Non-Compete Agreements Under Federal Scrutiny

Non-Compete Agreements Under Federal Scrutiny

Contact: Derrick Fong-Stempel

Non-compete clauses as we know them may be a thing of the past if a rule proposed by the Federal Trade Commission becomes final. This is particularly significant news for employers nationwide and across industries.

Cutting to the chase, the FTC’s proposed rule would serve to ban non-compete provisions, except in limited circumstances. By way of this alert, we answer specific questions raised by the FTC’s ongoing action.

Q. What is a non-compete clause?

A. As set forth in the proposed rule, a “non-compete clause means a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.” Otherwise known as restrictive covenants, these provisions are routinely included in contracts in an effort to prohibit one party from entering into or starting a similar profession or trade in competition against another party.

Q. What does the FTC’s proposed rule seek to prohibit?

A. By way of its rulemaking, the FTC is working to effect a sweeping ban prohibiting employers from entering into post-employment non-compete clauses with workers. Though it would generally not apply to other types of employment restrictions, like non-disclosure agreements, the FTC has made clear in its proposed rule that “other types of employment restrictions could be subject to the rule if they are so broad in scope [as to] function as non-competes.” Two examples have been provided by the FTC:

(1) a non-disclosure agreement between an employer and a worker that is written so broadly that it effectively precludes the worker from working in the same field after the conclusion of the worker’s employment with the employer, and

(2) a contractual term between an employer and a worker that requires the worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specified period, where the required payment is not reasonably related to the costs the employer incurred for training the worker.

Additionally, the proposed rule states that it is an unfair method of competition “for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with the worker a non-compete clause; or represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete agreement.”

If the proposed rule is adopted in its present form, disputes will certainly arise over whether NDAs, customer non-solicitation provisions, or other possible restrictions an employer might impose will pass muster under the FTC’s imprecise “functional test.”

Q. Does the FTC’s proposed rule look to impose any other requirements upon employers?

A. Yes. If finalized, the proposed rule would also require employers to rescind existing non-compete agreements and actively inform workers accordingly. This means employers would have to provide notice to workers that existing non-compete clauses are no longer in effect or enforceable—notice that would need to be sent individually and in writing to current and former workers and furnished within 45 days of rescinding the non-compete clauses.

Q. Are there exceptions to the FTC’s proposed rule?

A. Yes. The proposed rule contains an extremely narrow sale-of-business exception, but this only applies to sellers having at least a 25% ownership interest in the business being sold. In such a circumstance, the proposed rule would not apply to any non-compete clause that is entered into by a person selling all or substantially all of a business entity’s operating assets.

In addition, certain employers would not be subject to the proposed rule, including banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers, and persons and businesses subject to the Packers and Stockyards Act, 1921 (subject to certain exceptions).

Q. Does the FTC’s proposed rule apply to all workers?

A. The prohibition against the use of restrictive covenants would apply to employees, independent contractors, interns, and volunteers.

Q. If finalized, how would the FTC’s proposed rule impact existing state laws?

A. The proposed rule would supersede all contrary state laws.

Q. What are the next steps in terms of the FTC’s proposed rule becoming finalized?

A. Now that the rule has been proposed by the FTC, the public is invited to comment on it through March 10 (unless the FTC extends that deadline). Once the comment period has come to a close, the FTC can issue a new proposed rule, terminate its rulemaking, or finalize the rule as proposed.

If and when finalized, the rule would be published in the Federal Register, but would not take effect until it was sent to Congress and the Government Accountability Office for review and oversight. If approved, the proposed rule would become effective 60 days thereafter, but employers would have 180 days to comply.

Q. What should employers do during this process?

A. First, employers should understand that we are a long way from a blanket prohibition of non-compete provisions. The FTC rulemaking is in its early stages, with the public comment period just beginning. And even if the FTC rule as proposed is ultimately issued, it will surely be subject to litigation aimed at deeming such a sweeping ban on restrictive covenants unlawful. Legal challenges could result in revisions to the general scope of the rule, enumerated exceptions, and perhaps modification of the notice and rescission requirements. Michelman & Robinson, LLP will monitor any relevant litigation in real-time.

Regardless, as we await an outcome, employers wanting to impose non-compete clauses should do what they can to draft them reasonably (in terms of duration and geographic scope) and narrowly with an eye toward protecting legitimate business interests (e.g., trade secrets, confidential information, or customer goodwill).

Of course, the employment team at Michelman & Robinson, LLP will keep you apprised of significant developments related to the proposed FTC rule. In the meantime, feel free to reach out with any questions you may have about restrictive covenants and their proper use.

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.