Franchises – Employee Non-Compete Clauses Under The Gun

The Illinois Attorney General sued the Jimmy John’s fast food franchisor earlier this month [1], seeking a declaratory judgment that Jimmy John’s non-compete covenants violate the state’s Consumer Fraud and Deceptive Business Practices Act. All employees, including sandwich makers and delivery drivers, are barred from working at any business that earns more than 10% of its revenue from selling submarine and other sandwich types if that business is within two miles of a Jimmy John’s. The prohibition applies during, and for two years after employment.

The Illinois AG is arguing that the franchisor’s non-compete agreements don’t protect legitimate business interests, such as trade secrets or customer relationships, and is seeking a ruling that the non-competes are not only unenforceable but also illegal, raising the prospect of damages and fines.

In March 2016, the U.S. Treasury Department reported that about 18 percent of all American workers, or 30 million people, are covered by non-complete agreements.[2] The increasing use by employers of non-compete agreements for low wage, at-will jobs has tracked the growth of low paying positions and the decline of the middle class in the U.S. over the past decades. Five of the ten fastest growing jobs pay less than $25,000 a year [3], a level that qualifies a family of three for food stamps.

There is rising concern that low wage non-competes are preventing workers with already minimal bargaining power, from negotiating wages and working conditions, as well as from seeking better-paying jobs elsewhere, and giving employers no reason to increase wages or benefits.

Apart from the immediate impact on individuals and their families, the practice of using non-compete agreements with employees who pose no competitive risk has the potential to limit business dynamics and reduce economic growth by restricting the pool of available workers, and imposes broad social welfare costs, aka increasing public tax burdens.

The growing use of non-competes in low wage occupations and the different approaches taken by states to address it [4], has drawn the attention of the Obama Administration. In a May 2016 Report, Non-Compete Agreements: Analysis of the Usage, Potential Issues, and State Responses, [5] the Administration draws on the Treasury Report [6] to provide an overview of research on the effects of non-competes, as well as states’ efforts to limit their negative effects.

The Report acknowledges that non-competes have economically and socially beneficial uses such as protecting trade secrets [7] and incentivizing investment in worker training.  However, it also notes that these agreements may have detrimental effects by depressing wages, limiting worker mobility and inhibiting innovation.

The International Monetary Fund recently stated that among biggest risks to future U.S. economic growth are the declining participation in the labor force as the population ages, and the high number of Americans living in poverty; one in seven people, one of every three in households headed by women [8].

Take away

The broad and growing misuse of non-competes in low wage occupations are certain to be a target for Congressional action. And even in the absence of new federal legislation, it should be noted that franchisors may be held liable for franchisees’ employment practices deemed to violate the National Labor Relations Act under the NLRB’s “joint employer” rulings [9].


[2] U.S. Treasury Office of Economic Policy, Non-compete Contracts: Economic Effects and Policy Implications, p. 3, fn.1, March 2016.

[3] “Five of America’s fastest growing jobs (food prep workers, retail sales, restaurant cooks, personal care aides, home health care aides) pay less than $25,000”, T. Luhby, CNN Money, April 18, 2016, citing U.S. Census; Bureau of Labor Statistics data.

[4] States vary greatly in the manner and degree to which they will enforce non-competes. In some states, non-compete enforcement is determined by statute, while in others it is determined exclusively by case law. Some states, including California (except in connection with certain business sales), refuse to enforce non-competes or refuse to enforce non-competes that contain any unenforceable provisions, although a majority of states will modify overbroad non-compete contracts to render them enforceable. See Treasury Report, supra, note 2, at p. 5.

[5] Non-Compete Agreements: Analysis of the Usage, Potential Issues, and State Responses, May 6, 2016.

[6] Fn. 2, supra.

[7] See “New Federal Trade Secrets Law”, STBF Law Newsletter, April 2016 [please insert link to the newsletter]

[8] “IMF sees U.S. economy in ‘good shape’, too many in poverty”, D. Lawder, June 22, 2016, Reuters

[9] See “Franchisors Risk Liability as ‘Joint Employer’ Under NLRB Decision”, STBF Law Blog, December 31, 2015