New York’s Proposed Ban on Non-Compete Agreements Is Dramatically Overbroad

*This Article Was Originally Published By The New York Law Journal
New York state is poised to enact a radical change to its employment laws: the elimination of all noncompetition agreements. A sweeping bill passed by the state Legislature in June 2023 now awaits signature from Governor Kathy Hochul, who is considering the measure. Although well-intentioned, this legislation is deeply misguided. The governor would be wise to reject it.

New York state is poised to enact a radical change to its employment laws: the elimination of all noncompetition agreements. A sweeping bill passed by the state Legislature in June 2023 now awaits signature from Governor Kathy Hochul, who is considering the measure. Although well-intentioned, this legislation is deeply misguided. The governor would be wise to reject it.

What’s the purpose of noncompetes? Noncompetes prevent unfair competition. An employee who signs such an agreement can’t learn her employer’s confidential procedures and strategic weaknesses, and then walk across the street to work for a competitor. When used properly, noncompetes are a healthy restraint on sneaky business tactics.

But some evidence suggests that noncompetes have gotten out of control in recent years. The Federal Trade Commission (FTC) estimates that one in five Americans, about 30 million people, are bound by noncompetes. Overcautious employers routinely stick them into employment agreements, even for low-level employees without access to sensitive business information. Many don’t even realize they signed one—until they’re blocked from taking another job. Scholars have raised serious concerns about how these now-ubiquitous agreements affect the American economy.

Like many things in life, noncompetes are neither good nor evil. They’re a tool. Tools can be misused. Consider these two situations:

• A man works minimum wage as a waiter at a small diner in Brooklyn. As part of his hiring paperwork, he had to sign a noncompete agreement saying that he agrees not to work at any restaurant in New York State for two years after leaving the diner. One day, he receives an offer to become a waiter at a five star restaurant in Manhattan for more money.

• A Wall Street executive joins an investment bank. She gains access to proprietary algorithms developed by the bank’s analysts as well as the bank’s customer list. Her annual salary is $1,000,000.As part of her hiring paperwork, she had to sign a noncompete agreement saying that she agrees not to work at another financial services firm trading similar securities for two years after leaving the bank. One day, she receives an offer from a competing bank to take a similar role for more money.

Most would agree that these are radically different situations. In the first example, the waiter likely has no access to proprietary information. He simply wants to use his skills to earn a higher wage. While the diner may want to prevent staff turnover, the noncompete feels needlessly punitive. By contrast, in the second example, the highly compensated executive has access to all sorts of proprietary information. The investment bank has a legitimate interest in keeping that information away from competitors. Here, the noncompete seems like a fair bargain for both parties.

Beyond employment agreements, noncompetes are also common in the sale of businesses. Imagine that a man creates a world-class brewery in Poughkeepsie. He works for years to develop a unique formula, brand, and even visitor experience, attracting thousands of tourists each year to the facility on the banks of the Hudson River. Now imagine that a national hospitality company buys that brewery for a hefty sum of money. The sale contract would almost definitely include a noncompete to ensure that the man wouldn’t take the money and then open a brewery to compete with the one he just sold. Again, this feels like a fair bargain.

In recent years, policymakers have become increasingly interested in regulating the use (or over-use) of noncompetes. Different states have taken different approaches. Some essentially ban them entirely (e.g., California). Others enforce them so long as their terms are reasonable (e.g., Texas). Still others adopt some middle-ground approach. Delaware enforces reasonable noncompetes except those applying to medical practices (under the theory that doctors should not be barred from providing medical services). Illinois prohibits noncompete agreements except in certain contexts—for example, refusing to enforce them against employees earning less than $75,000 per year. Idaho permits noncompetes, but only against so-called “key” employees or independent contractors, rather than low-level workers.

That brings us to New York. The bill now awaiting Governor Hochul’s signature would ban noncompetes entirely: “Every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void. [N]o employer or its agent . . . shall seek, require, demand or accept a non-compete agreement from any covered individual.” No exception is made for the sale of businesses.

New York’s Legislature employs a sledgehammer rather than a scalpel. For three reasons, this is the wrong approach.

First, banning all noncompetes is just as silly as enforcing all noncompetes. Context matters. As the examples above show, noncompetes can be used as a legitimate tool where the parties have equivalent bargaining power and their contractual relationship is fairly negotiated. Noncompetes are not one-size-fits all.

Second, New York is unique. While many states have recently restricted noncompetes, each jurisdiction has its own particular regulatory needs. New York is home to a disproportionate number of ‘knowledge economy’ industries like finance, consulting, technology, media, and research. In these fields, a company’s competitive edge hinges on proprietary information. Preventing businesses from protecting that edge could harm their ability to remain competitive.

Third, banning noncompetes could dramatically increase litigation in New York’s already overcrowded court system. This may seem counterintuitive. One might assume that eliminating noncompetes will reduce litigation. But banning noncompetes will not stop lawsuits from proceeding on different grounds, such as theft of trade secrets or other business torts. Noncompetes actually prevent these disputes by setting clear expectations. If both parties know what’s permitted (and not) in black-and-white, they will often act accordingly without the need for expensive litigation.

To be sure, the legislature’s concerns are valid. Modest restrictions on noncompetes (for example, excluding low-wage employees) are worthy of consideration. But a one-size-fits-all approach to banning noncompetes will create more problems than it will solve.

As the leader of America’s business capital, Governor Hochul should not invite unintended consequences by signing the legislature’s overly simplistic bill.

Reprinted with permission from the December 7, 2023, edition of New York Law Journal© 2023 ALM Global Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.

Contacts

Continue Reading