On January 5, 2023, the Federal Trade Commission (FTC) posted its proposed rule for banning nearly all non-compete clauses nationwide (“Proposed Rule”).
What is a non-compete?
A non-compete is a contractual agreement between an employer and employee under which an employee agrees to not be employed by or participate in a business in competition with the employer after his/her employment with the employer ceases. In Ohio, non-competes have to be reasonable in their time and geographical scope. Non-competes often go hand-in-hand with other forms of restrictive covenants, including non-solicitations agreements and non-disclosure/confidentiality agreements. A non-solicitation agreement restricts an employee from soliciting clients and employees from an employer for the benefit of a new employer or the employee themselves. A non-disclosure/confidentiality agreement forbids an employee from disclosing or utilizing an employer’s confidential information outside the confines of the employer’s business, especially to the advantage of a new employer or company. In Ohio, non-solicitation agreements and non-disclosure/confidentiality agreements have not faced the heightened scrutiny non-competes cannot avoid, and usually have few limits on breadth and enforceability.
The typical factual pattern is: Red Corp. hires John Doe. As part of onboarding, John Doe signs an employment agreement (usually without reading it) which contains several restrictive covenants, including a non-compete. The non-compete prevents John Doe from working in any capacity and in any industry that competes with Red Corp. for two years, within 50 miles of Red Corp.’s brick-and-mortar shop. The geographical restriction is almost never carefully defined, and most employees do not know whether it is 50 miles as the crow flies or 50 miles on Google Maps’ driving directions. John Doe quits employment at Red Corp. and gets a job at Blue Corp., a direct competitor of Red Corp. Red Corp. notices business has started to go down since John Doe left, Red Corp. finds out John Doe is working at Blue Corp. Red Corp.’s lawyer sends a letter to John Doe and Blue Corp., informing of the non-compete and threatening a lawsuit, which will typically include rights to an injunction and an award of Red Corp.’s attorney fees. Blue Corp. thinks to itself, “I have no contract with Red Corp., what do I care?” Blue Corp.’s attorney explains to Blue Corp., by continuing to employ John Doe, Blue Corp. may be “tortiously interfering” with the non-compete and Red Corp. would not mind adding a defendant with bigger pockets than John Doe. Three options present themselves to Blue Corp. Option 1: Blue Corp. summarily fires John Doe. Option 2: Blue Corp. pays Red Corp. to let John Doe out of his non-compete or modify his non-compete. Option 3: Blue Corp. continues to employ John Doe and Red Corp. sues Blue Corp. and John Doe, which usually expensively delays the selection of Option 1 or Option 2.
Non-competes in Ohio are very common, even for some employees who seemingly pose no viable threat by moving to a new company. The most humorous non-compete situation this author has encountered was a dry-waller restricted by a non-compete.
What are the reasons for the Proposed Rule?
On July 9, 2021, President Biden signed Executive Order 14036 “Promoting Competition in the American Economy,” which included a directive to the FTC to “consider working with the rest of the Commission to exercise the FTC’s statutory rulemaking authority * * * to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”
The FTC states approximately one in five Americans are restricted by non-compete clauses and cites such provisions restrict employees from leaving jobs, lower wages, dissuade new businesses, stifle entrepreneurship, and prevent novel invention. It restricts competition, which is the antithesis of the FTC charge under the U.S.’s Antitrust laws. The FTC estimates the elimination of non-competes would increase workers’ earnings between $250 to $296 billion per year.
One of the most convincing reasons for banning non-competes is the fact California has restricted non-compete agreements in some form since 1872. Yet, it has only flourished as a cradle of innovation, especially in those highly technical areas often cited as the justification for restrictive covenants. California, North Dakota, and Oklahoma have all passed statutes rendering nearly all non-competes void and Washington, Colorado, Illinois, Arizona, and Nevada have passed laws voiding some based on a variety of factors, including income levels.
What does the Proposed Rule say?
The Proposed Rule is short and defines a “non-compete clause” as “a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.” It does not include agreements not to compete while the worker is still employed, a principle inherent in the employer-employee relationship through common law doctrines, including the “unfaithful” or “faithless” servant doctrine. The Proposed Rule also includes a functional test to include de facto non-competes, which though not styled as a traditional non-compete, would have the effect of wholly preventing separate and competitive employment. The Proposed Rule includes overly broad non-disclosure agreements as an example of a de facto non-compete.
The Proposed Rule makes it an unfair method of competition to enter into, attempt to enter, maintain, or represent to the employee that he/she is subject to a non-compete. For existing non-competes, there is a deadline to rescind and an employer who rescinds a non-compete must provide notice to the applicable worker, on paper or through email or text message. The notice must be provided within 45 days of rescinding the non-compete, which can be no later than the “Compliance Date” (defined below). The recission and notice requirements apply to both current and former employees subject to a post-employment “non-compete.” The Proposed Rule even includes model language for the notice, the submission of which can allow a safe harbor for compliance.
The Proposed Rule includes a specific exception for non-competes entered into by a person (including a business entity) who is selling a business or disposing of all their ownership interest in a business. The exception supports the reasonable conditions of mergers and acquisitions. The definition of “non-compete” also excludes agreements between franchisors and franchisees.
Are any employers excluded from the Proposed Rule?
Section 5 of the Federal Trade Commission Act of 1914 (“FTC Act”) does not apply to banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers, and those subject to the Packers and Stockyards Act. Section 5 is the section of the FTC Act cited by the FTC for its authority to promulgate the Proposed Rule.
When could this go into effect?
The FTC filed the Proposed Rule on the Federal Register on January 19, 2023, and will leave it open for comment for 60 days (March 20, 2023). The FTC is specifically seeking comments regarding whether senior executives should be exempted from the rule and whether high or low-wage workers should be treated differently under the rule. Once the comment period is closed, the agency may reopen the comment period, issue a new proposed rule, terminate the rulemaking, or move on to a final rule. If a final rule is published in the Federal Register, it will be subject to additional Congressional review.
The Proposed Rule as currently drafted includes a “Compliance Date” of 180 days after final publication. 45 days from the Compliance Date is the latest date in which employers must give the necessary notice of recission. If finalized at all, the final form of the Proposed Rule is unlikely to go into effect until well into 2024. Even then, it will be subject to judicial review pursuant to the Administrative Procedure Act and other legal challenges.
What are the challenges to the Proposed Rule?
The principal legal challenge is, Section 5 of the FTC Act does not provide the FTC with the authority to engage in this type of rulemaking. The US Chamber of Commerce has already pledged to sue to challenge the Proposed Rule.
Section 5 grants the FTC the power to prohibit practices it determines are an “unfair method of competition in or affecting commerce and unfair or deceptive acts or practices in or affecting commerce.” The FTC has not used this Section significantly in the past for rulemaking.
The Proposed Rule is certainly going to be challenged based on the “major questions” doctrine, which is essentially a separation of powers principle. Recently enumerated in the Supreme Court’s 2022 decision in West Virginia v. EPA, the major questions doctrine means if an administrative agency is attempting to regulate a fundamental sector of the economy, there must be a clear statement in the relevant statute to conclude Congress intended to delegate that authority. The Supreme Court rejected the idea Congress would grant expansive powers in “so cryptic a fashion.” The West Virginia v. EPA Court also emphasized the Clean Air Act, which the EPA was citing for its authority, had not been used for its current purpose before. The Court also reasoned, when Congress seeks to make a radical or fundamental change, it rarely does so with vague, modest, oblique, or elliptical language. It hurt the EPA’s position that the specific acts it was trying to bootstrap in through the statute, had been known, considered, and rejected multiple times by Congress.
If finalized, the Proposed Rule would likely suffer a similar type of skepticism, especially as Section 5 of the FTC Act has not been used in this wide sweeping manner before. Section 5 of the FTC Act may be considered by critics, like the Clean Air Act’s Section 111(d) was in West Virginia v. EPA, as an “obscure, never-used section of the law.”
An interesting practical critique of the Proposed Rule is it has no exceptions for C-suite employees, who obviously maintain important business strategy information and no matter how restricted by a non-disclosure or non-solicitation agreement, cannot detach important trade secret information from their intellect. Critics have gone so far to suggest employees should return some of the value of their compensation based on elimination of their non-compete, which was (in some cases) bargained for and supported by specific consideration. There are situations where non-solicitations, non-disclosure, and other applicable trade secret laws cannot protect a business’ legitimate interests. The FTC argues that the harm of non-competes outweighs those legitimate interests.
What are the practical implications?
The Proposed Rule would only be enforced by the FTC and would not provide a private right of action. Interested parties would be required to make a complaint or request FTC action through the FTC’s web-based complaint site. If an employer sued an employee on a non-compete, the employee could include the Proposed Rule in its affirmative defense of illegality or encapsulated as a basis for nullifying a non-compete through a declaratory judgment claim.
Employees may rejoice. Employers should be proactive in auditing their active employment agreements to analyze the effects of an elimination of all non-competes and see if any of their other provisions could qualify as a de facto non-compete. If the Proposed Rule is finalized, employers should be ready to fulfill the recission and notice requirements to enjoy a safe harbor of compliance and put into place new agreements which continue to protect their business.
Whether you are an employer or employee, OndaLaBuhn’s attorneys can help you successfully navigate the implications of the Proposed Rule. We can also assist in submitting comments on the Proposed Rule before March 20, 2023.
John P. Miller