In our August 2021 BAKER JENNER ALERT, we advised our clients and colleagues about the Biden Administration’s new policy initiative, centered on eliminating noncompete restrictions applicable to many aspects of the American workplace. Following, on January 5 and 19, 2023, the Federal Trade Commission (FTC) unrolled its sweeping new proposed rule that would ban noncompete restrictions on workers and others. A copy of the proposed rule can be found here. The FTC has opened the proposed rule to public comment through March 10, 2023, which can be accessed here.
What Does the Proposed Rule Do?
If implemented, the proposed rule would prohibit, and also mandate the subsequent rescission, of noncompete clauses and so-called de facto noncompete clauses. According to the proposed rule, a de facto noncompete includes any clause that is so functionally broad that it has the effect of prohibiting a worker from seeking or accepting employment with another company or operating a business after the conclusion of the worker’s employment.
The proposed rule gives two express examples of a de facto clause. First, any non-disclosure agreement that would effectively preclude someone from working in the same field due to the breadth of its restrictions. And second, contractual obligations imposed on workers to repay certain types of training costs incurred within a specified period. Based on its language, the de facto test is nonetheless open to being applied to a broader class of restrictions, including varieties of non-solicitation, non-recruitment, no-business, and other similar restraints. While the FTC’s supplementary materials profess to exclude non-disclosure agreements (despite the language of the proposed rule) and client or customer non-solicitation agreements from the ban, where these more acceptable forms of agreement end and unacceptable de facto clauses begin remains unclear. The grey-zone indicated between the proposed rule and the FTC’s supplementary materials leaves therefore significant doubt as to the lines the FTC would draw between acceptable and unacceptable post-employment restrictions.
Who’s Implicated?
The FTC’s proposed rule would apply broadly to all “workers,” defined as any person who works for an employer, regardless of whether paid, including employee, independent contractor, extern, intern, volunteer, apprentice, or sole proprietor. But even with this breadth, the term still does not eliminate all non-competes.
For example, non-competition clauses included as part of the sale of a business would remain in effect–although only for sellers who own 25 percent or more of the business as of the date of closing. The proposed rule nonetheless fails to specify more complex arrangements that may be possible to reduce an individual’s technical ownership interest below that threshold while still leaving many of the rights, interests and benefits of ownership in play.
Also in question are executive compensation provisions, like options and other types of incentive equity grants, retention bonuses, and executive compensation plans. While these incentives would not at first blush appear to fall within the ambit of the proposed rule, their deprivation at the time of resignation or termination may be argued to strongly disincentivize an executive from seeking employment alternatives, and thus to fall afoul of the de facto test. Whether the FTC is ready for the seriously disruptive consequences and effects, including in the area of tax, if it were to apply the de facto rule in this manner remains to be seen.
What Must Employers Do If the Proposed Rule is Adopted?
Employers would be prohibited from requiring non-competition and de facto non-competition clauses 180 days after the proposed rule’s publication. Employer’s would also be required to rescind all non-compete and de facto non-competes preceding that date. Based on the proposed rule’s current language, it appears that employers would have 225 days to deliver rescission notices to current and former employees following the date of the rule’s publication.
Practically, What Should an Employer Do?
Non-competition clauses have long been suspect in American jurisprudence. In more recent years, they have also come under political scrutiny.
Even if this proposed rule does not succeed, it appears increasingly likely some prohibition on non-competes will be implemented. Indeed, three states, including California, together with Washington D.C., have banned all noncompetes, except in limited circumstances. And over the last few years, nine states have banned noncompetes for all workers who earn under a specified threshold amount.
So what to do going forward?
At their root, contracts should fairly reflect and implement the business interests and objectives they serve. In prior posts, we have recommended businesses carefully draft restrictive covenants and other such clauses in a manner that tailors them to legitimate business interests and outcomes. To that extent, employers should contemplate employee contracts that pair workable and sufficiently narrow definitions with prohibitions that safeguard the business from discrete abuses of its customer and other relationships, confidential information, trade secrets and intellectual property. Thinking about how restrictions and prohibitions work with other parts of an agreement, like intellectual property assignments, will help create an agreement that is more likely to remain enforceable long term while providing the scope of protections that your business needs.
Get Proactive, not Reactive, Legal Counsel
Partnering with quality strategic representation remains critical to enforceable agreements that effectively protect your business relationships, trade secrets and other proprietary information. Baker Jenner provides innovative solutions for innovative businesses involved in highly regulated industries. Maintaining your company’s competitive edge while efficiently managing legal obligations is our purpose. We look forward to discussing your legal needs soon.
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