FTC PROPOSES NATIONWIDE BAN ON NON-COMPETE AGREEMENTS

On January 5, 2023, the Federal Trade Commission (“FTC”) announced a proposed rule that, if enacted, would amount to a virtual ban on the use of non-compete agreements and leave employers with fewer legal options of protecting their confidential and proprietary information.

Under current law, agreements containing non-compete clauses are governed by state statutes or common law. Most states limit non-compete clauses, requiring that their geographic scope, duration, and restrictions on competitive activity be reasonable. This leaves most non-compete agreements subject to courts’ interpretations about what constitutes a legitimate business interest.

The FTC’s newly proposed rule prohibits employers from imposing non-compete clauses on workers with only one narrow exception. The proposed rule recognizes the traditional state law exception to non-compete agreements or provisions that are entered into in the sale of a business. However, the exception is narrow, and applies only to those who own at least 25% of a company.

The effect of this proposed rule on standard executive and other forms of employment agreements could be significant. For example, the proposed rule would prohibit employers nationwide both from entering into new non-compete provisions and from maintaining its existing non-compete clauses with all workers. This would include not just employees, but also independent contractors, consultants, interns, and volunteers. Thousands, if not millions, of non-compete agreements in existence today would simply cease to have any legal effect under the FTC’s proposal.

Under the current formulation of the rule, this broad definition of “worker” extends to even senior-level executives with access to a company’s most sensitive and valuable information. Employers frequently condition executives’ participation in equity plans and other incentive-based compensation, such as profits interest agreements, short and long-term bonus plans and retention agreements, on an employee’s commitment to enter into and honor restrictive covenants. The scope of the proposed rule also would probably go beyond a traditional employer-employee relationship, extending to partnerships and membership agreements among individuals. As a result, standard noncompetition clauses within LLC and partnership agreements could also be impacted.

The proposed rule as currently drafted would also require that employers take active steps to rescind existing non-competes and inform workers that such clauses are no longer in effect. Specifically, employers would be required to rescind existing non-compete clauses with current and former workers within 180 days of the final rule going into effect. Those employers would also be required to inform their workers in an individualized communication that the non-compete clause is no longer in effect within 45 days of rescinding the non-compete clause.

While the proposed rule does not explicitly prohibit other forms of restrictive covenants, such as non-disclosure agreements or non-solicitation agreements, the rule also recognizes that those clauses can be broadly drafted to have the same effect as a non-compete and can practically serve as de facto non-compete agreements. As such, the rule prohibits the use of any form of agreement that has the effect of prohibiting workers from seeking or accepting new employment.

However, despite all of ominous warnings related to the proposed rule, employers who rely on non-competes should not panic just  yet. Most commentators agree that the proposed rule is unlikely to go into effect in its current form, if at all. The FTC will likely vote in April 2024 on the proposed rule. However, this effort by the FTC should serve as a wake-up call to employers who have traditionally relied upon non-competes. Many states have already taken or are considering efforts to limit or ban the use of non-competes, and that trend will continue over the next few years.

What should employers do?

If you use non-competes, reevaluate your current approach and prepare a backup plan for a scenario where non-competes become unlawful and unenforceable. Although it could be many months at a minimum before any broad non-compete ban becomes effective, any FTC rule is highly unlikely to “grandfather” or otherwise exempt pre-existing non-competes. Thus, any non-compete that you enter into now could become invalid. If that happens, you will want other safeguards in place to protect your proprietary information and defend against unfair competition.

Some options to consider to protect your business include:

1. Strengthening confidentiality agreements to fill any gaps created by non-compete bans. Most of the developments mentioned in this article affect non-competition and non-solicitation agreements, but do not address agreements that simply require maintaining the confidentiality of trade secrets and other nonpublic business information. In many cases, a strong and well drafted confidentiality agreement can protect an employer’s interests.
2. Leveraging the protection available under trade secret protection laws. The developments mentioned above do not eliminate rights existing under federal and state trade secret laws. These laws also can substitute for some of the protection that would be available from non-competes regarding the misappropriation of trade secrets, and they sometimes can help a damaged employer seek and obtain injunctive relief and monetary damages. Because these laws focus on protecting actual trade secrets, any employer who seeks to invoke them should take steps now to ensure that it is treating key proprietary information as trade secrets under the law.
3. Considering alternative compensation structures that can deter unfair competition. There are several ways employers can adjust employee compensation to deter problematic behavior. For example, revising annual bonus programs to condition receipt of a bonus on a departing employee taking specifically defined steps to help transition key relationships, return company property and provide sufficient notice prior to leaving can help mitigate the adverse impact of an employee’s sudden departure. Employers also can implement longevity bonuses and seniority-based pay raises to help deter unwanted departures of more senior employees who may have greater access to proprietary information and relationships, and thereby who pose more of a competitive threat.
4. Improving training in key areas. There are several ways that training can help fill any gaps. Consider training managers to ensure that multiple employees have strong relationships with any key customers and business partners, to reduce the downside if one of them leaves. Ensure that managers regularly conduct exit interviews and thoroughly understand beforehand the departing employee’s role and types of access, which can deter bad actors, retain proprietary information and ensure that key relationships get transitioned. As another example, if you improve and expand your training on your information security systems, that can create further deterrence and help fill any gaps that might otherwise impede enforcement.
5. Considering moving away from no-poach agreements with other organizations. No-poach agreements between two organizations are far more likely to experience challenges than traditional non-compete agreements and are far more likely to violate antitrust law.
6. Avoiding non-competes with low wage workers except in extraordinary circumstances. The FTC is targeting these types of agreements more than any others. As a practical matter, employees in these positions are far less likely to have access to proprietary information or other duties that would be necessary to justify a non-compete. If you are requiring non-competes from large numbers of employees in lower wage or lower ranking positions, you should reevaluate your approach as soon as possible.
7. Considering these possibilities when pursuing mergers, acquisitions and other transactions. Many deals rely on one party ensuring that the other party will not become a competitor after closing. Most of the restrictions discussed above create some exceptions for the sale of a business, but those exceptions are limited. For example, if the FTC’s proposed rule becomes effective, a buyer could not impose a non-compete against a seller’s key salesperson even if they previously owned 20% of the business.

If you use restrictive covenants, focus on where you really need them. Requiring that all employees sign non-competes may not be a wise approach. An overbroad approach can have adverse effects in certain situations where it really matters. An organization that requires non-competes from broad ranges of employees may draw additional scrutiny, which can threaten its truly important agreements. Also, if you require a non-compete from one employee but then decline to enforce it, that can affect your ability to enforce a restrictive covenant that you truly consider necessary.

If the information contained in this article show anything, it is that employers should be far more surgical with their restrictive covenants.