The Antitrust Boundaries of Nonsolicitation Agreements

9 Min Read By: Karma Giulianelli, Benjamin Smith, Polly Swartzfager

IN BRIEF

  • Transactional agreements that commonly include nonsolicitation provisions may have implications under the U.S. antitrust laws.
  • Recent events and agency guidance have highlighted the potential perils of these agreements.
  • At a high level, companies competing for labor inputs must take care to ensure that their agreements are narrowly tailored to meet a legitimate, procompetitive, business purpose, and do not foreclose a substantial amount of competition for employees in the relevant market.

For well over a century, the Sherman Antitrust Act has prohibited agreements to allocate productive resources or inputs. An agreement with a competitor to allocate the supply of steel, for instance, would be per se unlawful. So, too, are agreements to allocate customers or territories. Yet agreements between competitors or potential competitors not to “poach” one another’s employees—a potentially scarce resource, particularly for high-level talent in a tight labor market—are surprisingly common.

Since the high-profile case against major Silicon Valley companies—Apple, Google, Intel, and others—condemning such agreements, lawyers have become increasingly aware of the issues surrounding competitor agreements regarding the allocation of labor. See United States v. Adobe Sys., Inc., No. 1:10-cv-01629-RBW (D.D.C. Mar. 18, 2011); In re High-Tech Emp. Antitrust Litig., No. 5:11-cv-02509-LHK (N.D. Cal. Sept. 2, 2015). The Department of Justice and the Federal Trade Commission issued guidance in October 2016 on such agreements, noting that the antitrust laws apply to “competition among firms to hire employees.” Since then, they have pursued actions against companies that have agreed to allocate labor resources, as evidenced by the recent settlement with Knorr-Bremse AG and Westinghouse Air Brake Technologies Corporation, following an agreement not to solicit, recruit, hire, or otherwise compete with one another for employees. The Department of Justice has even recently announced that “naked” agreements not to compete for talent may be pursued criminally. In addition, private suits have been filed, with one alleging recently that McDonalds’ franchisees have agreed to limit competition for employees. See Leinani Deslandes v. McDonald’s USA, LLC et al., No. 1:17-cv-04857 (E.D. Ill June 2018).

Yet little has been written about the boundaries of agreements between competitors or potential competitors when it comes to such talent. Some agreements, of course, are clearly “naked,” per se unlawful agreements. Those are agreements that are not reasonably necessary to support a separate, legitimate business transaction or collaboration, and they would eliminate competition in the same way as agreements to fix prices or to allocate customers. For those agreements that might be something other than a naked agreement to eliminate competition, however, it is not always easy to ascertain the line between that which is permissible and impermissible under the “rule of reason,” a construct in antitrust law where a fact finder would weigh any competitive harm against potential legitimate justifications.

This piece examines the implications under U.S. antitrust laws of transactional agreements that commonly include nonsolicitation provisions.

Merger and Acquisition Transactions

Mergers and other acquisition transactions commonly include nonsolicitation covenants that prohibit the seller’s solicitation of employees of the divested business for some period after the transaction closes. Variants of these types of provisions may include exceptions for solicitations made generally in advertising job openings so long as they do not target the restricted employees specifically, or for hiring an otherwise restricted employee that makes unsolicited first contact with the seller seeking employment. The restrictions may also be broader in their scope, extending to employees of the buyer or its affiliates.

Also ancillary to the “due diligence” process leading up to mergers and acquisitions, parties commonly enter into agreements restricting the use and disclosure of confidential information shared by the parties in connection with those transactions. Those confidentiality agreements typically prohibit the receiving party’s use of confidential information for any purpose other than the narrowly defined purpose of the transaction. Although the restriction on use might generally prevent the receiving party from using confidential information (such as salary data) to its advantage in soliciting the disclosing party’s employees, confidentiality agreements frequently include express employee nonsolicitation provisions that go beyond restrictions on use of confidential information in their scope and specificity.

If these types of nonsolicitation agreements are entered into in connection with a potential merger or acquisition and are reasonably ancillary to the transaction (as opposed to a mere cloak to engage in the allocation of labor inputs or the fixing of employee salaries), they should not qualify as “naked” per se illegal restraints on competition.

Real-world concerns in fact often motivate these restrictions. For instance, a company that opens its plant and access to employees to a competitor evaluating an acquisition might be concerned that the competitor will simply take note of its key employees and, rather than continuing with the acquisition, decide to poach the talent. This is particularly the case with key employees in which the company might have years of training and investment, and where the assets of the company are largely found in human talent and know-how.

The Department of Justice implicitly recognized this in the final judgment of the Adobe Systems Inc. case where it agreed that a no “direct solicitation” agreement is not prohibited if it is “reasonably necessary for mergers or acquisitions, consummated or unconsummated, investments, or divestitures, including due diligence related thereto.” See United States v. Adobe Sys., Inc., No. 1:10-cv-01629-RBW (D.D.C. Mar. 18, 2011), ECF No. 17.

This leaves the question of what is “reasonably necessary” for a transaction and, if such agreements are “reasonably necessary,” whether the agreements would survive scrutiny after determining potential competitive consequences.

For purposes of considering the legitimacy of nonsolicitation agreements in these types of transactions, it is helpful to divide this category into two subcategories of merger or acquisition transactions: those involving a “financial buyer,” such as a private equity sponsor or other acquisition fund, and those involving a “strategic buyer,” such as a competitor of the target company. In the context of a financial buyer, the transaction does not diminish competition for employees in the applicable market—the owner of one employer is merely replaced with the financial buyer, who is unlikely to become an independent competitor for the labor inputs otherwise. Competition for employees, therefore, is unlikely to be diminished in this kind of arrangement. To the extent that the antitrust laws are concerned with competitive effects in a relevant market (here, the market for employees or talent), or foreclosure of inputs to actual or otherwise potential competitors, these types of agreements should not be problematic.

In the strategic buyer context, by contrast, competition for employees may be diminished as two previous employers in the market consolidate into one, which consequently has greater market power. In this context, as in any rule of reason inquiry, lawyers should inquire into the potential effects of any nonsolicitation agreements. This involves examining how consolidated the market might become after the transaction (i.e., how many options the employees might have elsewhere); how broad the nonsolicitation agreements are; and how many employees might be bound by them (i.e., do they apply only to executives or all employees?). The inquiry revolves around foreclosure of potential competition for employees and the tying up of potentially scarce labor inputs. The inquiry is context specific, and the answer to whether such agreements might pose problems in any circumstance depends on balancing the degree of impact on the labor market against the necessity of such agreements to consummate a potentially beneficial transaction for consumers more broadly.

Whether nonsolicitation provisions accompanying merger or acquisition transactions in the due diligence context are reasonably necessary to encourage what might otherwise be a beneficial transaction depends largely on the purpose motivating the nonsolicitation clauses, as well as the foreclosing effects of such agreements.

Employment Agreements and Other Commercial Transactions

Employment agreements often contain restrictive covenants made by the employee, commonly including nonsolicitation clauses. Those nonsolicitation covenants are designed to prevent the employee, who is frequently in a position of leadership over the company’s other employees, from using that relationship as an advantage in poaching other employees. These covenants typically apply during the employee’s employment and for a specified period (often a year or more) after that employment ends. Outside of the context of a customary employment agreement, nonsolicitation covenants are also commonly found in form confidentiality, intellectual property assignment, incentive equity, and similar uniform agreements that even nonexecutive employees are expected to sign as a condition of their employment or incentive equity participation.

Employee nonsolicitation agreements may also appear in supply agreements, distribution agreements, joint development agreements, executive search arrangements, and other service relationships with independent contractors, among others. The common thread in these types of relationships is the familiarity that the parties develop with each other’s employees, whether through information sharing, direct interaction, or otherwise, and each party seeks to prevent that familiarity from enhancing the other’s efforts to hire away that party’s employees. For example, a company may enter into an agreement with a marketing firm to promote the company’s products. The service agreement may contain a covenant of the company not to solicit the marketing firm’s employees to prevent the company from bringing the services in-house with the use of the marketing firm’s former employees. These agreements often apply both during the term of the relationship and for a specified period after the relationship ends.

To the extent that these agreements are widespread, attaching to employees throughout the company, one should determine their breadth, ensuring that they are narrowly tailored to address procompetitive, legitimate concerns and that they do not unreasonably hinder competition or potential competition for employees in a particular industry or market. Imagine, for instance, a situation where a company employs half of all relevant skilled employees in a geographic or product area, and where that company has included form nonsolicitation covenants in every employment or equity grant agreement. If an employee were to leave, either to start a competing venture on his or her own, or to work for an established competitor, that employee’s new venture (especially if the employee starts the venture) might have significantly diminished opportunities to recruit talent and therefore to compete. This would be an example of a situation in which the breadth and prevalence of such agreements might foreclose competition, outweighing any potential justifications.

Nonsolicitation agreements are common across industries through a variety of transactions and otherwise. Although nothing in the law of agreements in restraint of trade has changed, recent events—as well as agency guidance—have highlighted the potential perils of these agreements. As with any agreement between competitors or potential competitors, companies competing (or potentially competing) for labor inputs must take care to ensure that they only enter into agreements that are narrowly tailored to meet a legitimate, procompetitive, business purpose. This requires an analysis of the potentially foreclosing effect of such agreements on employee movement, the breadth and prevalence of such agreements, and whether the agreements are no more restrictive than necessary to meet their legitimate objectives.

ABOUT THE AUTHORS

Karma Giulianelli

Karma Giulianelli is a Partner at Bartlit Beck Herman Palenchar & Scott LLP, which she joined after her time as a Trial Attorney in the Honors Program at the Antitrust Division of the Department…

Benjamin Smith

Benjamin Smith is a partner in the corporate practice group of Bartlit Beck, where his practice is focused on mergers and acquisition transactions, including the representation of private equity funds…

Polly Swartzfager

Polly Swartzfager advises clients on debt and equity financing transactions, mergers and acquisitions and joint ventures. She also counsels clients on a variety of corporate governance,…

Login or Registration Required

You need to be logged in to complete that action.

Register/Login