Does your business use non-competes to stop (former) employees from leaving and starting or joining a business that competes directly against you? Do you want to hire an employee that is covered by a non-compete? What if you have a non-compete and want to leave to start your own competing business?
If you use or are subject to a non-compete or want to hire someone with a non-compete, then you’ll be interested in the latest proposal from the Federal Trade Commission (FTC). Yesterday, the FTC proposed a broad end to non-compete agreements in employment contracts.
What are Non-Compete Agreements?
Non-compete agreements are contracts between two or more parties where one party agrees not to participate in any activity (as defined in the agreement) that is in a similar profession or business as the other party.
Non-compete agreements are typically found in employee-employer relationships, with the employee agreeing not to compete against the employer. Non-compete agreements can also found in other agreements, such as in the sale and purchase of a business where the former owners agree not to compete against the new owners for a period of time.
The arguments in favor of non-competes are that it encourages employers to broadly invest in training employees and providing them with confidential information, without fearing that they will quit and then use that information against the employer.
Opponents, however, say that this restrictive covenant unfairly restrict employees being able to move between companies, particularly in the same or similar industries. This, in turn, depresses wages and hurts innovation.
The Biden administration says that approximately 30 million individuals are under a non-compete agreement. And that the use of non-compete agreements is costing employees about $300 billion (yes, with a B) a year in earnings.
Currently, there are few restrictions on non-compete agreements in employer contexts on a federal level. However, some states do have restrictions or even pretty broad prohibitions. California, for example, has a broad prohibition against non-competes in most employment contexts. Illinois, Oklahoma, South Dakota, and Washington also have restrictions on non-competes, usually limiting their use against workers earning under a certain threshold annual salary. Many states have other reasonableness standards limiting how long and how broad the agreements can be to be enforceable.
Proposal to End Non-Compete Employment Agreements
Before we proceed, it is important to note that this is only a proposed rule! Nothing has changed. And it could be a long time until something does happen.
If you have a non-compete, they could still be enforceable. You, as employee or employer, should take no action to change anything at this point based on this proposal alone without consulting a lawyer.
What does the FTC Non-Compete Proposal do?
The FTC proposal would be a broad prohibition against the use of non-competes in employment contexts. The ban would prohibit post-employment non-compete agreements. This means that once an employee leaves the company, the company would not be able to limit the employment opportunities for the now former employer. The proposal does not ban restrictive covenants for an employee during the term of their employment with the company.
The FTC wants to eliminate not only future non-competes, but also existing non-competes. And not only would the FTC rule invalidate prior existing non-competes, but employers would have to notify employees and former employees that the non-competes are no longer valid. The FTC would provide a model notice that employers could send to employees and former employees about the change.
While the proposal would ban non-competition agreements, it does not currently impact other restrictive covenants, like confidentiality agreements or non-disclosure agreements and non-solicitation of customers or employees. These agreements could protect sensitive company information. However, these agreements will need to be drafted narrowly to avoid a “function” test that these other restrictive covenants don’t act like a non-compete agreement.
Who is Covered by the FTC Proposal?
This FTC proposal to ban non-competes doesn’t cover everyone.
The ban would only cover those that are protected by the FTC Act. Certain industries like airlines are not subject to the FTC Act. Government employees are not covered by the FTC Act.
Other people that are excluded from the proposal includes those business owners with more than 25% ownership interest in the company. This includes partners in partnerships and other similar owners. The ban would also not extend to the sale of a business – when selling a company, the parties can agree to a non-compete agreement under the proposed rule.
On the other hand, there are some surprising people that are covered. Notably, independent contractors, interns, and externs are all included. This is partly to keep businesses from improperly classifying workers as independent contractors and not employees.
Also, there is no exclusion for small businesses. Many rules only apply to larger businesses with exclusions for smaller businesses, based on revenue or employee headcount. However, this proposal has no exclusions for small companies.
The FTC will open for comments from the public and interested parties as soon as the proposal is published in the Federal Register. There will be 60 days that the FTC will accept comments about the proposal.
After this period, the FTC could make changes to the rule before making it final. This review process could take months.
There could be changes relating to who is covered –
- What ownership percentage is proper? Currently at 25%, but that percentage could go lower, allowing more owners to be covered by a non-compete.
- Should small businesses be covered? If so, are there thresholds in terms of annual revenue or employee head count?
- Could top executives be excluded? They potentially have bargaining power to negotiate out of a non-compete while the company would argue that they know all the secret sauce of a company.
- What about managers and other high level employees? Some current jurisdictions that already limit non-competes say that over a certain annual salary, non-competes are effective and below the salary, they are prohibited.
- Will certain industries convince the FTC that they should also be excluded from this broad ban?
Another change that could happen would be to allow non-competes but change to a rebuttable presumption that the non-compete is not valid. But a company could argue in court that it really needs a non-compete agreement to protect its interests. The burden to prove that the non-compete agreement would be on the company, and it would be difficult to prove with the burden shifting.
The FTC will publish a final rule and then it will be 60 days to become effective. Then companies will have 6 months to comply with the provisions.
I’m going out on a limb (it’s a strong one, not a real risk here) to say that whatever the FTC passes as the final rule that limits non-competes in any way will be litigated. Some companies or business organizations are going to argue that the FTC does not have the authority to ban non-competes or limit them in this way. In particular, the part that nullifies or invalidates existing non-compete agreements.
And the first thing that will happen is that the Court, whichever conservative court they pick, will issue a nationwide stay on enforcing the regulation. Until the end of the litigation. The stay may be appealed, but that takes more time. Think: student loan forgiveness and how that still hasn’t happened.
Which means that if you have a non-compete agreement, nothing will change until 2024, at least. I don’t see the rulemaking process plus the litigation stay ending before then. For most of you that are leaving a job now, your non-compete may very well expire before the courts get done sorting this out.
This is a developing story that won’t settle anytime soon. Check back throughout the year for more details and updates.