirty million people – bound by a noncompete clause, the FTC has proposed a rule that bans employers from entering noncompete clauses with their employees and has asked the public’s opinion on its proposal to declare noncompete clauses an unfair method of competition.[14]
2. Delaware Law Enforces Noncompete Agreements & Advocates For the Advancement of Corporate Governance
The state of Delaware is notably known for being the domicile of choice for several Fortune 500 companies and having nearly two million business entities incorporated in the state.[15] Serving as the crucial place for corporate law and activity, it is well established that Delaware courts have favored the public interest of competition in their review of noncompetition agreements.[16] However, Delaware courts do not mechanically enforce noncompetition or nonsolicitation agreements.[17] Rather, when reviewing issues involving noncompete agreements, the Delaware courts “will specifically enforce a former employee’s agreement not to compete in the proper circumstances, when its purpose and reasonable operation is to protect the legitimate interests of the former employer and is not otherwise void as against public policy or contrary to the equities presented.”[18]
The Delaware Court of Chancery has adjudicated several lawsuits involving noncompete agreements, where the court has been asked to determine whether noncompete clauses were enforceable contractual provisions between an employer and its former employee. The Court of Chancery has taken the approach that “agreements not to compete must be closely scrutinized as restrictive of trade.”[19] Considering this, the Court of Chancery has utilized a three-prong test to determine whether a noncompete agreement is enforceable against a company’s former employee. In Ainslie v. Cantor Fitzgerald, L.P., the court’s most recent decision involving a noncompete clause in a limited partnership agreement, the court articulated the test and stated that “Delaware courts [must] ‘carefully review’ noncompete and nonsolicit agreements to ensure that they (1) are reasonable in geographic scope and temporal duration, (2) advance a legitimate economic interest of the party seeking its enforcement, and (3) survive a balancing of the equities.”[20]
For the first prong –“reasonableness” – the court focuses on whether the non-compete is essential for the protection of the employer’s economic interests.[21] The court then balances the employer’s interest against the employee’s interest to determine if the noncompete agreement is enforceable.[22] The Delaware courts have also considered the “geographic scope and temporal duration”[23] of the noncompete agreement. For the element of temporal duration, noncompetition agreements covering limited areas for two or fewer years generally have been found reasonable.[24] However, for the element of geographic scope, the Delaware courts have held that “if the employer overreaches by imposing an obviously overbroad geographic restriction on its employee’s ability to seek employment after separation, [the Court of Chancery] will readily decline to enforce the restriction.”[25]
For the second prong, the Court of Chancery has stated it will only enforce a noncompete agreement if it advances a legitimate economic interest of the party seeking its enforcement.[26] Interests which the law has recognized as “legitimate” include protection of employer goodwill and the protection of the employer’s confidential information from misuse.[27] However, under Delaware law, the courts will not enforce a noncompetition agreement “that is more restrictive than an employer’s legitimate interests justify or that is oppressive to an employee.”[28]
Lastly, the third prong requires Delaware courts to consider the equities of the noncompete agreement and “to carefully balance the legitimate interests of the parties and of the public.”[29] A court of equity will not enforce restrictive covenants if, on balance, to do so would impose an unusual hardship on a former employee.[30] Likewise, where a noncompete agreement would harm the public interest, the court may deem the agreement invalid and enforceable.[31]
3. The FTC Bans Noncompete Agreements: Its Controversial Effect On Delaware Corporations?
What makes Delaware unique is the fact that the state has provided expansive freedom to its businesses concerning noncompete agreements and has encouraged “healthy” competition in the labor market between competitors. By utilizing the three prong test adopted the by the Court of Chancery, Delaware ensures that employers do not exploit their workers when drafting and enforcing noncompete agreements. In addition, where noncompete or nonsolicit agreements are unreasonable in part, at times, the Delaware courts have “blue penciled” or corrected such agreements to make them reasonable.[32]
Ultimately, the FTC has concluded that employers’ reasoning for using noncompete agreements – to protect confidential information and trade secrets – is a flawed and weak argument, and that employers have other ways to protect their valuable investments that are significantly less harmful to workers and consumers.[33] However, the FTC made this assertion without considering how noncompete agreements play a pivotal role in business transactions throughout Delaware and how Delaware corporations will become defenseless against deceptive business practices if the FTC’s rule is adopted. To conclude, if the FTC’s proposal is adopted, the agency’s ban on noncompete agreements will materially alter corporate activity in Delaware and will have an adverse effect on the state’s management of corporate issues.
About the Author
Jazmine King is a second-year law student at Widener University Delaware Law School and serves as a Staff Editor on the Delaware Journal of Corporate Law. Jazmine received her B.A. in Political Science and Jurisprudence from Montclair State University in 2018. In her spare time, Jazmine enjoys going to the beach, playing with her Boston Terrier puppy, and attending concerts and festivals throughout the year. Currently, Jazmine is working towards a career post-graduation in insurance defense litigation. She is expected to graduate from Widener in May 2024.
[1] Non-Compete Clause Rulemaking, Federal Trade Comm’n, https://www.ftc.gov/legal-library/browse/federal-register-notices/non-compete-clause-rulemaking [hereinafter “Non-Compete”] (last visited Feb. 20, 2023).
[2] Id.
[3] Scott A. Holt, 5 No. 4 Del. Emp. L. Letter 4 (2000).
[4] Id.
[5] Sandeep Vaheesan, The Fight Over Non-Competes Is Heating Up. The FTC Must Stand Strong, TIME (Jan. 23, 2023, 4:47 PM), https://time.com/6249347/fight-over-non-compete-clauses/ (stating that in March 2019, a broad public interest and labor coalition, led by the Open Markets Institute and involving the AFL-CIO, Public Citizen, and SEIU, petitioned the FTC to adopt a rule regulating noncompete agreements).
[6] Najah A. Farley, FAQ on Non-Compete Agreements, Nat’l Emp. L. Project, https://www.nelp.org/publication/faq-on-non-compete-agreements/ (last visited Feb. 20, 2023) (explaining that “changing a job is one of the most common ways workers receive higher pay and ‘job hopping,’ especially early in one’s career, is correlated to stronger lifetime earnings”). See also Eli M. Rosenberg, FTC says proposed ban of noncompete clauses would strengthen workers’ hand, NBC News (Jan. 5, 2023, 12:33 PM), https://www.nbcnews.com/business/business-news/ftc-bans-noncompete-clauses-wages-rcna64445 (discussing that a 2019 study by the Economic Policy Institute found that somewhere between a quarter to about a half of all workers are subject to noncompete clauses).
[7] Id. (“Banning noncompete agreements would help alleviate racial and gender wage gaps because the underpaid workers who are most affected are disproportionality women and people of color.”).
[8] Fact Sheet: Executive Order on Promoting Competition in the American Economy, The White House, https://www.whitehouse.gov/briefing-room/statements-releases/2021/07/09/fact-sheet-executive-order-on-promoting-competition-in-the-american-economy/ (last visited Feb. 20, 2023).
[9] Id.
[10] Id. (“The Chair of the FTC is encouraged to consider working with the rest of the Commission to exercise the FTC’s statutory rulemaking authority under the Federal Trade Commission Act to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”).
[11] Fact Sheet: FTC Proposes Rule to Ban Noncompete Clauses, Which Hurt Workers and Harm Competition, Federal Trade Comm’n, https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete_nprm_fact_sheet.pdf [hereinafter Fact Sheet].
[12] Id.
[13] Id.
[14] Non-Compete, supra note 1.
[15] Annual Report Statistics: A Message from the Secretary of State Jeffrey W. Bullock, Del. Div. Corps., https://corp.delaware.gov/stats/ (last visited Feb. 20, 2023).
[16] Elite Cleaning Co. v. Capel, No. CIV.A. 690-N, 2006 WL 1565161 at *4 (Del. Ch. June 2, 2006).
[17] Kodiak Bldg. Partners, LLC v. Adams, No. 2022-0311-MTZ, 2022 WL 5240507, at *4 (Del. Ch. Oct. 6, 2022).
[18] Elite Cleaning Co., 2006 WL 1565161 at *4.
[19] Ainslie v. Cantor Fitzgerald, L.P., No. 9436-VCZ, 2023 WL 106924 at *5 (Del. Ch. Jan. 4, 2023).
[20] Id. at *8.
[21] FP UC Holdings, LLC v. Hamilton, No. CV 2019-1029-JRS, 2020 WL 1492783 at *6. See also Ainslie, 2023 WL 106924, at *16 (The reasonableness of the covenant’s scope is measured in relation to the employer’s legitimate interests: a greater scope must be supported by a greater interest.).
[22] FP UC Holdings, LLC, 2020 WL 1492783 at *6.
[23] Ainslie, 2023 WL 106924 at *8.
[24] Elite Cleaning Co. v. Capel, No. CIV.A. 690-N, 2006 WL 1565161, at *8 (Del. Ch. June 2, 2006).
[25] Id. See, e.g., Norton Petroleum Corp. v. Cameron, No. CIV.A . 15212-NC, 1998 WL 118198 at *3-4 (Del. Ch. Mar. 5, 1998) (finding that the employer did not establish that it would be “irreparably harmed” if its former employee conducted a “similar” business within a 100 mile radius of Newark, Delaware). See also Rsch. & Trading Corp. v. Pfuhl, No. CIV. A. 12527, 1992 WL 345465, at *12 (Del. Ch. Nov. 18, 1992) (“If this market, or more accurately, the employer’s customer base, extends throughout the nation, or indeed even internationally, and the employee would gain from the employment some advantage in any part of that market, then it is appropriate that an employee subject to a non-competition agreement be prohibited from soliciting those customers on behalf of a competitor regardless of their geographic location.”). But see Kodiak Bldg. Partners, LLC v. Adams, No. 2022-0311-MTZ, 2022 WL 5240507, at *11 (Del. Ch. Oct. 6, 2022) (explaining that in a case involving a restrictive covenant, “the reasonableness of a covenant’s scope is not determined by reference to physical distances, but by reference to the area in which a covenantee has an interest the covenants are designed to protect.”).
[26] Ainslie v. Cantor Fitzgerald, L.P., No. 9436-VCZ, 2023 WL 106924 at *8 (Del. Ch. Jan. 4, 2023). See also Kodiak Bldg. Partners, LLC v. Adams, 2022 WL 5240507 at * 8 (Del. Ch. Oct. 6, 2022) ( “A non-competition agreement will only be enforced to protect the legitimate economic interests of the employer.”).
[27] Kodiak Bldg. Partners, LLC v. Adams, 2022 WL 5240507 at * 8 (Del. Ch. Oct. 6, 2022). See, e.g., Rsch. & Trading Corp. v. Pfuhl, No. CIV. A. 12527, 1992 WL 345465, at *12 (Del. Ch. Nov. 18, 1992) (explaining that the “courts have long recognized that an employer has an interest in the goodwill created by its sales representatives and other employees, which is vulnerable to misappropriation if the employer’s former employees are allowed to solicit its customers shortly after changing jobs.”).
[28] Elite Cleaning Co. v. Capel, No. CIV.A. 690-N, 2006 WL 1565161, at *8 (Del. Ch. June 2, 2006).
[29] Kodiak Bldg. Partners, LLC, 2022 WL 5240507 at * 12.
[30] Id. See, e.g., Elite Cleaning Co., 2006 WL 1565161 at * 9 (In this case, the defendant was an at will employee of the plaintiff who did not have access to any sensitive information and received no special training. Under these circumstances, the court found that the balance of the equities weighed against enforcement of the agreement because the enforcement of the noncompete agreement would cause the defendant serious hardship and would discourage him from seeking better employment and greater security for his family elsewhere.).
[31] Elite Cleaning Co., No. CIV.A. 690-N, 2006 WL 1565161, at *4.
[32] See Norton Petroleum Corp. v. Cameron, No. CIV.A . 15212-NC, 1998 WL 118198 (Del. Ch. Mar. 5, 1998) (finding that the court reduced a noncompete agreement’s geographic scope from 100 miles to 20 miles based on “a form and scope consistent with the equities established by the factual record.”). But see FP UC Holdings, LLC v. Hamilton, No. CV 2019-1029-JRS, 2020 WL 1492783, at *8 (Del. Ch. Mar. 27, 2020) (“While, in some circumstances, a court may use its discretion to blue pencil an overly broad non-compete to make its restrictions more reasonable, this court has also exercised its discretion in equity not to allow an employer to “back away from an overly broad covenant by proposing to enforce it to a lesser extent than written.”).
[33] Fact Sheet, supra note 10 (explaining that in California, North Dakota, and Oklahoma –where employers can’t enforce noncompete clauses – industries that depend on trade secrets and other key investments have still been very successful).