Recently, the Federal Trade Commission (FTC) has proposed a rule, which would ban the use of noncompetes almost completely and require existing noncompete agreements to be rescinded. This comes with inherent legal challenges and has a broad implication for employers in the business community and their litigators.
In the January 19,2023 edition of The Legal Intelligencer, Edward T. Kang and Kandis Kovalsky wrote “The Noncompete Agreement: Is It a Thing of the Past?“
It goes without saying that many employers have trade secrets to safeguard. Noncompete clauses offer notable protections for companies and entrepreneurs, and their legal precedent dates back centuries. Recently, the Federal Trade Commission (FTC) has proposed a rule, which would ban the use of noncompetes almost completely and require existing noncompete agreements to be rescinded. This comes with inherent legal challenges and has a broad implication for employers in the business community and their litigators.
Noncompete laws have developed as the United States expanded. Noncompete clauses are most frequently used in the employer-employee context. Most states permit noncompetes to varying extents, to protect companies from unfair competition. Only a few states ban employee noncompetes entirely. Pennsylvania law specifies that any “restrictive covenant”—noncompetes, nonsolicitations, etc., must meet a standard of reasonableness. As the court in Mallet and Co. v. Lacayo, (W.D. Pa. Nov. 23, 2020) describes, a “restrictive covenant is valid under Pennsylvania law if it is ancillary to an employment relationship, supported by adequate consideration, reasonably limited in time and geographic scope and reasonably designed to safeguard a legitimate interest of a former employer.” Such a standard is narrowly tailored, requiring that an employer have a legitimate business interest to protect.
Noncompete agreements offer a lot of benefits to employers who wish to protect and maintain their competitive advantages in their industries. Of course, there are also drawbacks to signing off on noncompete clauses. The most obvious being that workers can be prohibited from seeking a better-paying position, the wait time for a new job can be significant, and low level employees without knowledge of trade secrets may be inadvertently restricted. Following much debate and at the urging of certain members of Congress, the FTC began looking into the propriety of regulating noncompetes in January 2020. In December that year, President Joe Biden announced his administration’s plan to effectively “eliminate noncompete clauses and no-poaching agreements that hinder the ability of employees to seek higher wages, better benefits, and working conditions by changing employers.” See, Russell Beck, “A Brief History of Noncompete Regulation, Fair Competition Law,” (Oct. 11, 2021),
To accomplish its consumer protection goals, the FTC uses “notice and comment” rulemaking. This authority to issue industrywide regulations is used to combat unfair or deceptive practices and unfair methods of competition. The text of any proposed rule should explain the agency’s reasoning for the proposal. Public comments are encouraged to allow community input, especially from those who may be directly affected by the rule’s publication. Further, congressional oversight committees ensure there is specificity regarding the practices that are unfairly affecting commerce. Finally, anyone interested may and should seek an informal hearing before the publication of the Final Rule, which remains open to judicial review for the next 60 days.
On Jan. 5, the FTC issued a notice of proposed rulemaking (NPRM) for a noncompete clause rule aimed at categorically banning noncompete agreements nationwide. This proposed rule would prohibit all employers from:
- entering or attempting to enter a noncompete clause with a worker;
- maintaining a noncompete clause with a worker or;
- representing to a worker that the worker is subject to a noncompete clause where the employer has no good faith basis to believe this.
The FTC’s rule is retroactive in that it requires the rescission of existing noncompete clauses under Section 910.2(b). Further, employers will be required to provide notice to all employees that such agreements are no longer in effect and, therefore, unenforceable. The proposed rule includes a narrow exception for those noncompetes entered between a buyer and a seller of a business, where the restricted party is a substantial owner. As Commissioner Christine Wilson points out in her dissenting opinion, this proposed exception is likely meant to acknowledge that noncompetes help to protect the value of the business acquired by the buyer. Despite this exception, the NPRM demonstrates an abandonment of legal precedent that requires a fact-specific inquiry into whether a noncompete clause is unreasonable either in duration or scope.
The FTC cites numerous incentives, claiming the proposed ban could increase workers’ earnings across industries and job levels by $250 billion to $296 billion per year. It also cites that banning noncompetes nationwide would close racial and gender wage gaps by 3.6-9.1%. Additionally, it claims new business ideas would be reinvigorated; workers would take back bargaining power and employers could explore numerous other opportunities to protect their trade secrets and other investments, further limiting the abuse potential of noncompetes. Despite these claimed incentives, the proposed rule would throw a wrench into the business world and such challenges may exceed any proposed benefit arising from the rule’s implementation.
Noncompetes are intended to protect a business’ legitimate interest. While some argue, credibly, that noncompete discourages innovation and freedom of workers to make a living and pursue other opportunities, it serves important purposes when used properly. In addition to providing protection for trade secrets and other legitimate interests, noncompete clauses can help employers negotiate with key employees over future employment situations. When used properly, a noncompete agreement could provide a win-win for both the employer and employee. The employer would have a dedicated, trusted employee for a certain time and the employee would receive more benefits (e.g., more money, more benefits such as stock options) than she would otherwise receive without the noncompete.
The FTC’s proposed rule also has a broad implication for litigators who represent a company’s legal rights and interests. Many lawyers advocate for the enforcement of intellectual property rights in addition to the prevention of theft by employees related to compromising information or the poaching of customers. This is also helpful in ensuring the company maintain its competitive edge. A complete ban may leave the company without many protections, opening their business interests up to vulnerabilities that neither companies nor their lawyers want.
Rather than outright banning the use of noncompetes, the FTC should have explored other alternatives. The FTC should have considered alternative, less Draconian methods before such a drastic step is undertaken. Pennsylvania has pending legislation where the use of noncompetes are unenforceable, except in certain instances. According to House Bill 1938, known as the Freedom to Work Act, Pennsylvania lawmakers acknowledge exceptions where noncompete covenants would remain enforceable in limited scenarios such as the sale of business, dissolution of a partnership or the dissociation of a partner, and a covenant that was reasonable and in effect before the effective date of the bill. See H.B. 1938, 2017 Gen. Assemb., Reg. Sess. (Pa. 2017). In order words, House Bill 1938 would not apply retroactively. Similarly, in 2018, Massachusetts passed the Noncompetition Agreement Act, requiring restrictive covenants to be supported by “garden leave,” which is continued salary payment during the noncompete period. To be valid and enforceable, the agreement must be supported by a garden leave clause which must provide “for payment on a pro-rata basis during the entirety of the restricted period, of at least 50% of the employee’s highest annualized base salary paid within two years” following the termination of an employee. See Massachusetts Noncompetition Agreement Act, 149 M.G.L. Section 24L (2018). Notably, the law allows for employers to arrive at “other mutually agreed upon consideration” with employees as an alternative to garden leave. Massachusetts sets the stage for alternatives to overtly strict bans as the FTC is proposing here.
Overall, the granting of the NPRM will likely create problems for businesses. Employers nationwide will be forced to consider alternative mechanisms for legal protection that may not effectively replace the benefits enjoyed by noncompetes. Noncompete agreements have long been integral to business solutions and still offer substantial protections today when used properly. The FTC’s proposed rule, especially the retroactive provision, is unreasonable given that many employers paid valuable considerations to obtain the noncompetes in place. The FTC should have considered alternative approaches like Pennsylvania’s pending legislation, which would allow for the variance of fact-specific noncompetes, rather than an unaccommodating outright ban. Practitioners should consider providing their views to the FTC during the 60-day review period that lasts until March 10, and demonstrate the stark reality this proposed ban would inflict on the business community.
Edward T. Kang is the managing member of Kang Haggerty. He devotes the majority of his practice to business litigation and other litigation involving business entities. Contact him at email@example.com.
Kandis L. Kovalsky, a member at the firm, focuses her practice on representing both corporate and individual clients in a broad range of complex commercial litigation matters in Pennsylvania and New Jersey state, federal and bankruptcy courts. Contact her at firstname.lastname@example.org.
Reprinted with permission from the January 19, 2023 edition of “The Legal Intelligencer” © 2022 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or email@example.com.