FAQS ON NONCOMPETE CLAUSES
By Benjamin C. Dunlap, Jr., Nauman Smith Managing Partner
As mentioned by President Biden in his State of the Union message, approximately 30 million American employees, which is about one in five workers, are bound by noncompete clauses in their employment. Earlier in his term, President Biden issued an Executive Order encouraging the Federal Trade Commission (“FTC”) to “curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”
Noncompete clauses prevent employees from working for a competing employer or starting a competing business for a set period of time after their employment ends. Many highly placed executives who are privy to sensitive confidential and trade secret employer information are subject to noncompete clauses. However, these clauses have also been used to keep restaurant workers and security guards from moving to competing employers where they might find higher pay or better working conditions.
The FTC, under its statutory authority to ban unfair methods of competition, issued a Notice of Proposed Rulemaking (“NPRM”) on January 5, 2023, which would essentially ban all noncompete clauses.[1] This article will explain the proposed rule, the reasoning behind it, arguments for the continued legality of noncompetes, some terms on which agreement might be reached, and what both employers and employees can do to protect themselves in this fraught area of employment law in the meantime.
Q: What does the proposed FTC rule provide?
A: The new rule would prohibit employers from entering into any new noncompete clauses with their workers and would require them to rescind any existing noncompetes, making those prior agreements unenforceable. It would apply to employees as well as independent contractors. The only exceptions under the current iteration of the rule would be persons who sell their interest in a company to another person or company or in a franchisor/franchisee relationship.
Q: What is the reasoning behind the proposed rule?
A: According to an FTC Fact Sheet released with the NPRM, noncompete clauses “significantly reduce workers’ wages.” Employer use of noncompete clauses that prevent workers from moving freely to other jobs suppresses wages and reduces competition for workers, along with preventing jobs from opening up when workers are bound by such clauses. Noncompete clauses stifle new businesses and new ideas by preventing the formation of new entrepreneurial ventures and bringing new ideas into companies. The lack of bargaining power faced by many workers in having to accept noncompete clauses forces many of those workers to stay in jobs they would rather leave. The proposed rule could increase worker earnings by $250 billion to $296 billion per year, according to FTC estimates.
Q: What are the legitimate business interests protected by noncompetes?
A: The protection of trade secrets is a right that many businesses seek to protect through noncompete clauses. That is the primary reason noncompete clauses should not be outlawed across the board, according to an open letter to the FTC and White House Director of Private Sector Engagement signed by 59 employment law attorneys (“BRR Letter”).[2] The BRR Letter cites a 2009 study in which “59 percent of ex-employees admit to stealing confidential company information” when they leave their jobs.[3] Noncompete clauses can be an effective tool in preventing such losses. Another widely recognized protectable interest is the goodwill developed with a company’s customers through the work it pays employees to perform. This is frequently a primary concern with departing salespersons. Other interests sought to be protected include the investment that a company makes in employee training and the development of unique skills.
Q: Are there not other less intrusive ways to protect these business interests?
A: Proponents of the proposed rule, including the FTC, point to state and federal trade secret laws[4] as well as nondisclosure agreements as alternate means of protecting company secrets while not preventing a departing employee from working for a competing company. However, as pointed out in the BRR Letter, a significant source of disagreement under trade secret laws surrounds customer information, including customer lists, and the extent to which that information can be classified as a trade secret. Another issue is how to handle trade secret information that can be retained in a person’s memory. Proving violations in these circumstances may be difficult if the violation is not blatant. Likewise, while a nondisclosure agreement puts the employee on notice as to what information the employer considers confidential and provides a contract remedy for breach, it does not prevent an employee from working for a competitor. Nondisclosure agreements, however, are an important building block in demonstrating a company’s efforts to maintain the secrecy of confidential and trade secret information.
Q: How are noncompete clauses currently enforced and regulated?
A: Noncompetes are subject to state law. As a result, the rules can vary widely from one jurisdiction to another. Only three states, California, North Dakota and Oklahoma, prohibit noncompete clauses in most or all circumstances, as does the District of Columbia. Noncompetes generally will not be enforced unless a court determines that it is reasonable to do so, balancing the interests of the employer and the employee in each particular scenario. As such, noncompetes generally must be:
- Reasonable in duration (typically one to two years);
- Reasonable in the geographic area to which they apply;
- Reasonable in the scope of restricted activities covered;
- Necessary to protect the enforcing party’s legitimate business interests; and
- Comport with public policy.
Q: How are noncompete clauses used and misused?
A: As argued in the BRR Letter, noncompetes can be used legitimately and effectively to prevent employee theft and misuse of valuable employer information and are much easier to enforce than trade secret or nondisclosure violations. However, from the worker viewpoint, the mere threat of a noncompete agreement lawsuit may prevent an employee from moving to a new and better-paying job, even if the noncompete is overbroad or even unenforceable in the particular circumstances.
Q: Are there some areas on which the two sides might agree to rein in some abuses of noncompetes?
A: The BRR Letter offers a number of potential compromises, three of which particularly resonate with this writer:
- Ban noncompetes for low wage workers. Some states already do this, with widely varying thresholds. The BRR Letter suggests defining low wage workers under any such rule as employees who are not exempt under the Fair Labor Standards Act.
- Require employers to provide advance notice of a noncompete. Many employees only find out that they will be subject to a noncompete when they report to work on their first day. Being provided a noncompete when an offer of employment is made, at the latest, will provide the employee an opportunity to negotiate for a higher salary if the noncompete is accepted. While employers generally have greater bargaining power in these situations, employees may have the upper hand at the present time when many employers are having difficulty filling open positions.
- Provide for “springing” or “time out” noncompetes. Massachusetts and Rhode Island allow for the use of noncompetes as a remedy when a former employee violates nondisclosure or nonsolicitation obligations or misappropriates the employer’s trade secrets, providing a big incentive not to do so.
Q: What advice can you give to employers and employees in the meantime, until the parameters of any new regulations become clear?
A: For employers I would say to keep in mind that a judge may be evaluating the reasonableness of your noncompete one day. As such, limit the terms to the minimum that will protect your legitimate business interests. Do not prohibit a sales employee operating in a three-state area from making calls throughout that territory, but instead limit it to customers with whom that employee has worked within the past several years and with the prohibition only on the sale of similar products. Do not prohibit a construction company executive from working for all other construction companies, but only those who directly compete with the employer. Limit the time period to no more than 18 months, and do not force noncompetes onto low wage workers who may generally move from job to job.
For employees, I would advise that you ask a potential employer early in the hiring process whether you would be asked to sign a noncompete if offered a position and what that would entail. This would serve to put the employer on notice that you are aware of this issue and further would provide the opportunity to reject the noncompete or perhaps to negotiate its terms to be more in your favor. While a noncompete for a lower wage worker who is not subject to confidential employer information likely would not be found protective of an employer’s legitimate business interests and thus be unenforceable, the employee still may be forced to litigate the matter.
Benjamin C. Dunlap, Jr. is Managing Partner at Nauman Smith and spearheads the Business & Employment Law practice group at the firm. To learn more about how Ben and his team can advise your business on these and other legal issues, please email him directly at bdunlapjr@nssh.com or call (717)236-3010 ext. 121.
[1] See https://www.ftc.gov/legal-library/browse/federal-register-notices/non-compete-clause-rulemaking
[2] The letter dated July 14, 2021, was submitted on the letterhead of the Beck Reed Riden LLP law firm, and is available at https://faircompetitionlaw.com/wp-content/uploads/2021/07/White-House-and-FTC-20210714-Joint-Submission-of-Trade-Secret-Lawyers-Beck-et-al.pdf
[3] More Than Half of Ex-Employees Admit To Stealing Company Data According To New Study, Ponemon Institute and Symantec Corporation (Feb. 23, 2009).
[4] A trade secret is information having commercial economic value derived from the fact that the information is not known by competitors, with reasonable efforts taken to maintain that secrecy.