How Might the Proposed FTC Noncompete Rule Affect Employers?

As part of the client-exclusive Law & the Workplace webinar series, labor and employment attorney Randall Armentrout took an in-depth look at the Federal Trade Commission’s proposed noncompete ban.

 

The proposed Federal Trade Commission noncompete rule would ban the use of most noncompete agreements. If it’s passed, employers will need to review—and likely adjust—employment agreements and policies.

 

For more than 100 years, Iowa courts have developed law regarding the enforcement of noncompete agreements. A traditional noncompete agreement prohibits an employee from working for a competitor within a defined geographic area, for a defined period of time, after the employee leaves employment.

 

Enforcement typically relies on whether the noncompete agreement protects a legitimate company interest. Court have recognized the protection of confidential information and customer relationships as legitimate interests. The courts balance the company’s at-stake interest against the employee’s right to a earn a living.

 

What Is the FTC’s Proposed Ban on Noncompete Clauses?

On January 5, 2023, the Federal Trade Commission issued a proposed rule that would prohibit the use of noncompete agreements in most circumstances.

 

The proposed rule banning noncompete agreements is a step in the FTC’s plan to “rededicate” the commission and reactivate Section 5 of the Federal Trade Commission Act. Section 5 empowers the FTC to prevent businesses from “using unfair methods of competition.”

 

The proposed noncompete ban prohibits noncompete clauses by name and effect.

• A noncompete clause is defined as a “contractual term” that “prevents the worker from seeking or accepting employment with a person, or operating a business, after” employment.
• Worker is defined as any “natural person who works, whether paid or unpaid, for an employer” including, but not limited to, employees, independent contractors, externs, interns, volunteers, or apprentices. Franchisees are one exclusion.
• The rule includes a functionality test. If the effect is that the clause prevents a person from going to a competitor, it’s considered a noncompete. That is banned under the proposed rule. For example, a broad nondisclosure agreement prevents an employee from saying anything about their employment when they leave. Considered to be in the nature of a noncompete, it may be covered by the rule. The FTC also included a training cost payback clause as an example of a de facto noncompete.
• Customer non-solicitation agreements are exceptions. They are not prohibited.
• The noncompete rule excludes the sale of a business. A noncompete can be included for those who own a substantial interest. That is defined as owning 25 percent or more of the company.
• The rule is both retrospective and prospective. It applies to both existing and future agreements with employees.
• The rule expressly superseded state law.
• Within 180 days after the final rule is published, an individualized communication must be sent to every current and former employee with a noncompete agreement. Employers can use the FTC’s model notice language to give proper notice to employees about rescinding or removing noncompete provisions and replacing them with something compliant with the new rule.

 

The proposed FTC rule does not prohibit agreements with similar restrictive covenants. For example:

• Non-solicitation: A restrictive covenant that allows an employee to leave to join a competitor. The former employee is not allowed to take or solicit customers of the original company. Non-solicitation clauses also may apply to soliciting employees of the original company to work for the competitor.
• Confidentiality: An agreement designed to protect trade secrets, proprietary information, financial information, customer information, and other similar information.
• Intellectual property ownership: Clauses that largely state that if an employee creates a piece of intellectual property, process, or technique during the scope of employment, the company owns that invention.

 

What Are the Issues with the Proposed Noncompete Rule?

Before the rule can go into effect, the FTC is required to have a public comment period. The FTC received more than 27,000 comments. The huge volume caused the FTC to pause before issuing a final rule. Next steps will not take place before April 2024.

 

The FTC separated the comments into major areas of concern:

• The adverse impact on the protection of intellectual property in the absence of any IP exception in the current rule.
• The proposed rule’s tendency to disincentivize investments in worker training.
• Concerns that nonprofit health care providers would be unfairly advantaged by the proposed rule since they are exempt from it.

 

Also, one FTC commissioner issued a dissent to the proposed rule. She found it to be a radical departure from centuries of legal precedent. She also attacked the data used by the majority with regard to whether it offers help to the U.S. market. In other words, she cited a lack of clear evidence to support the rule. The commissioner also indicated the rule would likely have unintended consequences. She predicted legal challenges to the FTC’s rulemaking authority.

 

After reviewing comments, the FTC may:

• Adopt the rule as proposed.
• Make changes to the proposed rule based on comments.
• Issue a different rule.
• Restart the process.

 

How Can Employers Respond to the FTC Noncompete Ban?

Until the FTC issues a final rule, employers are in a waiting game. But, if the proposed rule is issued as final, employers will have only 180 days to comply. Taking an inventory of existing noncompete agreements and company policies now has advantages.

 

If the rule becomes final, employers can consider other means to protect the same company interests, such as customer non-solicitation agreements and confidentiality agreements.

 

Cleaning up employment agreements now will preempt the rule—no matter its final elements.

 

Also, employers should assess access to trade secrets and proprietary information. The results can help determine agreements that should be in place for employees with access to vital information.

 

Is the FTC Noncompete Rule Enforceable?

Legal challenges are expected. A rule that’s the same or similar to the proposed rule will likely face legal action. Employer groups are likely to file actions to strike down the rule. Constitutional legal arguments will come into play. The suit will likely request that a federal judge ban such a rule being passed. From there, it will likely work its way up the appellate courts to the U.S. Supreme Court.

 

Employers are unlikely to have to deal with the noncompete ban in the immediate future. That doesn’t mean employers should ignore the situation. Reviewing employment practices and agreements ensures employers are prepared for changes.

 

It’s always a good practice to discuss the use of noncompete and other employment agreements with your employment attorney. Contact your Nyemaster labor and employment attorney with questions about your individual business.