On July 9, 2021, President Biden signed an Executive Order that, in part, seeks to limit the inhibition of competition in the American labor market. To that effect, the Executive Order authorized and ordered the Federal Trade Commission (FTC) to develop a rule that restricts noncompete clauses or other agreements that limit the mobility of American workers. The FTC, on January 5, 2023, published a proposed rule (the “rule”) that would prohibit the vast majority of those agreements, including those that are currently in effect. Although the rule is not yet law, and is subject to subsequent legal challenges, it is important for employers and employees alike to become familiar with the policies that the FTC is proposing.
Noncompete Agreements and Their Current Status
Noncompete agreements are contractual agreements in which an individual, usually an employee, agrees not to work for any competitors for a specified time after their employment ends. These agreements typically also prohibit an employee from owning a competing business or otherwise performing service similar to those provided by their former employer within the restricted timeframe and/or geographical area. More than 30 million Americans are currently bound to noncompete agreements, according to the FTC. Although many of these agreements may be protecting an employer’s business interest, they also make it difficult, or even impractical, for a bound employee to find meaningful work using their skillset until their restrictive period has expired. The FTC crafted the proposed rule in an effort to eliminate this inhibition on the labor market.
No federal law or uniform standard exists that directly regulates noncompete clauses, so enforceability is generally left to the states. In states where noncompete clauses are enforced, the general rule (which varies from state to state) is that the clause is only permitted if it (i) is needed to protect a legitimate business interest of the employer, (ii) is reasonable as to its time limitation, (iii) is reasonable as to its geographic area, and (iv) is supported by consideration to the employee (e.g. payment or a new position). Some states, including California, ban such clauses altogether or have additional safeguards in favor of the employee, while other states like New York are making it increasingly difficult to enforce noncompete clauses.
What the Proposed Rule Prohibits
As written the proposed rule would prohibit noncompete agreements between employers and employees, and would render existing noncompete agreements unenforceable as of the rule’s effective date.
Per the rule, noncompete agreements do not need to be labeled as such to fall subject to the prohibition. Any contractual clause between an employer and a worker that prevents the worker from seeking or accepting employment or from operating a business after the conclusions of the worker’s employment would be prohibited. Such a clause would amount to a “de facto” noncompete agreement. Further, even if no noncompete clause actually exists, the rule states would make it unlawful to represent to a worker that the worker is subject to a noncompete clause.
If an employer has an existing noncompete clause that violates the rule, the employer must rescind the clause before the rule’s compliance date (which is scheduled to be 180 days after the rule becomes effective). Employers may rescind noncompete clauses by delivering individualized communication to the worker explaining that the noncompete is no longer effective. The proposed rule contains a model notice form that employers can use.
Exceptions to the Rule
The proposed rule currently contains 2 notable exceptions to the noncompete invalidation. Firstly, the rule will not apply to noncompete clauses made between buyers of a business and any persons who own at least 25% interest in that selling business. This means, subject to applicable state law and antitrust laws, a buyer of a business may still be able to prevent substantial owners of the seller from competing with the buyer for a reasonable timeframe after the purchase. The second exception is that the rule will not apply to agreements between franchisors and their respective franchisees.
What Employers Should Do Now
The FTC is currently seeking public comments, and may make changes before a final rule is ultimately put into effect. Even after a final rule is published, however, the rule’s validity may be challenged in federal court. Because a final rule may affect noncompete agreements that are being negotiated right now, it is important for employers to understand how those agreements might be affected in the coming months or years. In light of the risk of noncompete agreements becoming invalidated, it may be prudent to seek other lawful means of protecting business intellectual property – employers may wish to implement nondisclosure agreements, non-solicitation clauses, and/or business protection agreements.
The Law Office of Robert G. Bruechert has extensive experience in protecting the intellectual property of New York business owners from unfair competitive practice. Contact us to see how we can help you and your business