In a landmark decision on April 23, 2024, the Federal Trade Commission (FTC) voted 3-to-2 to approve a final rule prohibiting for-profit employers across the nation from enforcing non-compete agreements on any worker, regardless of their status (employee, contractor, etc.). This rule, declared as an unfair method of competition under section 5 of the FTC Act, represents a significant shift in the legal landscape surrounding employment contracts. Many employers use some form of non-compete agreement to protect their proprietary relationships and confidential information. A traditional non-compete agreement will be negotiated with the employee by the employer as a condition of employment and prevents the employee for a particular period of time from working in a certain field as their employer and from working within a certain distance in that certain field after their employment ends.
The particular concerns for non-compete agreements is that an employer will impose unreasonable restrictions on the departing employee that prevents the employee from seeking gainful employment after they leave the former employer. Some examples of unreasonable non-compete agreements include terms that prohibit the former employee from working in the entire state for a competing business or prevents the employee from seeking any employment in their given field of choice for an extended period of time. On the other hand, an employer generally has a right to protect their proprietary relationships with their vendors and clients and will entrust those relationships to a new employee who later departs to a competitor and tries to solicit those customers at the employee’s new job. Courts and governing bodies across the United States have struggled with how to protect an employer/business owner’s legitimate business interest in protecting their proprietary relationships and confidential information while also balancing an employee’s right to seek gainful employment in their field of choice. That is what presents the current issue with the FTC’s new rule completely banning the use of non-compete agreements in certain contexts.
Implications of the Rule:
Effective 120 days after publication in the Federal Register, the rule will nullify existing non-compete agreements and prevent the creation of new ones. However, exceptions exist for “senior executives” meeting specific compensation and duties criteria. Notably, the rule extends beyond traditional non-compete clauses to include provisions penalizing workers for seeking or accepting employment elsewhere.
Exceptions and Notice Requirements:
Non-competes associated with business entity sales are exempted, aligning the rule with California’s stringent laws. Additionally, “in-term” restrictive covenants and protections for confidential information remain unaffected. Employers have 120 days post-rule publication to notify affected individuals of the non-enforceability of their agreements, with specific guidelines outlined by the FTC.
Legal Challenges and Policy Implications:
Legal challenges from various business sectors have already been initiated, questioning both the rule’s validity and the FTC’s authority. Despite dissenting views, the rule underscores Chair Lina Khan’s proactive stance in shaping competition law through rulemaking rather than case-by-case adjudication.
Functional Approach to Non-Competes:
Beyond traditional agreements, the FTC’s rule scrutinizes contracts’ functional aspects, including Non-Disclosure Agreements (NDAs). While NDAs are commonplace in safeguarding trade secrets, their alignment with the rule depends on how they operate practically. The FTC’s approach aims to differentiate between appropriately tailored NDAs and those functioning as de facto non-competes.
Conflict with Existing Trade Secret Laws:
The FTC’s rule presents potential conflicts with existing trade secret laws, particularly the Defend Trade Secrets Act (DTSA). While NDAs are traditionally seen as reasonable protection for trade secrets, their unlawful characterization as non-competes may alter their legal implications. Employers must carefully draft and periodically review NDAs to ensure compliance and effective protection of trade secrets.
Conclusion:
The FTC’s final rule on non-compete agreements marks a significant departure in employment contract regulation, prompting legal challenges and strategic adjustments from employers. Understanding the rule’s implications and ensuring compliance with evolving legal standards is paramount for businesses navigating this new regulatory landscape.
If you have questions about your current restrictive covenants, and how you can better use those agreements in your business, or if you are an employee and have questions about your current restrictive covenants, please contact me directly at dwilliams@davismiles.com or at 480-344-4047
