Requiem for Non-Competes? Proposed FTC Rule Would Make Almost All Such Agreements Unlawful

Distributors need to be ready for a post-non-compete world.

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As is the case in countless other industries, distributors have used non-competition agreements for decades to protect their business interests from departing employees who seek to use the knowledge, insights and information they gained during their tenure to go head-to-head against their former employer or work for a rival company. Non-competes can be powerful tools for employers – so long as they are enforceable.

But for as long as non-competes have been around, judges and legislators have struggled to determine the line between protecting businesses against unfair competition and protecting an individual’s right to engage in fair competition and make a living in their chosen occupation. This has led to a patchwork of case law and state statutes that attempt, with varying degrees of clarity, to define the acceptable scope – in terms of time, geography and activities – of non-competition agreements. As a result, employers and employees alike have been left uncertain as to whether their non-competes are worth the paper they’re printed on — and whether they will withstand a judge’s scrutiny.

But that uncertainty could become a thing of the past if the U.S. Federal Trade Commission (FTC) has its way. That is because a proposed new rule it published in January would make almost all existing and future non-competition agreements unlawful, void and unenforceable. If this rule comes to pass – and that is a very big “if” – former employees from c-suite executives to minimum wage workers would be free to engage in competitive activity against their former employer, subject to limited exceptions detailed below.

In many ways, the FTC’s proposed ban on non-competes is the culmination of years of increasing skepticism and criticism of such agreements, especially as applied to lower-wage workers. Even if the rule isn’t finalized in its present form, distributors will still face headwinds if their non-competes aren’t tailored as narrowly as needed to protect their business interests.

Non-Competes As An 'Unfair Method of Competition'

The FTC’s proposed rule would supersede any inconsistent state laws and deem non-competition agreements an “unfair method of competition” unlawful under the Federal Trade Commission Act.

Specifically, the proposed rule would make it unlawful for employers to “enter into, attempt to enter into, or maintain a non-competition agreement with a worker or represent that the worker is subject to a non-competition agreement.” All existing non-competition agreements would become void and unenforceable as of 180 days of the final rule’s publication.

Employers Must Notify Employees That Their Non-Competes Are No Longer Binding

While the proposed rule is self-executing – that is, it would automatically void all non-competes – it does impose affirmative obligations on employers to rescind any existing agreements and advise any affected employees that they are no longer bound by them.

If the rule becomes finalized in its current form, employers will need to:

Within 45 days of rescinding the non-compete, provide each worker with an individualized paper or digital communication (such as email) advising them that their non-compete has been rescinded; and

Provide the notice to current and former workers if the employer has the former worker’s latest contact information readily available.

The rule contains model language for the required notice, if implemented.

Rule Does Not Prohibit Non-Competes As To The Purchase and Sale of a Business

One notable exception to the rule applies to non-competes executed as part of the purchase and sale of a business. Specifically, the rule would not prohibit:

“a non-compete clause that is entered into by a person who is selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or by a person who is selling all or substantially all of a business entity’s operating assets, when the person restricted by the non-compete clause is a substantial owner of, or substantial member or substantial partner in, the business entity at the time the person enters into the non-compete clause.”

According to the FTC, “this exception would only be available where the party restricted by the non-compete clause is an owner, member or partner holding at least a 25% ownership interest in a business entity.”

Non-Solicitation And Non-Disclosure Agreements Still Valid – If They Don’t Function As Non-Competes

Of course, non-competition agreements are not the only tools available to businesses to prevent former employees from exploiting their prior positions. Just as courts have been more willing to enforce non-solicitation and non-disclosure agreements than non-competes, the proposed rule does not ban such agreements so long as they don’t effectively function as non-competes.

The rule clarifies that prohibited non-competition clauses:

“would generally not include other types of restrictive employment covenants such as non-disclosure agreements (‘NDAs’) and client or customer non-solicitation agreements because these covenants generally do not prevent a worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer.”

However, the proposed rule provides that an agreement purporting to be something other than a non-compete could be found to be one, and thus unlawful, “where they are so unusually broad in scope that they function as such.” Accordingly, “whether a contractual provision is a non-compete clause would depend not on what the provision is called, but how the provision functions.”

What Happens Next

The fate of the proposed rule is far from certain. It could ultimately be finalized in its current form, adopted with modifications or additional exceptions, or withdrawn entirely. Judicial challenges are likely.

Given its profound impact on the business and employment landscape, however, the proposal has drawn vocal opposition from the business community and equally strong support among workers’ rights advocates. The FTC received substantial public comments on the rule during the comment period, which closed on March 20. The FTC has stated that it expects to issue a final rule in May.

In the meantime, the status quo remains. But given the proposed rule, as well as ever-increasing judicial and legislative hostility to non-competes, distributors that rely on non-competition provisions to protect their business interests should engage counsel to review non-competition language to ensure that they are as current and enforceable as possible.

If you have questions or concerns about the FTC’s proposed rule or your company’s use of non-competes, please contact me at 312-840-7004 or [email protected].

The information contained in this article is provided for informational purposes only, and should not be construed as legal advice on any subject matter. The author expressly disclaims all liability in respect to actions taken or not taken based on any or all the contents of this article.

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