Authors: Charles Valente and Heather Kuhn O’Toole
The Federal Trade Commission (FTC) is an independent agency of the United States government that is charged with protecting consumers and maintaining competition in the marketplace. Recently, the FTC gave public notice of a proposed rulemaking which would severely limit the use of non-compete agreements in employment contracts. According to the proposed rulemaking, noncompete agreements are anticompetitive and result in artificially suppressed wages, inhibit innovation, and create significant barriers to entrepreneurs starting new businesses.
In a traditional non-compete agreement, an employee agrees not to work for a competitor for a certain period of time, generally within a specific geographic area, following the termination of employment. Employers often favor these agreements as a means of protecting, among other things, long-standing customer relationships, confidential information, trade secrets, and other valuable business assets. Opponents of non-compete agreements argue that non-compete agreements are not necessary to protect an employer’s legitimate business interests and that they are frequently overly-restrictive and prevent employees from finding new work, which can be detrimental both to the economy at large and to the individual employees.
Even prior to the proposed rulemaking, the use of noncompete agreements has been an issue of concern for some state legislatures. In fact, some states, such as California, have statutory bars to non-compete agreements in employment agreements. Illinois has adopted the Freedom to Work Act, effective in 2017 and recently amended, which places significant limits on the enforcement of non-compete agreements, and in some cases, non-solicitation agreements. Under the amended Illinois law, Illinois employers cannot enter into non-compete agreements with employees earning less than $75,000 per year (escalating over time). The amended law also requires employers to advise employees in writing to consult with an attorney before entering into a non-compete agreement and to provide a copy of the non-compete agreement to employees at least 14 calendar days before the commencement of employment or at least 14 calendar days to review the agreement.
Under the FTC’s proposed rulemaking, all state laws governing non-compete agreements would be superseded by the federal rule. As currently envisioned by the FTC, any contractual term between an employer and a worker that prevents the worker from seeking or accepting employment or operating a business after the conclusion of the worker’s employment will be banned. Notably, the traditional non-compete agreement is narrower than that which the FTC seeks to prohibit. The FTC’s proposed ban is based on the effect of the contract term challenged. To that end, the FTC noted two examples of terms subject to the ban: (1) a non-disclosure agreement which is so broad that it prevents a worker from working in the same field after termination of employment; and (2) an obligation to repay training costs if employment terminates within a set period where the amount to be paid does not bear a rational relationship to the expense of the training.
If the current proposed rule is adopted, the courts will need to decide what is and what is not a banned non-compete agreement. Nonetheless, we believe that, with careful drafting, effective non-disclosure and non-solicitation agreements will survive the proposed rule.
As proposed, the rule would also require employers to rescind all existing non-compete agreements, as well as give written notice to all current and former employees otherwise subject to a non-compete agreement that the employer has rescinded such agreements.
The proposed rulemaking may never become law. Indeed, the FTC itself has questioned the broad applicability of its rule and invited comments about whether an outright ban should apply to senior executives or highly paid workers, and whether other alternatives should be considered for such employees. Even if ultimately adopted, the proposed rule will likely be subject to immediate court challenges as to whether the FTC exceeded its authority in adopting the rule.
With respect to the sale of a business, the FTC has proposed an exception permitting non-compete agreements entered into by a substantial owner, investor, member, or partner of a business (currently defined as a 25% equity interest in the business) in connection with the sale transaction. The contemplated exception essentially acknowledges that in these circumstances, there is a lesser basis to conclude that non-compete agreements are anticompetitive or create artificial barriers to enter the marketplace. In fact, there are strong arguments that upholding non-compete agreements in connection with the sale of a business or a buy-out of significant investors enhances both competition and innovation. Ultimately, it remains to be seen how the proposed rule will impact non-compete agreements in such transactions.
What should business owners do now?
All business owners should undertake a self-assessment of the critical needs of their businesses to function. Who are the key employees of the business? What are the key assets of the business? What are the key processes of the business? Once these risks are identified, plans need to be made to manage those risks, including potential alternatives to traditional non-compete agreements. We can help with that.