Non-compete obligation

 

Author Definition

 

Definition

A non-compete obligation is a contractual promise by one party to refrain from conducting business of a similar nature to that of the other party. Non-compete obligations are encountered principally in contracts for the sale of a business and contracts of employment. In general (although with localized exceptions, e.g., regarding employment in the State of California), such agreements are enforceable provided they are reasonable and limited in scope, territory, and duration. In addition, employment non-compete obligations typically must be supported by adequate consideration. Non-compete obligations may be anticompetitive if they amount to a naked division of territory or customers among the parties or are collusively deployed among competing firms (i.e., “no poach agreements”).

 

Commentary

A non-compete obligation is a contractual promise by one party to refrain from conducting business of a similar nature to that of the other party. Non-compete obligations are encountered in many circumstances, but principally in contracts for the sale of a business or contracts of employment.

The U.S. Supreme Court in United States v. Addyston Pipe & Steel Co. concluded that it would be impossible for the Sherman Act to prohibit every restraint of trade because virtually every contract, including those that include non-compete obligations, involves some restraint of trade. Following common law precedent, the court ruled that reasonable restraints were permitted, but only if the restraint was ancillary to the main purpose of the agreement and necessary to protect the enjoyment of legitimate fruits of the contract or protect from the danger of unjust use of those fruits by the other party.

Business-to-business non-compete obligations

In the United States, courts are generally more deferential to non-compete obligations associated with the sale of a business than those regarding employment. In particular, courts note that a non-compete obligation reduces the risk that the seller will diminish the goodwill acquired by the buyer by re-entering the market to compete against the buyer. See, e.g., Shearson v. Schmertzler (“[C]ovenants not to compete incident to the sale of a business are more liberally enforced ‘on the premise that a buyer of a business should be permitted to restrict his seller’s freedom of trade so as to prevent the latter from recapturing and utilizing, by his competition, the good will of the very business which he transferred for value.’”).

A non-compete obligation is generally enforceable provided it is reasonable and limited as to time and territory. See United States v. Addyston Pipe & Steel Co. (a “reasonable” contract in restraint of trade was enforceable provided that it was made for “good and adequate consideration” and imposed a restraint which was “particular” rather than “general”).

Despite the deference generally accorded to non-compete obligations associated with the sale of a business, courts have scrutinized contracts that amount to a de facto market allocation agreement. In In re Wholesale Grocery Prods. Antitrust Litig., an asset-exchange agreement between two grocery wholesalers included an agreement not to compete for each other’s former customers. The court opined that, while the agreement pertained only to former customers, there was evidence that the wholesalers may have had a tacit agreement not to compete for current and future customers (“[T]he written non-compete agreement applied to former customers, theoretically permitting the wholesalers to compete for the existing and future customers. But this is not a contracts case in which the scope of the alleged anticompetitive agreement is cabined by the four corners of the written document. [Plaintiff] could use all manner of extrinsic evidence to persuade a jury that what the wholesalers actually agreed to was a naked division of territory and customers.”).

In Europe, article 1(d) of EU Regulation 330/2010 (Vertical Block Exemption Regulation, VBER) defines a “non-compete obligation” as any contractual “obligation causing the buyer not to manufacture, purchase, sell or resell goods or services which compete with the contract goods or services.” This also includes any agreement in which 80% or more of a buyer’s total purchases in the relevant market are provided by the contracted supplier or its designee.

VBER Article 2(1) exempts non-compete obligations from TFEU Article 101(1) prohibitions if several conditions are fulfilled. In particular, the market share of each buyer and seller cannot exceed 30% (Article 3) and the duration of the non-compete obligation cannot exceed five years or be indefinite (Article 5(1)(a)). A non-compete obligation that is tacitly renewable beyond a period of five years is deemed to have an indefinite duration (Article 5(1)).

Post-term non-compete obligations are generally excluded from the exemption provided by the VBER (Article 5(1)(b)) unless the restriction is indispensable to protect seller know-how and narrowly limited both geographically and temporally (Article 5(2)). Nor do the VBER exemptions generally apply to vertical agreements entered into by competing companies, except in the case of non-reciprocal vertical agreements (Article 2(4)).

Employee non-compete obligations

While employment non-compete obligations may appear to be clear restraints of trade that impair an employee’s job mobility, they can also serve legitimate economic interests, such as the protection of trade secrets, customer lists, and business methods specific to a particular employer. Unique qualifications of an employee also have been held to constitute legitimate interest for protection by covenants not to compete. See United States v. Addyston Pipe & Steel Co. (employers “would naturally be reluctant” to train employees unless the employees were “able to bind themselves not to set up a rival business in the vicinity after learning the details and secrets of the business of their employers”); Ticor Title Ins. Co. v. Cohen (“Unique services have been found in various categories of employment where the services are dependent on an employee’s special talents; such categories include musicians, professional athletes, actors and the like.”). But see Vencor, Inc. v. Webb (refusing to enforce a non-compete where the information to which the employee had access was confidential but “not unique or proprietary”).

U.S. courts that have evaluated the legality of employment non-compete clauses under the Sherman Act have applied the rule of reason, rather than subjecting the agreements to per se treatment. See Bradford v. N.Y. Times Co. (“Although employee restraints have been known to the common law since the 15th century, their evolving history illustrates that rule of reason considerations continue to apply…. There is therefore not enough here to justify… classify[ing] such a restraint as a per se violation of the Sherman Act.”). Courts will thus generally enforce employment non-compete clauses under the antitrust laws when it is part of a valid agreement supported by consideration, is reasonable in time and scope, and serves to protect the employer’s legitimate economic interests.

Employment non-compete obligations are more likely to violate U.S. antitrust law if they stem from naked horizontal agreements among competitors to allocate employees. For example, “no-poach agreements” among competitors have been subject to intense scrutiny from U.S. competition agencies and from private plaintiffs. The most well-known instance is United States. v. Adobe Systems Inc., et al., in which the U.S. Department of Justice alleged several tech firms had violated Section 1 of the Sherman Act by entering into a series of bilateral “No Cold Call” agreements to prevent recruitment of their employees. The case was settled before trial. This was followed by a class action lawsuit, In re High-Tech Employee Antitrust Litigation, filed on behalf of the firms’ employees, who claimed that their wages were suppressed due to the alleged agreements. This case also settled.

In Europe, Article 15 of the European Charter of Fundamental Rights establishes a freedom to choose an occupation and the right to engage in work, which may be infringed by a non-compete obligation that is arbitrary or excessive. Even so, employment non-compete obligations are not specifically governed by EU competition law.

 

Bibliography

Bruce H. Kobayashi, Antitrust, Non-Competition, and No-Poach Agreements in Digital Industries, in Global Antitrust Institute Report on the Digital Economy (Joshua D. Wright & Douglas H. Ginsburg eds., 2020) 707, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3733724.

Antitrust Section of the American Bar Association, Comments Submitted in Connection with the Federal Trade Commission Workshop on “Non-Competes in the Workplace: Examining Antitrust and Consumer Protection Issues”, FTC Comment ID FTC-2019-0093-0329 (Apr. 24, 2020), available at https://www.regulations.gov/comment/FTC-2019-0093-0329.

John M. McAdams, Non-Compete Agreements: A Review of the Literature, Federal Trade Commission Working Paper (Dec. 31, 2019), available at https://ssrn.com/abstract=3513639.

OECD, Competition Concerns in Labour Markets—Background Note by the Secretariat (Jun. 5, 2019), available at https://one.oecd.org/document/DAF/COMP(2019)2/en/pdf.

Norman D. Bishara & Evan Starr, The Incomplete Noncompete Picture, 20 Lewis & Clark L. Rev. 497 (2016), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2782137.

Author

  • International Center for Law & Economics (Portland)

Quotation

Geoffrey Manne, Non-compete obligation , Global Dictionary of Competition Law, Concurrences, Art. N° 12156

Visites 19305

Publisher Concurrences

Date 1 January 1900

Number of pages 500

 

Institution Definition

Contractual clause bringing about a direct or indirect obligation causing the parties to an acquisition agreement, or at least one of them, not to manufacture, purchase, sell or resell independently goods or services which compete with the contract goods or services. Such an obligation on the seller of the assets guarantees that the acquirer receives the full value of the assets transferred and hence is normally considered as ancillary to the main agreement. © European Commission

 
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