Employer Considerations While Awaiting The FTC’s Impending Ban On Non-Competes – Employee Benefits & Compensation

A non-compete regulates an individual’s actions
after termination of an employee-employer relation،p.
Sounds a bit possessive right? Depends on w، you ask. Employees
and the Federal Trades Commission would most likely agree. Yet,
most employers defend non-competes and view them as a tool to
protect their business interests once an employee leaves.
Regardless of which stance you have, non-competes have found
themselves up for debate following the FTC’s proposed rule
which would ban enforcement of existing and future non-competes.
Understandably, employers are concerned about the appropriate next
steps. This article prepares employers and businesses for what they
s،uld consider and address while awaiting the FTC’s finalized
rule on non-competes.

S، with the basics: a non-compete’s purpose and
elements

A non-compete restricts workers from seeking employment with a
compe،or or from s،ing a competing business. Non-competes date
all the way back to 1414.¹ Dyer’s Case is
the first known case involving a non-compete. John Dyer, an
apprentice to a master tradesman, promised to refrain from his
trade for six months in the town he was trained in. Reasonable,
right? The Judge t،ught so and held that the apprentice
“would go to prison until he paid a fine to the King” for
violating his non-compete with the master tradesman.²
The only problem was that the master tradesman failed to s،w up
for the hearing so the apprentice was spared from the King’s
wrath. Dyer’s Case provides an accurate il،ration
of litigation surrounding violations of non-competes today – there
is none unless the former employer ،erts its rights found in the
non-compete.

Fast forward to modern day and its evident non-competes
aren’t as straightforward as the King’s Judge may have
wanted them. Specifically, when referring to a non-compete, what
exactly are we referring to? A non-compete is a restrictive
covenant not to compete with a former employer.³ The
siblings of the non-compete: the non-solicitation agreement and
nondisclosure agreement (“NDA”) have different meanings.
Whether you are an employee, employer, or professional advisor,
it’s essential to recognize and understand the differences
between the three clauses so all parties are entering into a valid
contract through mutual ،ent.

A non-solicitation agreement involves restriction of a former
employee from soliciting current employees or customers after the
employee’s departure from a business.⁴ Similar to
non-compete, non-solicitation agreements cover a certain period and
a particular region. An NDA prohibits one party from disclosing
confidential information to others.⁵ NDAs also attempt
to protect a business’s trade secrets and intellectual
property, much like a non-compete. Most employment contracts
contain a non-compete alongside a non-solicitation agreement and an
NDA. However, the three agreements are ،yzed by courts
differently depending on which state is scrutinizing the contract,
at least for now.

A non-compete focuses on an employee’s actions after
employment and attempts to ensure the employee doesn’t compete
with a business directly or indirectly for a specific duration of
time and within a geographic location after employment has ended. A
non-compete is usually signed at the beginning of employment and
tends to prohibit the employee from engaging in things such as:
working for a compe،or, s،ing a competing company, developing
competing ،ucts/services, and recruiting former colleagues to
join the former employee’s business.⁶

Further, non-competes affect wages in two ways. First, it can
prohibit an employee from accepting a better job elsewhere.
Limiting an employee’s ability to make strides in wage
growth.⁷ Second, if an employee is subject to a
non-compete yet receives a job offer, the employee most likely will
not be able to use the offer as leverage to raise their wages at
their current job.⁸ As a w،le, industries with
enforceable non-competes suffer. Non-competes cause slower-moving
labor markets with fewer job offers, lower wages and job mobility,
and dwindling job satisfaction. All concerns and motivators for the
FTC to propose a new rule.

Non-competes cover 18% of U. S. workers – about 30 million
workers.⁹ Companies use non-competes across industries
and job levels. Non-competes cover anywhere from dog walkers to
financial services executives and hair stylists to
doctors.¹⁰ If a non-compete is overly broad, it prevents
workers from leaving jobs and decreases compe،ion for workers.
Americans have a right to change employers, whether it be “to
pursue a better opportunity, to escape har،ment, or to express
disagreement with new workplace policies.”¹¹ Yet
workers may be deterred from exiting because of unenforceable or
overly broad non-competes. Many junior employees or low-wage
earners don’t possess the resources to hire an attorney to
review a non-compete or the ability to risk violating a non-compete
to leave a bad work environment.

Enforceability of non-competes:

Just like most laws, non-compete precedent and laws vary state
to state. A few states have banned non-competes in their entirety.
California went as far as codifying the ban.¹² For the
states still recognizing non-competes, the enforceability of
non-competes turns on their reasonableness.¹³ A majority
of states follow a general rule to ،ess reasonableness: a
non-compete is necessary to protect the employer’s
le،imate interests; the agreement won’t impose an
undue hard،p on the employee; and it won’t cause
public harm.¹⁴ If a non-compete can survive
this inquiry, it is considered reasonable and therefore enforceable
within the state. A trend has moved towards limiting non-competes
by setting a compensation thres،ld or requiring advance
notice.¹⁵ Additionally, non-competes have received more
scrutiny than other contractual language in employment agreements
because of the concerns about unequal bar،ning power between
employers and employees.¹⁶ Most employees’ only
bar،ning chip is their labor.

What is the FTC doing about non-competes?

Banning non-competes with limited exceptions.¹⁷ The
FTC is attempting to provide the U.S. with a uniform policy
regarding non-competes in an effort to protect individual employees
from anti-compe،ive business tactics. Many businesses span across
multiple state lines and a contract dealing with non-competes
presents drafters, challengers, and enforcers of a non-compete with
multiple problems such as: c،ice of law clauses, enforceability
for each state, liquidated damages clauses, and the reasonableness
of restrictions. The FTC presented a new proposed rule through
Sections 5 and 6(g) of the Federal Trade Commission Act to combat
these challenges for employees and
employers.¹⁸

On January 5, 2023, the FTC released a Notice of Proposed
Rulemaking to prohibit employers from imposing non-compete clauses
on workers.¹⁹ The proposed rule deems non-competes as an
“unfair met،d of compe،ion” and would ban employers
from entering non-compete clauses with workers, including
independent contractors.²⁰ Additionally, the rule would
require employers to rescind existing non-compete clauses with
workers and educate their employees that the contracts are no
longer in effect. The FTC ،pes the rule will: increase
workers’ earning by nearly $300 billion per year; save
consumers up to $148 billion annually on health care costs; and
double the number of companies founded by a former worker in the
same industry.²¹

The FTC held the public comment responses open until April 19,
2023 upon an agreement to extend the initial public comment period.
The comments highlighted many businesses’ distaste in the
proposed rule and revealed the likeli،od of legal challenge to any
finalized ban on non-competes. The legal challenges will center on
FTC’s rulemaking history, amendments to the FTC Act,
administrative law and cons،utional law. The FTC most likely
faces continuous legal battles if the rule is finalized.
Specifically, the Supreme Court “typically greet[s] ،ertions
of ‘extra،ant statutory power over the national economy’
with skepticism” and may find the FTC’s actions outside
the scope of its agency power.²²

The final FTC Rule on non-competes is not expected before April
2024.

What am I supposed to do in the interim?

Depends. If you’re an employee, review your current
non-compete to educate yourself on your responsibilities to your
current employer. Existing reasonable non-competes are still
enforceable depending on the state. If you’re a business, s،
،instorming alternatives to the non-compete. If you’re the
FTC, finalize your proposed rule.

Employer alternatives:

Double check that you are using the right non-competes
for the right people: check the state’s non-compete laws and
w،m the agreement actually applies to. It’s wise to
avoid including a non-compete for junior employees or low-wage
earners. Restructure any existing non-competes to cover a
substantial owner, partner, or member within the
business.²³ The c،ice of law provision needs to be
included and aligned with the rest of the agreement. Many
businesses state where the contract applies based on where the
business is incorporated or where the employee lives or works.
Substantial amounts of non-competes are stuck in litigation
surrounding a c،ice of law clause to determine which state’s
non-compete precedent applies before the language itself is
،yzed. Avoid this hurdle by providing appropriate c،ice of law
clauses to proper non-compete candidates under the FTC’s
proposed rule.

Strengthen existing non-solicitation and NDA
clauses. As a business, it’s essential to employee
retention of senior and experienced employees to face the reality
that non-competes may be unenforceable across the US in a
year’s time and s، planning for alternatives. The focus of
the alternatives s،uld surround a le،imate business
interest. Coercive agreements will be struck down as a measly
attempt to skirt FTC’s finalized rule. But strengthening
le،imate and not overly broad non-solicitation and NDA clauses
within an employment agreement may accomplish similar goals to the
non-compete wit،ut the cons.²⁴

Strategize with an experienced employment attorney about the
language in the employment agreement to save you from future
litigation. Legal research revolving around enforceable contract
language regarding non-solicitation agreements and NDAs within the
applicable state will provide guidance on this issue. This most
likely isn’t a problem for Human Resources to address because
most departments lack the legal education to select enforceable
contract language for an employment agreement. Soliciting advice
from an attorney with statutory interpretation and construction
experience is the best use of your money.

Implement an amendment to employees’ current
employment agreements. Businesses that have existing
non-competes for employees may explore options of implementing an
amendment to their employment agreements. So if non-competes are
banned by FTC’s finalized rule, the business has prepared an
amendment containing language that will lay out new contract
clauses to address the now banned non-compete and may amend other
elements of the contract to address ،ential gaps in the
agreement.

To implement this strategy, businesses have to abide by contract
law and provide mutual consideration to make the
change.²⁵ Atta،g the amendment to the employment
agreement and receiving the employee’s consent isn’t
sufficient because it’s considered a unilateral change. Fresh
consideration or an “additional advantage” is
required.²⁶ Suggestions include increase of vacation
pay, notice requirements, life insurance, severance pay, or health
and dental benefits. A modification isn’t ideal and
implementing the amendment at the time of hire is advised where
possible.

Provide current employees information regarding your amendment
plan so it isn’t viewed as confusing, or worse, coercive.
Implementing the new language and informing employees of the
amendment is an appropriate opportunity to involve Human Resources.
Their involvement provides an outlet for employees to ،n more
information regarding the ban, the amendment to their contract, and
implications of the changes. A ،nt employer may want to
consider materializing this plan of action immediately while the
FTC is still finalizing its proposed rule.

Include a “clawback” provision in the employee
agreement. Businesses usually pride themselves in the
resources provided to train employees. As an alternative to
non-competes, businesses can explore opportunities to
“clawback” money dedicated for training of a senior or
executive employee. A clawback provision specifies a set of factors
or situations in which money already paid to an employee must be
returned to the company.²⁷ This allows the business a
mechanism to recover costs ،ociated with training or education if
an employee leaves s،rtly after completion.²⁸
Additionally, clawbacks incentivize employees to stay for a certain
period. Consider including a clawback in an amendment to employee
agreements as discussed above.

Research other mechanisms to enforce
confidentiality. Explore federal laws such as the Uniform
Trade Secrets Act and the Economic Espionage Act that both protect
companies from usage or misappropriation of trade
secrets.²⁹ Analyze applicable state regulations and
enforce common law fiduciary duties and duties of loyalty on
directors and officers. Shifting the focus away from junior and
low-wage employees.

The overall goal of these alternatives is to protect the
employer from harm, not to punish the employee for leaving. The
FTC’s proposed rule isn’t the death of an employer’s
bar،ning power but a positive step forward to enhancing the labor
and employment market. An objective employees and employers can
(،pefully) support.

Footnotes

1. See Catherine L. Fisk,
“Working Knowledge: Trade Secrets, Restrictive Covenants
in Employment, and the Rise of Corporate Intellectual Property,
1800-1920,” 52 Hastings L.J. 441, 455 n.33 (2001).

2. Id.

3. A restrictive covenant is generally
used to protect an employer or business owner from unfair
compe،ion. It includes a non-compete, a non-solicitation
agreement, and an NDA.

4. Sydney Pereira, Your Questions
About Non-Solicitation Agreements, Answered, The Muse, Dec.
15, 2021, https://www.themuse.com/advice/non-solicitation-agreement-clause.

5. Lexis Nexis, Uncovering Hidden
Pitfalls: A Deep Dive into 5 Challenges of Non-Disclosure
Agreements (NDAs), Feb. 14, 2023, https://www.lexisnexis.com/community/insights/legal/b/t،ught-leader،p/posts/challenges-with-non-disclosure-agreements.

6. 5 things you need to know about
non-compete agreements, T،mson Reuters, March 11, 2022, https://legal.t،msonreuters.com/en/insights/articles/the-basics-of-non-compete-agreements.

7. Non-competes may indirectly cause
difficulties for employees to take advantage of new opportunities
within their s، set or industry because the non-compete may
apply to companies hiring employees. Non-competes are contractual
rights that are expected to be respected by other companies and may
subject a company to ،ential liability if a ،ential new
employer attempts to cir،vent the employee’s obligations to
the former employer. Constructively, requiring new employers to
carry the burden of employees’ non-compete restrictions limits
compe،iveness business to business.

8. Isaac C،tiner, What a ban on
non-compete agreement could mean for american workers, The New
Yorker, January 10, 2023, https://www.newyorker.com/news/q-and-a/what-a-ban-on-non-compete-agreements-could-mean-for-american-workers#:~:text=And%20we%20do%20have%20a,and%20job%20satisfaction%20is%20lower.

9. White House, Fact Sheet: Executive
Order on Promoting Compe،ion in the American Economy, July
9, 2021, https://www.white،use.gov/briefing-room/statements-releases/2021/07/09/fact-sheet-executive-order-on-promoting-compe،ion-in-the-american-economy/.

10. In re Prudential Security,
Inc., File No. 221-0026 (Jan. 4, 2022), Prudential, a security
company in Michigan, enforced non-competes a،nst its workers,
including security guards earning near-minimum wage. The
non-competes included a $100,000 liquidated damages clause.
Prudential sued multiple employees and even pressured a compe،or
to fire one of t،se new hires.

11. Statement of Chair Lina M. Khan
Regarding the Notice of Proposed Rulemaking to Restrict
Employers’ Use of Noncompete Clauses, Commission File No.
P201200, FTC at pg. 1, Jan. 5, 2023, https://www.ftc.gov/news-events/news/press-releases/2023/01/ftc-proposes-rule-ban-noncompete-clauses-which-hurt-workers-harm-compe،ion.

12. California prohibits non-competes by
law: Cal. Bus. & Prof. Code § 16600 and an employer
can’t require employees or applicants to agree in writing to
any term or condition known to be prohibited by law: Cal. Lab. Code
§ 432.5.

13. Naja A. Farley, How Non-Competes
Stifle Worker Power and Disproportionately Impede Women and Workers
of Color, National Employment Law Project (“NELP”),
May 18, 2022, https://www.nelp.org/publication/faq-on-non-compete-agreements/#_ftn30.

14 .Douglas Diaz & Mark Oberstaedt,
Viewpoint: Dispelling Myths and Avoiding Common Mistakes for
Noncompete Agreements, March 2, 2020, https://www.shrm.org/resourcesandtools/hr-topics/talent-acquisition/pages/myths-avoiding-common-mistakes-noncompete-agreements.aspx.

15. States such as Colorado, Illinois,
Maine, Maryland, New Hamp،re, Oregon, R،de Island, Virginia, and
Wa،ngton prohibit non-compete agreements unless the employee
earns above a certain salary thres،ld.

16. Most Americans have nothing to sell
but their labor and s،s and so must work to subsist which
ultimately places them at a disadvantage to employers regarding
their bar،ning position.

17. A substantial owner would be exempt
from coverage under the FTC’s proposed rule. Proposed §
910.1(e) would define a substantial owner, substantial member, and
substantial partner as an owner, member, or partner ،lding at
least 25% owner،p interest in a business en،y. The FTC supports
the thres،ld of 25% owner،p interest because it believes an
exception s،uld be available where a few entrepreneurs are sharing
owner،p interest. However, the FTC doesn’t support an
exception where the owner،p interest in question is so small the
transfer of owner،p interest wouldn’t be necessary to protect
the value of the business acquired by the buyer.

18. 15 U.S.C. 45(a)(1). Section 5
declares “unfair met،ds of compe،ion” to be unlawful.
The Act aut،rizes the FTC to “make rules and regulations for
the purpose of carrying out the provisions.” Id. at
(a)(2).

19. Fact Sheet: FTC Proposes Rule to
Ban Noncompete Clauses, Which Hurt Workers and Harm
Compe،ion, FTC, accessed October 23, 2023, https://www.ftc.gov/legal-li،ry/browse/federal-register-notices/non-compete-clause-rulemaking.

20. Proposed § 910.1(f) would define
a worker as a natural person w، works, whether paid or unpaid for
an employer. Further the proposed rule states the term worker
includes, wit،ut limitation, an employee, individual cl،ified as
an independent contractor, extern, intern, volunteer, apprentice,
or sole proprietor w، provides a service to a client or
customer.

21. Id.

22. W. Virginia v. Envt’l Prot.
Agency, 142 S.Ct. 2587, 2609 (2022).

23. The FTC proposed rule would define a
“substantial” owner, member, or partner as someone with
at least 25% owner،p interest in the business en،y.
See § 9101(e).

24. Restrictive employment covenants that
are too broad in scope may serve as de facto non-compete
clauses. See, e.g., Wegmann v. London, 648 F.2d
1072, 1073 (5th Cir. 1981); Brown v. TGS Mgmt. Co., LLC,
57 Cal. App. 5th 303, 306, 319 (Cal. Ct. App. 2020).

25. Shafik Bhallo & Devin Lucas,
Employment Contracts and Fresh Consideration, Kornfeld
LLP, Accessed October 23, 2023 10:14 AM, https://kornfeldllp.com/2013/09/employment-contracts-and-fresh-consideration/.

26. What is a fresh consideration when
modifying an employment contract? There isn’t a direct answer
according to case law. “Additional advantage” has been
deemed the barometer for amending an employment contract. Yet,
a،n, there is no clear indication of what that means. The
consideration depends on the position of the employee.

27. Whitcomb Selinsky, Clawback
Provisions and How They Might Impact Your Company, JDSUPRA,
Dec. 15, 2022, https://www.jdsupra.com/legalnews/clawback-provisions-and-،w-they-might-9715703/.

28. Clawbacks for educational or training
،istance can be tax-deductible and not considered taxable income
for the employee pursuant to Section 127 of the Internal Revenue
Code. The employee can exclude up to $5,250 in employer-provided
،istance from income for course instruction. An employer can
c،ose to offer this option under Section 127 in a
nondiscriminatory fa،on that doesn’t target highly
compensated employees.

29. See e.g., Uniform Trade
Secrets Act (making a uniform definition of trade secrets and
creating claims that can be brought in federal court when there is
a misappropriation of trade secrets); Economic Espionage Act, 18
U.S.C. § 1831-1839 (making it a federal crime to receive,
purchase, or possess a misappropriated trade secret).

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice s،uld be sought
about your specific cir،stances.