FTC votes to ban non-competes across the US

The United States Federal Trade Commission has voted 3-2 to adopt the “Non-Compete Clause Rule” – or the “Final Rule” as it’s called – which will prohibit most existing non-compete clauses in employment contracts, except those for ‘senior executives’”  The rule will also ban future non-competes, including for senior executives, with some limited exceptions. We’ll speak to a US lawyer about the significance of this development for employers.

The rule is set to take effect 120 days after its publication in the Federal Register, so around August this year, and by its own estimate it could affect up to one-in-five American workers. However, it is highly controversial and it will face a number of legal challenges concerning the FTC's rulemaking authority as well as the legality of the rule itself. It means that even the legal challenges were unsuccessful they could potentially delay the rule's effective date. So there is a lot of uncertainty around this. 

This is a big news story in the US and companies right across the country are, understandably, concerned about what might lie ahead. So, let’s consider that. Earlier I caught up with US employment lawyer Ben Stockman who joined me by video-link from New York to discuss the rule. I asked Ben how big a deal is this for companies, potentially? 

Ben Stockman: “Oh, it’s a massive change for companies, employers. Interestingly, I saw as well some statistics that of those who have non-compete clauses in their employment agreements, close to 95% also have confidentiality provisions, or agreements, with those same employers and I think the FTC has made it clear that they think that non-disclosure agreements are sufficient to protect trade secrets in a way that non-competes are unnecessary to do.”

Joe Glavina: “The rule bans new non-competes, including with senior executives, and the FTC spells out what they mean by ‘senior executives,’ giving a definition. So will it be necessary for companies to conduct some sort of audit to see who falls into that category?” 

Ben Stockman: “Yes, Joe, and companies will have to either wait for additional guidance, learn what they can glean from litigation that plays out or, as you've suggested, take their own measures to audit their senior executives to determine who meets the test and who doesn't and the test and the burden is quite high on an employer. The FTC has made clear in its rule that only those who are responsible for policy that impacts significant aspects of the business would meet the test.”

Joe Glavina: “As I understand, on the face of it, the rule doesn’t catch other types of restrictions such as non-disclosure agreements and non-solicitation agreements but it will catch those clauses if they operate as non-competes in practice.”  

Ben Stockman: “Yes Joe, and what employers will need to police for now, assuming that the rule is validated through the courts, and that's a big, I think that that's a big question as to whether it will be,  but operating under the existing rule employers will need to revisit their non-disclosure clauses, which can be quite extensive, to make sure that they are not so overly broad that the FTC would view them as, in effect, prohibiting employee mobility. One example I would provide would be a non-disclosure agreement that would prohibit an employee from using or disclosing information that is generally known within the industry or to the public. That would be an example of a non-disclosure prohibition that would be probably viewed as overly broad by the FTC and, in effect, a non-compete in and of itself.”

Joe Glavina: “I see there is a sale of business exemption which, I think, you talked about last time when we spoke about this.” 

Ben Stockman: “Yes, that's crucial and I don't know of any practitioner who works in this area who thought that the FTC would do away with the sale of business exception to a non-compete ban. Even in California that exception still exists despite a statutory prohibition on non-competes that's extremely broad. So, that has survived as part of this rule and, frankly, it's underpinned by the principle that one cannot sell their business and profit from the goodwill of that sale and then turn around and immediately compete to try to undermine that which he, or she, has just sold. So, the principles underlying the sale of business exception are sound and it appears that the FTC has followed those principles here.”

Joe Glavina: “There’s a requirement that employers serve a written notice on employees telling them that their non-competes are going to be unenforceable. Could that result in employers looking to renegotiate contracts with those employees, what we would call here in the UK, ‘fire and rehire’? Might that happen?”

Ben Stockman: “It could and certainly, in certain circumstances, I think it will. Look, this is good news for executives. This is good news for - well, let me caveat that  - this is good news for executives in their own personal employment arrangements with their employers. It's not the best news for executives who are running a business and trying to keep their high-level employees from competing. So, it's a bit of a double edged sword for senior executives in the sense that, on the one hand, it makes their negotiations of their employment arrangements with their employer a bit easier and if an employer were to attempt to reopen a negotiation based on the passage of this rule I think they could expect that sophisticated executives might not be all that interested in the renegotiation unless there was something to be gained by the executive. I will say this. It is certainly impacting current negotiations between executives and their employers and, anecdotally, I've seen this in my own practice. I'm in the middle of a few different negotiations on behalf of senior executives and the passage of this rule in the middle of those negotiations certainly has thrown a curveball. So we're seeing it impact current negotiations and I could certainly see circumstances where the employer would want to reopen negotiations - and there's nothing prohibiting the employer from doing that - but it's just a question of leverage.”

Joe Glavina: “All of this depends on the rule coming into force and I see some legal challenges have already started. So what chance of this rule surviving in your view?”

Ben Stockman: “Well, that's a million-dollar question, Joe, and I, frankly, can't predict. I would say, those litigations are in their infantile stages, they'll need to go through the full litigation process, and I would expect this type of case to go all the way to the Supreme Court. I think the fundamental question is, does the FTC have the jurisdiction and authority to issue this rule? On that question, I think that the FTC could expect to meet a sceptical Supreme Court, as it's currently composed, but how that will play out I can't predict.”

Joe Glavina: “As I understand it, The Final Rule pre-empts conflicting state laws, effectively banning otherwise lawful employee non-compete clauses in the states that permit them. So, presumably companies will need to look to other ways to protect the business?”

Ben Stockman: “Yes, and Joe, you know, although this is a massive change to how employment relationships exist in this country as you know there are many states in the US that have been passing laws to restrict the ability of employers to impose non-competes on employees. California is the example I referred to earlier, but there are others. So, employers have been wrestling with this conundrum for quite some time. If they operate in multiple states and one of the states of California how do we try to uniformly apply employment policies to our entire company for those who are in California and those who are not? Companies are well aware of how to wrestle with states where non-competes have already been banned and, to your point in your question, an extra emphasis is really placed on tightening up confidentiality agreements, proprietary information and invention protection agreements, and then the utilisation of non-solicit clauses to protect their existing workforce, and their investment in their existing workforce, as well as their existing client base and their investment in their existing client base. This new rule throws a bit of grey area into the question as to how far companies can go with non-solicit provisions, for example, to protect their client relationships. I think that an overly broad non-solicit provision, at least theoretically, could run afoul of the FTC’s new rule so employers will have to be mindful of that as they revisit their existing language and fine tune it to the new reality that we are all confronting with the passage of this rule.”

I continued that interview with Ben to ask about what employers should be doing now if anything. So whether to do nothing and wait and see what happens with the legal challenges to the rule or embrace the change and review employment contracts. We’ll have more on that next week.