In 2016, the Department of Justice (DOJ) and the Federal Trade Commission (FTC) jointly issued “Antitrust Guidance to Human Resource Professionals,” addressing employee no-poach agreements – agreements between two or more employers that restrict employee recruiting or hiring.1 According to the agencies, these agreements may violate Section 1 of the Sherman Act by depressing wages and impeding employee mobility. No-poach agreements also fall within the purview of various state consumer protection statutes, such as California’s Cartwright Act and Washington’s Consumer Protection Act.
Recently, private litigants and state enforcers have targeted no-poach clauses in franchise agreements spanning the economic spectrum, including fast-food, fitness studio, hotel/motel, automotive service, and tax preparation chains. Typically, these franchise no-poach agreements restrict franchisees from hiring employees of the franchisor or other franchisees. Discussed in detail below, Stigar v. Dough Dough spotlights the antitrust debate over franchise no-poach agreements and underscores the discord over the appropriate legal standard.
The purpose of this alert is to demystify the antitrust implications of franchise no-poach agreements by (1) providing an overview of the potentially applicable legal standards, (2) discussing the current judicial split over their application, (3) forecasting which standard will eventually prevail, and (4) proposing general guidelines to avoid liability in the meantime.
The Significance of Different Legal Standards
Much of the antitrust debate over franchise no-poach agreements focuses on the applicable legal standard, which effectively can determine the outcome of a case. There are three contenders:
- The rule of reason requires the government or plaintiff to prove that the agreement in question is, on balance, anti-competitive. It protects agreements that are pro-competitive (meaning they lower prices, increase output, and promote innovation), even if they have some offsetting anti-competitive consequences. The rule of reason is the presumptive or default standard and is generally applied to “vertical agreements” – those between noncompeting firms at different levels of the market (e.g., manufacturers vs. distributors).2 The rule of reason can also apply where an otherwise anti-competitive agreement is ancillary to a legitimate transaction, such as a corporate spinoff3 or joint venture, and is reasonably necessary to accomplish its purpose.
- The per se rule requires the government or plaintiff only to prove the existence of an agreement to which the per se rule applies. As its name suggests, it is more of an outright ban rather than a test. The per se rule applies to certain types of “horizontal agreements” – those between direct competitors – such as price fixing or customer allocation. In United States v. eBay, the Northern District of California held that an executive-level agreement between eBay and Intuit not to recruit or hire each other’s employees could be a per se violation of the antitrust laws.4
- The quick-look rule is a truncated version of the rule of reason that requires the government or plaintiff to show an agreement has some anti-competitive effects, at which point the burden of proof shifts to the defendant to provide a pro-competitive justification. Rarely applied, it is reserved for situations where “an observer with even rudimentary understanding of economics could conclude that the arrangements in question would have an anti-competitive effect on customers and markets.”5
Stigar v. Dough Dough: The Debate in a Nutshell
Stigar v. Dough Dough, Inc. displays the variety of arguments concerning the legal standard that should apply in franchise no-poach cases. In Stigar, Auntie Anne’s, a franchisor, and Dough Dough, a franchisee, signed a franchise agreement stating in part: “You further agree that you will not employ or seek to employ an employee of ours or another franchisee, or attempt to induce such an employee to cease his/her employment without the prior written consent of such employee’s employer.”6
Claiming the agreement depressed his wages, a former employee named Joseph Stigar sued under the Sherman Act and Washington’s consumer protection statute, using a per se theory of liability. In a motion to dismiss, Auntie Anne’s argued that the rule of reason, not the per se rule, applied because franchisors and franchisees are vertically oriented and, moreover, the agreement restricted only “intra-brand” hiring.7 Stigar opposed application of the rule of reason and argued that even though the agreement was vertical, it was designed to apply horizontally by preventing franchisees from hiring other franchisees’ employees.8
In an unusual move, the DOJ filed a statement of interest siding with Auntie Anne’s and arguing that the rule of reason should apply.9 It noted, however, that franchise no-poach agreements may be subject to the per se treatment if (a) franchisors and franchisees compete for the same employees or (b) franchisees were to agree with each other directly not to hire employees. The DOJ added that even if the agreement were not vertical, the rule of reason would still apply because the no-poach provision was ancillary to a legitimate franchise agreement.
The Washington attorney general’s office jumped into the debate by filing its own amicus brief.10 While it took no position on federal law, the state argued that there are horizontal aspects to franchise no-poach agreements. It also argued that no-poach provisions are not reasonably necessary to the proper functioning of franchise agreements, so the ancillary-restraint exception should not apply.
The Stigar case settled before the court issued an opinion, but other courts that have weighed in are split over the applicable test.
A Survey of Federal Cases: The Courts Are Split
Generally, courts have taken three positions on the applicable legal standard:
- A court in the Eastern District of Michigan concluded that the default rule of reason applied to a franchise no-poach agreement because it was vertically oriented, was ancillary to a legitimate franchise agreement, and was not the type of clearly anti-competitive restraint to which the per se rule traditionally has been applied.11
- Courts in the Western District of Washington and the Northern District of Illinois have concluded that the quick-look rule may apply because there were at least some horizontal facets to the franchise no-poach agreements at issue.12
- A court in the Southern District of Illinois suggested that the per se rule may apply, depending on how independently the franchisees operated, where a franchise no-poach agreement contained an enforcement provision allowing franchisees to sue for poaching violations.13
History suggests courts will apply the rule of reason or, at most, the quick-look rule in ordinary franchise no-poach cases, i.e., those between franchisor and franchisee. First, courts appear to view them as predominantly vertical even if they have some horizontal effects on hiring. Second, they commonly restrict only intra-brand hiring, while the Supreme Court has long held that “the primary purpose of the antitrust laws is to protect inter-brand competition.”14 Third, the per se rule is reserved for agreements that unquestionably harm competition and that courts have “considerable experience” with;15 it is probably too early for courts to conclude franchise no-poach agreements have no redeeming value.
State Enforcers Are Pursuing Per Se Claims Under State Law
Even if the per se rule does not apply under federal law, several states seem determined to pursue franchise no-poach agreements as per se violations of state law. California Senior Assistant Attorney General Kathleen Foote has stated publicly that franchise no-poach agreements are probably per se violations of California’s Cartwright Act. Moreover, the Washington AG’s office, which has investigated more than 100 franchise no-poach agreements, recently convinced a state court that the per se rule may apply to claims under Washington’s consumer protection law, apparently because the franchisor and franchisee were potentially competing for the same employees and because the agreements inured to the benefit of franchisees.16 Therefore, franchises operating in those and other states with similar laws should avoid no-poach language in franchise agreements subject to their jurisdiction.
Practice Pointers – Navigating the Legal Uncertainty
Although the law is unsettled, there are several guidelines that franchisors and franchisees should follow:
- Franchisors should steer clear of no-poach agreements with other franchisors, and franchisees should avoid similar agreements with other franchisees. These horizontally oriented no-poach agreements are likely per se violations of federal law, not to mention state laws, and the DOJ may be inclined to prosecute them as criminal violations.17
- Franchisors and franchisees should avoid franchise no-poach agreements where they compete for the same employees. For example, a franchisor may operate company stores or may compete with franchisees for employees with transferrable skill sets.
- Where franchise no-poach agreements between franchisors and franchisees are desirable, franchisors should identify pro-competitive justifications for them and maintain contemporaneous records of those justifications. Further, no-poach agreements should be narrowly tailored – outright, perpetual hiring bans are more likely to violate the antitrust laws than, for example, non-solicitation or temporally limited restrictions (e.g., those that limit hiring for several months after leaving another franchisee).
- Franchisors should avoid using franchise no-poach agreements in Washington, California, and other states that have stricter antitrust and consumer protection laws. State investigations can have extra-jurisdictional implications. For example, the Washington attorney general has pushed investigated franchisors to drop no-poach agreements even where they pertain to franchise stores outside those states.
1. Department of Justice and Federal Trade Commission, Antitrust Guidance for Human Resource Professionals, October 2016, available at https://www.justice.gov/atr/file/903511/download.
13. Butler v. Jimmy John’s Franchise, LLC, 331 F. Supp. 3d 789, 796-97 (S.D. Ill. 2018) (“If the evidence in this case shows that the franchisees are truly as independent as the plaintiff. pleads, this case will likely result in a quick look analysis. If the evidence of franchisee independence is Herculean, then the per se rule might even apply.”); see also Blanton v. Domino’s Pizza Franchising LLC, No 18-CV-13207, 2019 WL 2247731 (E.D. Mich. May 24, 2019) (finding that plaintiff pled plausible per se and quick-look claims but that “factual development” was necessary to determine which standard applied).
17. Department of Justice and Federal Trade Commission, Antitrust Guidance for Human Resource Professionals, at 4, October 2016 (“Going forward, the DOJ intends to proceed criminally against naked wage-fixing or no-poaching agreements.”), available at https://www.justice.gov/atr/file/903511/download.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.