Are non-competes dead? How the FTC proposal could impact adland and other businesses
Commercial litigator Maryann Stallone spells out the details of the FTC’s new proposed ban on non-compete agreements.
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On January 5, the US Federal Trade Commission (FTC) proposed a new rule that, if enacted, would effectively ban most non-compete agreements with workers nationwide and require employers to rescind existing non-competes with current and former workers.
Non-compete clauses are commonly found in employment or independent contractor agreements. They restrict an employee or a contractor’s ability to work for a competing company during – and often for a period following – the term of employment or engagement, often in a specified geographic location.
As it stands, agreements containing non-compete clauses are governed by state statutes or common law. Though generally disfavored, non-competes are enforceable in most jurisdictions if they protect a company’s legitimate business interests – such as client goodwill and confidential company information – and are otherwise reasonable in scope and duration. In other words, most non-compete agreements are subject to courts’ interpretation concerning reasonableness and what constitutes legitimate business interests.
With its proposed rule, the FTC seeks to remove any analysis from the courts and create a wholesale ban on non-compete agreements. The FTC’s stated motivation for the rule is to level the “unequal bargaining power between employers and the fact that non-compete clauses limit a worker’s ability to practice their trade.”
However, the proposed rule does not consider the potential harm to employers – many of whom have made substantial investments in developing their client base and protecting their confidential information – if key employees were to leave and misappropriate client goodwill and confidential information to benefit competitors.
The FTC’s rule announcement came a day after it brought lawsuits against Prudential Security, O-I Glass and Ardagh Group, alleging that their non-compete agreements constituted an unfair method of competition. In each case, the FTC ordered the company to cease enforcing, threatening to enforce or imposing a non-compete agreement on its workers and to relieve all affected workers of such agreements. Historically, the FTC has not regulated non-compete agreements between employers and workers.
If the FTC’s proposed rule is enacted, thousands if not millions of non-compete agreements in existence today will cease to have any legal effect, which could have significant ramifications on businesses. Already, the US Chambers of Commerce, various trade associations and employers are considering challenges to the rule, largely on the basis that the FTC does not have the statutory authority to issue a nationwide rule of this sort.
Is a bright-line rule really the best way to protect against stifling competition? Would a more measured approach – analyzing such clauses on a case-specific basis – prove more effective? These and other considerations will be the subject of an increasingly heated debate over the next few months.
What does the proposed rule entail?
In addition to making it illegal for companies to enter into or attempt to enter into non-compete clauses with workers, the proposed ban would also require companies to rescind existing non-compete agreements with former or current workers and inform workers that the agreements have been canceled no later than 180 days from the date the rule is published in the Federal Register.
Further, the rule would prevent companies from requiring workers to reimburse them for certain training costs if workers leave before a certain period of time where “the required payment is not reasonably related to the costs the employer incurred for training the worker.”
While the proposed rule does not explicitly prohibit or regulate other types of restrictive covenants, such as non-disclosure, non-solicitation or employee raiding agreements, the rule recognizes that those types of restrictions could also be subject to the rule if they are so broad in scope that they effectively function as non-competes. Therefore, the proposed rule prohibits the use of any type of agreement that has the effect of prohibiting workers from seeking or accepting new employment or engagement.
Who does it apply to?
Under the current formulation of the rule, the term ’worker’ is broadly defined to include not just employees but also independent contractors, externs, interns, volunteers, apprentices and sole proprietors. It further extends to senior-level executives who have access to a company’s most sensitive proprietary data.
Are there exceptions to the rule?
The proposed rule provides for a narrow exception for non-compete agreements entered into in a sale-of-business context. These types of non-compete agreements may still be used to prevent sellers of a business from competing with the purchasers of their businesses. However, this exception is applicable only where the restricted party is an owner, member or partner holding at least a 25% ownership interest in a business entity.
Who can enforce the rule?
The proposed rule may only be enforced by the FTC. Private parties would not be able to seek damages or penalties for violations of the rule.
When would the rule go into effect?
The proposed rule is the first step in the FTC’s multi-step rulemaking process. The FTC has invited comments to the proposed rule, which are due 60 days after the FTC publishes the proposed rule in the Federal Register.
We expect the FTC to receive thousands of comments to the proposed rule. The FTC will then review all public comments received and must consider such comments when drafting and publishing any final rule. After considering the public’s input, the FTC may then finalize the proposed rule.
The FTC has indicated that, if it proceeds to finalize the proposed rule, it would then set a compliance date of 180 days after it publishes the final rule in the Federal Register. Thus, the earliest the proposed rule could go into effect is 240 days after the FTC publishes the proposed rule in the Federal Register. However, the rule may be delayed further or derailed entirely by legal challenges. For example, it’s likely that companies will try to shoot down the rule on the argument that the FTC lacks the statutory authority to enact and enforce it.
Could the proposed rule be narrowed?
The FTC, perhaps anticipating challenges to the broad scope of the proposed ban, has included several potential alternatives to the proposed rule in its notice. These include:
A categorical ban on non-compete agreements for workers earning below a wage threshold (eg $100,000), with no changes to the law for workers earning above that threshold;
A categorical ban on non-compete agreements for workers earning below a wage threshold (eg $100,000), with a rebuttable presumption (ie an assumption made by a court that is taken to be true unless proven otherwise) that non-compete agreements are illegal for workers earning above that threshold;
No ban on non-compete agreements, but a rebuttable presumption that non-compete agreements are illegal for all workers; or
No ban on non-compete agreements, but a rebuttable presumption that non-compete agreements are illegal for workers earning below a wage threshold (eg $100,000), with no changes to the law for workers earning above that threshold.
The notice further questions “whether [the FTC] should adopt different standards for non-compete clauses with senior executives.”
What does this mean for employers and businesses?
The proposed rule will not become effective for some time, if at all. However, companies should nevertheless begin contemplating steps to both protect their business interests and comply with the rule, should it go into effect. They can do so by, among other things, meeting with qualified legal counsel to navigate the law governing restrictive covenants (non-competes, non-solicits, non-disclosure agreements) and taking proactive steps to protect their businesses if the rule takes effect.
In the short term, companies should consider whether to submit comments on the proposed rule and its alternatives. Comments must be made within 60 days of the publication of the proposed rule in the Federal Register.
Further, companies should evaluate their current and projected use and enforcement of non-compete agreements and consider how the implementation of the rule would impact their business. Companies should also be judicious when entering into restrictive covenants or seeking to enforce them. The ill-advised attempt by companies to enforce these clauses without a legitimate business interest – and particularly against former low-level or modestly compensated employees – has led to the political scrutiny that inspired the proposed rule.
We will continue to monitor the reaction to the proposed rule as this undoubtedly will not be the last word on it.
Maryann Stallone is a partner at Tannenbaum Helpern Syracuse & Hirschtritt.