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The End Of Employee Non-Competes?

Employee non-compete clauses – contractual covenants that restrict an employee’s right to work for a competitor after the end of the contracted employment – have been around for many decades. They have become part of the fabric of employment in America.

Employers view these covenants as critical protections for processes, techniques, pricing structures, customer details, and other pieces of an employer’s business that an employee might have stored in his or her head, but that might not strictly qualify as trade secrets. Often this information has taken the employer many years to develop. Without non-competes, what is to prevent the employee from giving all of that information to any new employer who offers an increase in pay in exchange for that information?

On the other hand, employees see these covenants as unfair impediments to earning a livelihood elsewhere if the particular job does not work out, even when the employee is fired or laid off from that job. Why should it be that an employer can use a non-compete to prevent a worker from selling his only talents to another employer, thereby effectively either forcing that employee into unemployment or trapping that employee into forever working for that one employer?

Except in California, North Dakota, and Oklahoma, where employee non-competes are already largely banned, the drafting and litigating of employee non-compete agreements is a major part of many a lawyer’s practice. So many lawyers, as well as members of the broader business community, are taking note of the proposed rulemaking of the Federal Trade Commission (“FTC”) released on January 5, 2023, which would effectively ban the enforcement of employee non-competes nationwide.

In support of its proposed rulemaking, the FTC estimates that “about one in five American workers – approximately 30 million people – are bound by a non-compete clause and are thus restricted from pursuing better employment opportunities… . Because non-compete clauses prevent workers from leaving jobs and decrease competition for workers, they lower wages for both workers who are subject to them as well as workers who are not. Non-Compete clauses also prevent new businesses from forming, stifling entrepreneurship, and prevent novel innovation that would otherwise occur when workers are able to broadly share their ideas.”

The FTC also reasons that “[c]ompanies use non-competes for workers across industries and job levels, from hairstylists and warehouse workers to doctors and business executives. In many cases, employers use their outsized bargaining power to coerce workers into signing these contracts. Non-competes harm competition in U.S. labor markets by blocking workers from pursuing better opportunities and by preventing employers from hiring the best available talent.”

The FTC estimates that the proposed new rule would increase the earnings of American workers by almost $300 billion each year by preventing employers from entering into new non-compete agreements and requiring them to rescind existing non-compete clauses. The rule would supersede any inconsistent state law. The rule would also require employers to affirmatively notify their affected employees in writing that their now-rescinded non-competes are no longer in effect and may not be enforced. An employer’s failure to abide by these requirements would amount to an “unfair method of competition,” which could trigger potential civil liabilities.

The only exception to this across-the-board ban on non-competes would be for a “substantial owner, member, or partner” in a business upon the sale of that business. In the case of the sale of a business, a “substantial” owner of that business – someone who owns at least a 25% stake in that business – can be bound to a non-compete as a condition of the sale of that business.

The FTC’s proposed rule would apply not merely to restrictive covenants denominated as non-competes, but also to any “de facto non-compete clause” that “has 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.” Thus the prohibition could extend to any non-disclosure agreement 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… .”

As currently written, the prohibition also extends to a contractual term that requires a worker to pay an employer for training costs if the worker’s employment terminates within a specified time period where the required payment is not reasonably related to the training costs incurred by the employer.

The FTC’s proposed rule can be read as a reaction to employer overreach in trying to bind even low-level employees to non-competes and non-disclosure agreements that are not designed so much to protect the employer’s legitimate interests but rather simply to prevent employees from seeking more lucrative positions elsewhere. That said, an employer does have a legitimate interest in preventing its high-level employees and executives – those who do in fact know the formula to the special sauce – from taking the employer’s secrets and selling them to a higher bidder.

So in very short order, we can expect employers and chambers of commerce across the country to pursue legal challenges to the FTC’s proposed new rule. It is likely that the rule will be challenged on grounds of federalism – i.e. that the proposed federal rule interferes with the prerogatives of the states – or more simply on grounds that the proposed rule exceeds the statutory powers of the FTC.

If one were to wager on the topic, it might be safe to bet that the proposed new prohibition on non-competes will at least be narrowed to protect only lower-level employees, while allowing enforcement of non-competes as to high-level executives and those who earn above a certain salary and bonus threshold.

It should be noted that as currently written, the FTC’s proposed rule does not purport to limit the enforcement of state or federal trade secrets laws. So employers may still pursue employees for the misappropriation of true trade secrets. Likewise, the proposed prohibition does not purport to extend to non-solicitation clauses. So it would appear that, even if the proposed rule is implemented as currently written, employers would still be able to contractually prohibit former employees from soliciting other employees, and would likewise be able to prohibit former employees from soliciting or serving the employer’s customers.

The proposed ban on employee non-competes will not become effective until 180 days after publication of the final rule. The rule is likely to undergo significant change in the meanwhile. Stay tuned.

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