To Poach or Not to Poach: Franchise No-Poach Clauses Under Scrutiny

January 23, 2020Articles The Legal Intelligencer

Franchise systems, and many licensing arrangements contain anti-poaching provisions. These provisions are being tested under the antitrust laws as being anticompetitive. This article will discuss the benefits and burdens of including such provisions in your agreements.

These “no-poach” or “anti-poaching” clauses are standard provisions that restrict franchisees from soliciting or hiring employees of the franchisor or another franchisee of the same franchise system. Formerly enforced by courts as legitimate efforts to prevent cannibalization of employees from one franchisee to another, are now the subject of scrutiny by 16 state attorneys general and at least seven federal district court cases. U.S. District Court Judge Anita Brody of the Eastern District of Pennsylvania denied a motion under 12(b) (6) for dismissal of such an antitrust claim in Fuentes v. Royal Dutch Shell, 2019 US. Dist. Lexis 224708 (EDPA Nov. 25, 2019).

The no-poach provisions were previously justified as strengthening inter-brand competition and promoting a uniform, noncompetitive environment among the franchisees. Recent critics have argued that the data shows no-poach clauses might suppress employee wages and mobility. These arguments are data driven, so the antitrust analysis is necessary to sort through the issues.

Why are no-poach provisions being targeted?

The issue was first raised in the technology licensing environment. In Silicon Valley, it was becoming increasingly difficult to find highly skilled, highly paid workers for the development of emerging companies and technology. California’s public policy prohibits enforcement of restrictive covenants against employees and even franchisees, and to a lesser extent, this policy is reflected in many western states. These states rely more on information restrictions, trade secrets agreements, to prevent raiding by competitors of skilled technologists. Still, the private equity companies funding the startups did not want one startup to raid another, so they imposed, as the franchise community had done so for many years, prohibitions against raiding other companies for workers. Because these skilled technologists were highly paid, the economic impact of restricting employee mobility, and therefore salaries, was substantial and easily measured. The date showed that tech employees were being injured where the technology companies agreed they would not raid each other or hire each other’s employees.

Then we have the issues of unionization of franchise employees and joint employer issues. Collective bargaining and organization could be impeded if worker mobility were impeded. Impact on the salaries of fast-food workers, however, is not as easy to show as it would be for Silicon Valley employees and there is a lot of disagreement among economists of the actual impact on lower-paid workers. Like Silicon Valley, there may be great geographic differences in impact and the empirical evidence is subject to great debate. Because the numbers involved are huge, the debate will not end quickly or easily.

Why are the states involved?

Activist state governments are becoming more active in response to political voices favoring workers and the attitude of the federal government not to regulate this area of commerce. The states are able to regulate commerce within their borders, but the extra-territorial regulation of wages is probably prohibited by the Constitutional allocation of power and the dormant commerce clause. Just because the federal government has not regulated this area yet, does not mean that the states can regulate it outside of their borders.

Washington’s attorney general has an initiative to eliminate no-poaching clauses from franchise agreements nationwide, and some attorneys general have followed his lead. He has issued information subpoenas called civil investigative demands to many national franchisors concerning no-poach provisions in franchise agreements used in his state. The information demands have not been limited to franchisors, but many others who do business in the franchise community to determine whether franchisors and those similarly situated have colluded to impose no-poach provisions. In the case of Jersey Mike’s, the Washington attorney general demanded that all no-poach provisions be removed from all existing franchise agreements. Jersey Mike’s responded that it did not and would not enforce the provision and would remove the provision from Washington franchise agreements. The attorney general sued to compel removal nationwide as a per se violation of the state antitrust law. Jersey Mike’s settled the case after discovery. Under the settlement, Jersey Mike’s agreed to exclude anti-poaching provisions in any new or renewed franchise agreements, to remove the language from existing franchise agreements, and to pay the attorney general $150,000 for costs and attorney fees.

What is the best practice?

I am unconvinced that a no-poach clause is a per se violation of the antitrust laws. Moreover, I am of the opinion that no-poach clauses are rarely enforced by anyone. The mechanics of enforcing such a clause, one franchisee against another or the franchisor, is rarely warranted.

If the clause is important to a system, I would probably recommend that the clause remain as it does not appreciably impact wages. But franchisors and licensees should expect more scrutiny of such clauses and be willing to defend such clauses. In some systems, I have recommended a systemwide statement that the clause will not be enforced, or an amendment of the operations manual to the same effect. In other systems, I have suggested that no action be taken as to existing franchise agreements. I generally recommend that in the new form of franchise agreement that a specific decision be made why such a clause should be included, with the suggestion that it not be included unless necessary. Franchisors should review their current agreements with counsel to decide whether it is necessary to defend such a clause if challenged.

Reprinted with permission from the January 23, 2020 issue of The Legal Intelligencer. (c) 2020 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.