The Antitrust Challenge to Covenants not to Compete in Employment Contracts

• Author: Eric A. Posner
• Position: Kirkland & Ellis Distinguished Service Professor, University of Chicago Law School
• Pages: 165-200

THE ANTITRUST CHALLENGE TO COVENANTS NOT

TO COMPETE IN EMPLOYMENT CONTRACTS

E

RIC

A. P

OSNER

*

For many years, Jimmy John’s franchises included a covenant not to com-

pete (or “noncompete”) in the employment contracts signed by their workers,

including entry-level sandwich makers. The noncompete barred employees

from working for any sandwich shop within three miles of any Jimmy John’s

franchise for two years.

1

Because thousands of Jimmy John’s outlets are scat-

tered across the United States, with most of them concentrated in cities, the

noncompete barred sandwich-shop work over huge swathes of the country,

including major urban areas. The disclosure of the noncompete arrangement

caused a public outcry and litigation. The noncompetes were very likely ille-

gal because they did not protect trade secrets or customer goodwill,

2

but may

well have deterred low-income workers from seeking higher-paying jobs from

Jimmy John’s competitors. Jimmy John’s eventually settled litigation brought

by state attorneys general and withdrew the noncompetes.

3

Noncompetes are clauses in employment contracts that forbid workers to

work for competitors of their former employer, for a certain period of time

* Kirkland & Ellis Distinguished Service Professor, University of Chicago Law School.

Thanks to Steve Salop and Evan Starr for helpful comments, to an audience at the University of

Chicago Law School faculty workshop for questions, and to several anonymous referees for their

helpful suggestions. Particular thanks to Randy Picker for his challenging questions. And thanks

to Maia Dunlap and Justin Taleisnik for valuable research assistance.

1

Dave Jamieson, Jimmy John’s Makes Low-Wage Workers Sign ‘Oppressive’ Noncompete

Agreements, H

UFF

P

OST

(Oct. 13, 2014), www.huffpost.com/entry/jimmy-johns-non-compete_n_

5978180.

2

See discussion infra Parts I.B, II.A.2.

3

See, e.g., Press Release, Office of the Attorney General for the State of Illinois, Madigan

Announces Settlement with Jimmy John’s for Imposing Unlawful Non-Compete Agreements

(Dec. 7, 2016), www.illinoisattorneygeneral.gov/pressroom/2016_12/20161207.html; Press Re-

lease, Office of the Attorney General for the State of New York, A.G. Schneiderman Announces

Settlement with Jimmy John’s to Stop Including Non-Compete Agreements in Hiring Packets

(June 22, 2016), www.ag.ny.gov/press-release/2016/ag-schneiderman-announces-settlement-jim

my-johns-stop-including-non-compete.

165

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AW

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OURNAL

[Vol. 83

and over a defined geographic area.

4

Despite its traditional orientation toward

laissez faire, the common law has always regarded noncompetes as restraints

of trade, and hence presumptively unenforceable. Noncompetes are subject to

a reasonableness test: a noncompete is enforceable only if the restrictions it

imposes on the worker are no more burdensome than necessary to protect the

employer’s legitimate business interest—usually, in protection of trade secrets

or customer goodwill. In practice, however, noncompetes are frequently en-

forced, or simply not challenged, and may deter workers from quitting even

when they are unenforceable. New research reveals that they appear in mil-

lions of employment contracts, and may deter workers from quitting and seek-

ing alternative employment.

5

While noncompetes were traditionally

understood to be justified only for specialized and well-compensated employ-

ees, it turns out they are frequently imposed on low-skill employees like the

Jimmy John’s sandwich makers.

6

In recent years, controversies over noncompetes and the new academic re-

search that documents their prevalence have put the noncompete on the public

agenda. Congress and state legislatures have considered or passed new laws

restricting noncompetes, and presidential candidates have touted proposals for

reform.

7

The Federal Trade Commission has held hearings on whether it

should regulate noncompetes under Section 5;

8

the Department of Justice has

intervened in cases involving no-poaching clauses in franchise agreements

which function similarly to noncompetes.

9

State attorneys general in Illinois,

4

My focus is on “employee non-competes.” I do not address the use of noncompetes in other

settings, for example, as part of the sale of a business. I also exclude franchise no-poach clauses

from the general discussion.

5

See Evan Starr, J.J. Prescott & Norman Bishara, Noncompetes in the U.S. Labor Force 1–4

(U. Mich. L. & Econ. Research Paper No. 18-013, 2019). The authors found that 18.1% of the

U.S. labor force, or roughly 28 million people, were subject to a noncompete agreement as of

2014, and nearly 40% have signed a noncompete at some point in their careers. Id. at 2.

6

See id. at 16–17. Approximately 14.3% of workers without a bachelor’s degree were subject

to noncompetes in 2014, compared to 26.6% of those with bachelor’s degrees. Id.

7

See infra Part I.D.

8

See, e.g., Fed. Trade Comm’n Event Calendar, Non-Competes in the Workplace: Examin-

ing Antitrust and Consumer Protection Issues (Jan. 9, 2020), www.ftc.gov/news-events/events-

calendar/non-competes-workplace-examining-antitrust-consumer-protection-issues.

9

The Antitrust Division of the Department of Justice filed Statements of Interest in three

private no-poach cases filed by former employees against Auntie Anne’s, Arby’s, and Carl’s Jr.,

respectively. Corrected Statement of Interest of the United States, Harris v. CJ Star, LLC, 2:18-

cv-00247 (E.D. Wash. Mar. 8, 2019); Corrected Statement of Interest of the United States, Rich-

mond v. Bergey Pullman Inc., 2:18-cv-00246 (E.D. Wash. Mar. 8, 2019); Corrected Statement of

Interest of the United States, Stigar v. Dough Dough, Inc., 2:18-cv-00244 (E.D. Wash. Mar. 8,

2019).

2020] A

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167

Washington, and New York have challenged noncompete agreements under

state consumer protection laws, and won several settlements.

10

In this article, I argue that legal regulation of noncompetes should be

strengthened because of their adverse effect on competition.

11

The common

law approach is inadequate because employers do not face substantial sanc-

tions if a court invalidates a noncompete, and—more significantly—the com-

mon law does not provide the right approach for evaluating noncompetes.

Because noncompetes pose a threat to competition, the analytic lens of anti-

trust law should be used. Antitrust law focuses on the market effects of

noncompetes and provides for a significant deterrent in the form of treble

damages when employers abuse them. However, antitrust enforcement has

rarely been successful because of difficulties of proof. Accordingly, I argue

for a stronger antitrust regime that incorporates presumptions derived from the

empirical literature on noncompetes and related labor market behavior. The

law should treat noncompetes as presumptively illegal, allowing employers to

rebut the presumption if they can prove that the noncompetes they use will

benefit rather than harm their workers.

Noncompetes have received significant attention from legal scholars and

economists. One body of research stems from Ronald Gilson’s hypothesis that

by reducing employee mobility, noncompetes prevent cross-fertilization of

ideas across firms, in turn reducing innovation and growth.

12

Another group of

articles discuss the antitrust analysis of noncompetes, but these articles are

more than 30 years old, have had no influence, and do not incorporate the

latest findings from economists.

13

The most significant body of work, which is

10

See, e.g., Robert Channick, Low-Wage Workers Free to Quit Chicago-Area Payday Lender

for New Jobs After State Ends ‘Unfair’ Noncompete Agreements, C

HI

. T

RIB

. (Jan. 7, 2019), www

.chicagotribune.com/business/ct-biz-illinois-payday-lender-noncompete-20190107-story.html.

11

I briefly touched on some of these arguments in a short piece written for a general audience.

See Eric A. Posner, The Anticompetitive Effects of Covenants Not to Compete, C

OMPETITION

P

OL

’

Y

I

NT

’

L

(Jan. 23, 2020), www.competitionpolicyinternational.com/the-anticompetitive-ef

fects-of-covenants-not-to-compete/.

12

Ronald J. Gilson, The Legal Infrastructure of High Technology Industrial Districts: Silicon

Valley, Route 128, and Covenants Not to Compete, 74 N.Y.U. L. R

EV

. 575, 578 (1998). See also

A

LAN

H

YDE

, W

ORKING IN

S

ILICON

V

ALLEY

: E

CONOMIC AND

L

EGAL

A

NALYSIS OF A

H

IGH

-V

E-

LOCITY

L

ABOR

M

ARKET

(2003); A

NNE

L

EE

S

AXENIAN

, R

EGIONAL

A

DVANTAGE

: C

ULTURE AND

C

OMPETITION IN

S

ILICON

V

ALLEY AND

R

OUTE

128, at 2–4 (1996); On Amir & Orly Lobel, Driv-

ing Performance: A Growth Theory of Noncompete Law, 16 S

TAN

. T

ECH

. L. R

EV

. 833, 861–63,

866 (2013); Bruce Fallick et al., Job-Hopping in Silicon Valley: Some Evidence Concerning the

Micro-Foundations of a High Technology Cluster, 88 R

EV

. E

CON

. & S

TATS

. 472, 472–73 (2006);

Sampsa Samila & Olav Sorenson, Noncompete Covenants: Incentives to Innovate or Impedi-

ments to Growth, 57 M

GMT

. S

CI

. 425, 427 (2011).

13

See, e.g., Harvey J. Goldschmid, Antitrust’s Neglected Stepchild: A Proposal for Dealing

with Restrictive Covenants under Federal Law, 73 C

OLUM

. L. R

EV

. 1193 (1973); Charles A.

Sullivan, Revisiting the “Neglected Stepchild”: Antitrust Treatment of Postemployment Re-

straints of Trade, 1977 I

LL

. L.F. 621 (1977); Pamela Carder Fletcher, Antitrust Implications

Arising from the Use of Overly Broad Restrictive Covenants for the Protection of Trade Secrets,