Navigating Non-Competes in a Time of Uncertainty
Photo by Katie Moum on Unsplash
Author: Ty Leitow
Last Updated: October 2, 2024
For most companies, part of the standard onboarding process for new employees includes having them sign a non-disclosure agreement (“NDA”), non-solicitation agreement, and a non-compete agreement (or some other employee agreement that includes non-disclosure, non-solicitation and non-compete clauses). This is especially true for executives, senior managers, and other subject matter experts or employees with special or unique knowledge about the business.
NDAs, Non-Solicitation Agreements, and Non-Compete Agreements
Generally, NDAs are used to protect the company from employees sharing or using a company’s confidential information and trade secrets with third parties or for their own benefit. Non-solicitation agreements prohibit employees from soliciting the company’s clients, customers or employees for their own benefit or the benefit of a third-party. Non-compete agreements prohibit employees from competing with the company, and often restrict employees from working for competitors of the company or starting a similar business that competes with the company.
Until recently, it was standard operating procedures and a recommended form of risk management to have all employees enter a NDA, non-solicitation agreement and non-compete agreement upon being hired. However, the 2020s have seen a new focus on anti-competitive activities, and that focus has included anti-competitiveness in the employer-employee relationship.
United States Federal Trade Commission’s Final Rule Banning Non-Competes
In the Spring of 2024, the U.S. Federal Trade Commission (“FTC”) finalized and published a rule banning most non-compete clauses in employer-employee contracts (the “Rule”).[1] However, soon after the Rule was published, several legal challenges to the Rule were filed. On August 20, 2024, a U.S. Federal Court for the Northern District of Texas set aside the FTC’s non-compete Rule, ordering that it shall not be enforced throughout the United States. The District Court’s ruling will likely be appealed to the U.S. Court of Appeals for the Fifth Circuit.
The procedural timeline has left employers in a bit of limbo, knowing that the FTC is motivated to eliminate non-compete clauses, but also knowing that currently, the FTC cannot enforce the Rule until the appeals process has run its course.
The Rule
If the Rule goes into effect, it will prohibit employers from imposing non-compete agreements on employees, including independent contractors and unpaid workers. This ban is broad, applying to all terms and conditions of employment, including any agreement between the employer and employee (oral and written), as well as company policies and employee handbooks.[2]
The Rule defines non-compete clauses as:
(1) A term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:
(i) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or
(ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.
(2) For the purposes of this part 910, term or condition of employment includes, but is not limited to, a contractual term or workplace policy, whether written or oral.
Generally, all businesses are subject to the rule. There are limited exceptions for certain financial institutions and non-profit organizations.
The Rule would also require companies to provide clear and conspicuous notice to its employees that non-competes are no longer enforceable.[3] The notice must be in writing (email and text message are acceptable), and the FTC has provided model language for the notice.[4]
Exceptions to the Rule
The Rule provides two exceptions to the broad ban on non-compete clauses. The first relates to “senior executives”, allowing existing non-competes with senior executives to remain in force. The Rule bans new non-competes with senior executives.
Under the Rule, a “senior executive” is defined as an employee earning more than $151,164 who is in a “policy-making position”.[5] Policy-making positions includes chief executive officers, presidents, and any other person who has the “final authority to make policy decisions that control significant aspects of a business entity or common enterprise.” Excluded from this definition are individuals whose “authority is limited to advising or exerting influence over such policy decisions or having final authority to make policy decisions for only a subsidiary of or affiliate of a common enterprise.”[6]
FTC guidance on this exception suggests that many C-suite executives will be considered senior executives if they have the authority to have a significant impact on the overall business. Generally, managers and directors of a division or similar sub-part of the business will probably not be covered by the “senior executive” exception, and therefore their non-compete clauses would not be enforceable under the Rule.
There is one more narrow exception that applies to the sale of a business (e.g. Mergers and Acquisitions). Generally, a non-compete clause will be enforceable under an agreement where a business owner sells his/her stake in a business.[7]
Penalties for Violating the Rule
Violations of the Rule can result in fines, penalties and other injunctive relief. The Rule states that any use of non-competes is an unfair method of competition that violates Section 5 of the FTC Act. Practically, this means that the Rule not only makes non-compete agreements unenforceable, but it makes entering into such non-compete agreements or attempting to enforce existing non-compete agreements an unlawful act.
State Non-Compete Laws
In addition to the FTC Rule at the federal level, many states have also enacted their own laws prohibiting non-compete clauses. Currently, 4 states have enacted a complete ban of non-competes (California, Oklahoma, North Dakota, and Minnesota), and a majority of other states have laws that conditionally ban or limit non-competes. There are only 10 states that have no restrictions for non-competes: Michigan, Wisconsin, Ohio, West Virginia, North Carolina, South Carolina, Mississippi, Kansas, Nebraska and Wyoming.[8]
Practically speaking, unless your business is a smaller operation with employees located only in a state with no restrictions, it would be prudent to carefully review your employee agreements to ensure you’re not running afoul any state laws, in addition to the pending FTC Rule.
Status of Cases Challenging the Rule
Currently, there are three cases challenging the Rule. Ryan, LLC (Case No. 24-cv-986, Northern District of Texas) held that the FTC cannot enforce the rule nationwide. In the other two cases, one court partially granted a preliminary injunction, and the other court granted a preliminary injunction as to the plaintiff only.[9] This split in decisions suggests that appellate review will eventually occur.
The likelihood of the FTC prevailing on appeal has been greatly affected by the Loper Bright decision.[10] Loper Bright overruled the longstanding precedence known as Chevron deference, which generally held that when legislation was ambiguous or left an administrative gap, the courts must defer to the regulatory agency’s interpretation if the interpretation is reasonable. This ultimately gave government agencies significant power in interpreting legislation.
However, in Loper Bright, the Supreme Court shifted that power of interpretation to the judicial branch, allowing federal courts to substitute their own judgement in determining the meaning of legislation, and not simply defer to agency interpretations.
As of the date of this writing, the FTC has not yet appealed the Ryan decision, but it is expected to do so.
Alternative FTC Attacks on Non-Competes
While the Rule’s ultimate fate is unknown, the FTC has shown that it will use alternative methods to chill the effects of non-compete clauses. On January 4, 2023, the FTC announced that it filed its first lawsuits to stop companies from enforcing non-compete restrictions.[11] These lawsuits allege that non-competes violate Section 5 of the FTC Act which governs unfair methods of competition.
Review Your NDAs, Non-Solicitation Agreements, and Onboarding Processes
The Rule does not explicitly prohibit NDAs or non-solicitation agreements with customers or employees, but it does set outer boundaries for what may be allowable in an NDA or non-solicitation agreement. Under the Rule, regardless of title or name, if the content of an agreement is “so broad and onerous” that it has the “same functional effect” as a non-compete clause, then it would be illegal and unenforceable under the Rule.[12]
Pending the outcome of any appeal of the preliminary injunction rendering the Rule unenforceable, Legal Teams and HR Departments should review their NDA and non-solicitation agreements to ensure they protect their company’s confidential information and against solicitation. Properly tailored NDAs and non-solicitation agreements are good tools in managing information risk and competition risk. With that said, the language in those agreements should be checked to make sure it is not so broad and onerous as to effectively make them non-compete agreements.
For NDAs, they may violate the Rule “where they span such a large scope of information that they function to prevent workers from seeking or accepting work or starting a business after they leave their job.” Here, practically speaking, the FTC argues that these overly broad NDAs “function to prevent the worker from working for another employer in the same field and are therefore non-competes under the Rule.”[13]
Similarly, non-solicitation agreements may be considered an illegal non-compete clause “where they function to prevent a worker from seeking or accepting other work or starting a business after their employment ends.”[14]
This national focus on non-competes marks a good time for companies to review their existing employee agreements with their key employees, managers and executives. It may also be a good time to review the company’s overall onboarding process.
Ideally, all onboarding procedures are documented in a written policy. Within those written policies, there should be clear steps that require all new employees sign and deliver an NDA and non-solicitation agreement. Proper training should be given on a periodic basis to HR employees responsible for onboarding new employees to ensure (i) the policies are followed for every hire, and (ii) the signed employee agreements are properly saved.
Corporate lawyers and HR professionals will undoubtedly be watching the expected appeal of the injunction against the Rule and monitoring both state and federal activity regarding non-competes.
References
[1] Federal Trade Commission. (April 23, 2024). FTC Announces Rule Banning Noncompetes. Accessed October 2, 2024: https://www.ftc.gov/news-events/news/press-releases/2024/04/ftc-announces-rule-banning-noncompetes
[2] Federal Trade Commission. Noncompete Rule, § 910.1. Accessed September 29, 2024. https://www.ftc.gov/legal-library/browse/rules/noncompete-rule
[3] 16 C.F.R. § 910.2(b)(1).
[4] Federal Trade Commission. Noncompete Rule, § 910.2(b). Accessed September 29, 2024. https://www.ftc.gov/legal-library/browse/rules/noncompete-rule
[5] Federal Trade Commission. Noncompete Rule, § 910.1. Accessed September 29, 2024. https://www.ftc.gov/legal-library/browse/rules/noncompete-rule
[6] Id.
[7] Federal Trade Commission. Noncompete Rule, § 910.3(a). Accessed September 29, 2024. https://www.ftc.gov/legal-library/browse/rules/noncompete-rule
[8] Economic Innovation Group. (August 21, 2024). State Noncompete Law Tracker. Accessed October 1, 2024: https://eig.org/state-noncompete-map/
[9] ATS Tree Services (Case No. 24-cv-1743, Easter District of Pennsylvania) & Properties of the Villages (Case No. 24-cv-316, Middle District of Florida).
[10] Loper Bright Enterprises v. Raimondo, 603 U.S. ____ (2024).
[11] Federal Trade Commission. (January 4, 2023). FTC Cracks Down on Companies That Impose Harmful Noncompete Restrictions on Thousands of Workers. Accessed October 1, 2024: https://www.ftc.gov/news-events/news/press-releases/2023/01/ftc-cracks-down-companies-impose-harmful-noncompete-restrictions-thousands-workers
[12] Brandon H. Elledge. (April 29, 2024). Don’t Fret (Yet): Trade Secrets, NDAs and Non-Solicts After the FTC Non-Compete Rule. Holland & Knight. Accessed October 2, 2024: https://www.hklaw.com/en/insights/publications/2024/04/dont-fret-yet-trade-secrets-ndas-and-non-solicits
[13] Draft Final Rule 78 n.341 & n. 346.
[14] Draft Final Rule 84.