Dive Brief:

• The Federal Trade Commission voted 3-2 April 23 to impose a nationwide ban on the use of noncompetes and other types of agreements that keep employees from leaving to work for a competitor.
• The ban passed in a party line vote and is similar to the agency’s proposed version. In one difference from the earlier version, executives subject to a noncompete agreement today will remain subject to the agreement; the ban will apply to executives going forward, with an exception for agreements made in connection to certain bona fide sales of a business. 
• Critics, including the U.S. Chamber of Commerce, are expected to challenge it, creating an uncertain landscape that could last for years as courts decide if the agency is trying to stretch the meaning of “unfair practices” in Section 5 of the FTC Act too far by using that as the basis for the ban. “The fact that a federal agency is coming in and using Sec. 5 of the FTC Act, saying these things could be illegal, means cases will be litigated to see if the FTC indeed has the authority,” Dennis Cuneo of Fisher Phillips told Legal Dive before the proposal was released.

Dive Insight:

Under the newly passed ban, employers aren’t allowed to require job candidates to sign noncompetes as a condition of employment and existing noncompete agreements can no longer be enforced. The one exception is the new requirement that senior executives currently subject to a noncompete will remain subject to it. Going forward, senior executives hired after the ban takes effect can’t have their hiring be made contingent on signing a noncompete. 

“Noncompete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new startups that would be created a year once noncompetes are banned,” said FTC Chair Lina Khan said after commissioners voted on the regulation. “The FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.”

Khan, Rebecca Kelly Slaughter and Alvaro Bedoya voted to approve the ban, while newly seated commissioners Melissa Holyoak and Andrew Ferguson voted no.    

The U.S. Chamber of Commerce has called the ban blatantly unlawful, CNBC has reported.  

Other types of agreements, like nondisclosure and nonsolicitation, also won’t be allowed to the extent they’re found to be functioning as a noncompete. 

Determining if another form of agreement is functioning as a noncompete creates a legal gray area that will put the onus on in-house counsel to justify why their company’s use of these alternative agreements doesn’t amount to de facto noncompetes, John Chun, a partner at Herrick, Feinstein, told Legal Dive last year. There’s “little guidance as to when an NDA will cross that line,” he said

A number of states already ban noncompetes or otherwise have some restrictions imposed on their use, and these states can continue to enforce their laws under the proposal if they’re stronger than what the nationwide ban ends up being; if they’re weaker, the FTC ban would supersede them.       

“States have led the way on restricting the use of noncompetes and our experiences inform our support of the proposed rule,” the attorneys general in 18 states say in a letter last year asking the FTC not to preempt their laws. “State action has both revealed the harm caused by noncompetes and allowed researchers to quantify the benefits of banning noncompetes on worker earnings and job mobility.”

The ban wouldn’t just apply to employees; it would apply to people who own an equity interest in a company as well, although it contains a sale-of-business exception. In these cases, anyone who owns at least a 25% interest in a company at the time they enter into a noncompete would stay bound to it when they sell. 

Franchisees would stay bound to a noncompete as well; the proposal treats them as businesses, not as employees. 

Compliance

Many companies are already preparing for the possibility of a ban by rethinking their use of noncompetes as a way to protect their interests. 

For those that haven’t, Debbie Berman, a partner at Jenner & Block, has recommended general counsel undertake due diligence on what trade secrets need protecting and who among the company’s employees could take those secrets with them were they to leave for a competitor.  

Once that due diligence is complete, the company can look at non-disclosure and non-solicitation agreements to see if they can be narrowed to just what’s needed to protect company secrets from high-risk employees. That way, companies can use those types of agreements in lieu of noncompetes in a way the FTC would have a hard time challenging. 

“The old days of having the broadest agreement you could have to cover anything that basically keeps someone from leaving are gone,” Berman told Legal Dive last year.

Another strategy is to use what’s known as garden leave, a cooling-off period of typically six months that the company and outgoing employee negotiate during which the employee agrees not to go to a competitor in exchange for compensation.  

It’s a way for the company to protect its interests without having to use a noncompete or other type of agreement that can be challenged as a de facto noncompete, but it’s costly; the company is essentially paying a former employee not to do anything for the agreement period. That’s an expense not all companies can afford.

“[With] companies that aren’t necessarily well-funded, how are they going to be able to pay off these people who may want to … go to a competitor?” Damian Cavaleri, a partner at Hoguet Newman Regal & Kenney, said in earlier Legal Dive coverage. 

The FTC livestreamed its April 23 vote on the noncompete ban.  

This piece has been updated to reflect the outcome of the vote. Access the final FTC rule banning noncompete agreements.