What proposed Federal Trade Commission rule on non-competes means for suburban businesses
Last month, the Federal Trade Commission announced that it is proposing a new rule to ban employment-based non-compete agreements. The rule, which must still go through an extensive notice and comment period, would bar employers from implementing or enforcing non-compete contracts with employees.
The impact of the rule would be sweeping. By some accounts, nearly 20 percent of American employees have signed some sort of a noncompete contract.
The FTC's proposal, which is likely to pass in some form, will bring a legal challenge on the grounds that it's an invalid exercise of federal power. Though the FTC claims it has the authority to implement a noncompete rule as an "unfair method of competition," the legal grounds to do so are far from certain.
Businesses challenging the rule likely will be able to show that the noncompete rule is a "major question," meaning that the FTC then must show clear Congressional authorization to impose a sweeping nationwide ban through the agency rule-making process. It is questionable whether the FTC can point to such authorization, particularly in light of recent Supreme Court precedent.
But if passed and upheld, the noncompete rule would cause businesses to take immediate action. Not only would it prohibit employers from requiring employees to sign restrictive covenants going forward, but it also would effectively rescind contracts that predate the rule altogether.
Indeed, the FTC's proposed rule contains a model rescission notice that employers would need to send within 180 days of the rule's passage to affected workers (current and former) bound by noncompete contracts.
What's more, the rule calls out "de facto" noncompete agreements under an effects test. As the FTC has explained, broad nondisclosure agreements can operate like noncompetes and thus are susceptible to the rule's reach as well.
Complicating matters further, noncompetes signed in connection with a business sale - long uncontroversial - only would be valid for shareholders who own at least a 25 percent equity stake. That limited carve-out exceeds even California's well-known ban on noncompetes.
Nor is the FTC sitting by and waiting for the rule-making process to run its course. The proposed rule operates in tandem with enforcement actions the FTC already has filed against private employers. In one of those actions, a security company used a broad noncompete with low-wage employees and included a contractual penalty of $100,000 for breach. That same company also continued to require new employees to sign noncompetes despite having a court declare them unenforceable.
By pursuing companies individually, the FTC is not waiting on rule making to address what it perceives as employer overreach in particular cases. It appears, at least right now, that the FTC is focusing on egregious cases where employers attempt to use exceedingly broad restraints indiscriminately for a wide variety of jobs.
Alongside the FTC's proposed rule, federal legislators may be sensing a renewed opportunity to get involved. On Feb. 1, a bipartisan group of legislators introduced the Workforce Mobility Act of 2023. A version of this statute, which also would bar noncompete agreements, has languished before in committee. This particular iteration of the act would not go as far as the FTC's proposed agency rule and would permit all business sellers to sign noncompetes in connection with a sale. It also would allow noncompetes tied to executive severance contracts. But still, the vast majority of noncompetes fall within the draft legislation's broad prohibition.
In recent years, many states - including Illinois - have begun to limit the enforceability of employee noncompetes. As a result of a new law that went into effect last year, Illinois employers must give employees adequate notice to review covenants and advise them to consult with counsel.
And employees making less than $75,000 cannot be bound by a noncompete at all. Despite the uncertainty that remains, noncompete agreements continue to draw scrutiny at both the state and federal level, compelling employers to continually reassess how and whether to use them.
• The information in this article is intended for general purposes only and does not constitute legal advice. Readers should not act upon the information in this article without individual professional counseling.
Ken Vanko specializes in corporate counseling and commercial litigation at Clingen Callow & McLean LLC, a full-service law firm of business advisers and counselors with offices in Lisle and Geneva. You may contact Ken Vanko at (630) 871-2609 or vanko@ccmlawyer.com.