Attraction and retention of a talented workforce is a common priority and, oftentimes, a challenge in today’s employment environment. Similarly, employers may look for ways to help ensure that when they devote time and resources to training employees, those employees do not subsequently begin working for a direct competitor of the employer. One common tool that an employer may try to utilize to prevent such a situation is a non-compete agreement (“NCA”). However, the Federal Trade Commission (“FTC”) recently proposed new administrative rules that could curtail the use of NCAs on a federal level, and so the current outlook on the effectiveness of NCAs is in an uncertain state. This article discusses various limitations on NCAs as they exist now, and then provides an overview of the rule proposed by the FTC.
I. NCAs: Governed by State Law and Trending Towards Limitations.
Historically, NCAs have been governed exclusively by state law. Accordingly, there is currently a broad spectrum of treatment for NCAs, depending on the jurisdiction. Some states, such as Minnesota, do not have any statutes or regulations governing NCAs. Rather, NCAs in specific professions (such as lawyers, health care workers, etc.) are governed by ethical rules promulgated by state boards, and NCAs in broader contexts are subject to judicial “common law.”
For instance, Minnesota caselaw holds that NCAs are disfavored, and that, in determining whether to enforce a certain NCA, courts must balance the employer’s interest in protection from unfair competition against the employee’s right to earn a livelihood, using certain factors as benchmarks in their determinations. Such balancing tests typically end up simply muddying the water and leaving employers unsure of their legal protections.
Other states have enacted statutes that provide varying levels of detailed guidance regarding the legality of NCAs. For instance, Illinois has recently enacted a comprehensive statute providing for the broad prohibition of NCAs between employers and employees who are low-wage workers, covered by a collective bargaining agreement, or are members of specific fields.
In general, states have been trending against NCAs in recent years. For example, in 2019, Maryland, Maine, New Hampshire, and Rhode Island all passed legislation restricting NCAs for low-wage workers. In 2020, Virginia and Nevada took similar steps. In 2021, Oregon amended its NCA statute to erode their enforceability, and Nevada amended its laws to penalize employers that attempted to enforce already prohibited NCAs. The District of Columbia simply banned NCAs outright in nearly all circumstances. The Minnesota legislature has been debating bills that would ban all NCAs with employees who make less than a certain salary threshold or meet other criteria over the past few years. On top of these state-led initiatives, the FTC proposed its own rule on January 5, 2023, to address the use of NCAs.
II. The FTC’s Proposed Rule on NCAs.
The FTC’s proposed rule can be seen as the culmination of state action like that discussed above, as well as a response to multiple years of encouragement from the Biden Administration. In short, the FTC’s proposed rule would broadly prohibit employers from entering into NCAs with “workers,” which includes both employees and independent contractors. The rule has been introduced through a “notice of proposed rulemaking,” which is a public notice issued by an independent agency of the federal government that wishes to add, remove, or change an administrative rule or regulation as part of the agency rulemaking process. Once a notice of proposed rulemaking is issued, the public has the opportunity to submit comments to the agency in either support or opposition to the proposed rule. If a rule is ultimately passed, it becomes enforceable but could still be subject to challenge through the litigation process.
In this instance, the FTC’s proposed rule includes multiple parts. First, it would provide an official definition of an NCA as “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.”
Second, the proposed rule would include the application of a “functional test” in determining whether a contractual provision is truly an NCA; namely, if the provision would have the “effect of prohibiting 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.” The proposed rule also lists the following examples of de facto, although perhaps non-traditional, NCAs:
- 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.
- 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 time period, where the required payment is not reasonably related to the costs the employer incurred for training the worker.
Third, the proposed rule does not provide for the “grandfathering in” of previously made NCAs. To the contrary, the new rule would require employers to rescind existing NCAs within 180 days of publication of a final rule, and to provide individualized notice to current and former workers who were previously covered by an NCA that the NCA is no longer in effect. The proposed rule provides model language for employers to use in providing such written notice to their workers. Notably, the proposed rule provides a limited exception for NCAs that were entered into in connection with the sale of a business or business assets; however, the FTC is careful to note that these NCAs are still subject to Federal antitrust law and other applicable laws.
Lastly, the proposed rule notes that the FTC’s new rule would supersede any State laws allowing for the use of NCAs or that in any way would be inconsistent with the new rule. However, any State law that provided for greater protections for workers would still be valid and enforceable.
The FTC is now seeking public comment on several modifications to the proposed rule, including whether franchisees should also be covered; whether different standards should apply to senior executives; and whether low-wage and high-wage workers should be treated differently under the new rule. The period for public comments opened on January 9, 2023, and remains open until March 10, 2023. Subsequent action on the proposed rule is not expected for several months following the close of the public comment period.
As was expected, the proposed rule has already garnered significant response. FTC Commissioner Christine Wilson has already issued a dissenting statement, and the U.S. Chamber of Commerce has declared the proposed rule “blatantly unlawful” in a press release on January 5, 2023. Ultimately, any final rule will undoubtedly include significant changes from the wide-sweeping blanket ban as proposed and will also face numerous challenges in court.
While the proposed rule has not yet reached a stage that would require employer action, it is important for employers to be aware of the legislative – and now regulatory – trends at the state and federal levels targeting the use of NCAs. Employers will want to begin tailoring their separation agreements to comply with any current applicable state law, while still maintaining protections of their trade secrets or confidential information, both of which are still legally protectable outside the use of an NCA.