Articles

The Future of Non-Competes – What to Do Now

January 17, 2023

The Federal Trade Commission (FTC) recently announced for public comment a proposed rule banning existing and future non-competes, with few exceptions.

Proposed Rule

The proposed rule would only permit non-competes as part of the sale of a business –and then only when the restricted individual owns at least 25% of the entity being sold. The proposed rule permits non-solicitation agreements as long as they are not so extensive as to amount to a non-compete. The draft rule also requires employers to give written notice to current and former employees with whom it has a non-compete agreement that this non-compete is no longer effective and will not be enforced (this notice is to be given within 225 days after the FTC publishes the final rule).

Next Steps

The FTC is accepting comments on the proposed rule through March 10, 2023. Thereafter, on an indefinite date, the FTC will issue a final rule which the current draft would make effective 180 days later. Numerous lawsuits will seek to enjoin and invalidate the rule. The potential is high for a court injunction blocking the rule from going into effect.

In addition to challenges to the FTC’s authority to ban non-competes, a key question will be whether the rule can ban existing or only future non-competes. There may be a political compromise or court decisions grandfathering non-competes signed prior to the rule’s effective date.

Recommendations

It is too soon to confidently predict the outcome. Employers who haven’t already been doing so should hedge their bets by making sure that, if they are going to continue signing non-compete agreements, they at least also include a non-solicitation provision to retain some restrictions if the FTC final rule contains and the courts uphold a ban on enforcement of previously signed non-compete agreements. Many employers already do this. It is even more important now.

The FTC action also adds more publicity and thus impetus to the recruiting impact of these restrictive covenant agreements, providing employees more motivation to reject non-competes and employers more reason to consider non-solicitation rather than non-compete agreements to attract employees.

Employers and employees should not lose sight of other important aspects about non-competes and other restrictive covenants (e.g., non-solicitation and confidentiality agreements). State law is the primary source on the enforceability of restrictive covenants; and some states, like Pennsylvania, require the employer to provide something of value to the employee above and beyond continued employment in order to make the restrictive covenant valid (signing a restrictive covenant as a condition of and at or before hire is sufficient value). Provisions in the agreement on what happens if a court later rules the non-compete exceeds legal boundaries are also common and even more important given the uncertainty over what will be in the final FTC rule and judicial acceptance of it.

While waiting to see how this situation develops, think about what measures, in addition to non-solicitation agreements, may be worth considering, particularly for very valuable employees. The cost to employers of retaining employees will increase, as the FTC’s goal of more competitive labor markets will drive up compensation, so the cost of measures beyond non-solicitation agreements may make them only appropriate for a few employees.

For example, it will be interesting to see if/how the FTC and courts deal with severance provisions continuing some level of pay to a voluntarily departing employee with a requirement to refrain from employment anywhere else (not just with a competitor). The present FTC is likely to consider these “garden leave” provisions that restrain trade; but courts may accept an argument that, unlike a non-compete, these provisions are an employment retention device not targeted against market competitors—a golden handcuff, so to speak, that tries to keep talented individuals from going anywhere, not just to a competitor (with a similar purpose to other lawful employee retention incentives).

Employees also should consider protections, such as limiting the scope of non-solicitation agreements—for example, excluding a salesperson’s prior customers from the scope of a non-solicitation agreement with a new employer (whether individually named or by description).

Most importantly, the new rule will make it more important for employers to improve their trade secret and proprietary business information protections, both by contract and their daily practices in handling, labeling, and limiting access to this information. The stated purpose of the planned FTC rule, namely barring enforcement of non-competes, will, when an employee jumps ship to a competitor, make more consequential the legal battles seeking to restrict the individual from using the former employer’s trade secret and proprietary business information. Many employers are laxer than they should be to effectively protect this information and will want to tighten up their practices. Even with good agreements, businesses can lose the legal protections available for this information if they do not act, day in and day out, like it is special and restricted.

While waiting for this new rule, assess your agreements and practices regarding restrictive covenant agreements and trade secret/proprietary business information, along with considering options to be ready and flexible when/if the final rule goes into effect (the proposed rule states employers must start complying with it 180 days after the final rule is published). A key question for both employers and employees to consider is whether you want to be or try to avoid being a test case under the new rule. This will not be an easy question to answer and it will affect your approach given the significant difference the rule will make if not blocked in the courts.

Please contact your Houston Harbaugh attorney with any questions or for assistance, such as the author of this article, Craig Brooks, Esq., at cbrooks@hh-law.com — 412-288-2214, or Brian Lipkin, Esq., blipkin@hh-law.com – 412-288-2256, who also practices employment law as well as trade secret law, or our other attorneys that also handle trade secrets, intellectual property, and litigation. The firm represents individuals as well as employers in these areas.

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