FTC bans noncompetes: How will you protect your company’s information and keep your customers?

The Federal Trade Commission voted today to adopt a rule banning noncompetes.

Summarized below are what the Rule requires, when it takes effect, and what you need to do.

But first, I note that, while doing away with noncompetes may be a good thing philosophically, the Rule represents as enormous a step backward for the protection of trade secrets as the Defend Trade Secrets Act was a step forward.1

That said, there’s a lot that can happen between now and when the Rule takes effect. So, in the immortal words of Kevin Bacon, “Remain calm. All is well… All is well!

What the Rule requires: 

I am still making my way through the 570-page documentation, but in short, the new Rule will ban all employee noncompetes.

Prohibited Conduct

Subject to three exemptions (see below), the FTC will consider it to be an unfair method of competition for an employer:

(i) To enter into or attempt to enter into a non-compete clause;

(ii) To enforce or attempt to enforce a non-compete clause; or

(iii) To represent that the worker is subject to a non-compete clause.

Prohibited Agreements

Noncompetes are defined as follows:

A term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:

(i) seeking or accepting work in the United States . . . where such work would begin after the conclusion of the employment . . . ;

(ii) operating a business in the United States after the conclusion of the employment . . . .

This is very broad.

But if its breadth is not obvious enough, the FTC provides examples of agreements that you might not think would violate the rule, but do.

For example, in addition to expressly calling out forfeiture-for-competition provisions as penalizing employees, the FTC goes so far as to say that a “severance arrangement in which the worker is paid only if they refrain from competing” would be a penalty. The FTC doubles down on this, noting “that a payment to a prospective competitor to stay out of the market may also violate the antitrust laws even if it is not a non-compete under this rule,” presumably considering the soon-to-be-former employee a “prospective competitor.”

Whatever the nature of the purported penalty, the FTC made it clear that it is focused on agreements in which the penalty is “triggered where a worker seeks to work for another person or start a business after they leave their job . . . .”

The FTC also rebranded the “de facto” test from the rule it proposed last year. But it is largely the same. Referencing nondisclosure agreements (NDAs), training repayment agreements (pejoratively called “TRAPs”), nonsolicitation agreements, no-hire agreements, and “no-business” agreements (presumably meaning no-service agreements) as examples, the FTC stated that where such an agreement is “so broad or onerous that it has the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends, such a term is a non-compete clause under the final rule.” The FTC justifies this in part by pointing to outlier cases concerning overly broad NDAs as the general rule; they are not.

On a superficially more reasonable note, the FTC did not “replace the term ‘prevent’ with ‘restrains’ or ‘limits,’ as “the Commission is concerned that different language could greatly expand the scope of the definition and reduce its clarity.” That said, given the startling breadth (and vagueness) of the Rule as written, it seems that the alternate language would have been a distinction without a difference.

Exemptions

The rule lists three exemptions, though, practically, there are really only two, and one of those is temporary:

  • Noncompetes entered into in connection with a bona fide sale of business, meaning, the sale of the person’s ownership interest in a business entity or of all or substantially all of a business entity’s operating assets.
  • Causes of action concerning noncompetes that accrued prior to the effective date.
  • Enforcement or attempts to enforce a noncompete, or making representations about a noncompete, where the person has a good-faith basis to believe that the ban is inapplicable.

As noted below, there is a limited exemption for existing noncompetes with senior executives.

Retroactivity

The Rule will operate retroactively for all noncompetes except those agreed to by “senior executives (to the extent the senior-executive noncompetes were agreed to before the effective date of the Rule).

Don’t get too comfortable; senior executives are a very limited group.

To qualify, the employee must be in the C-suite or hold an equivalent role, have “final authority to make policy decisions that control significant aspects of a business entity or common enterprise,” and earn over $151,164 (excluding discretionary bonuses, board, lodging, payments for medical, dental, or vision insurance, retirement contributions, or other “fringe benefits”).

If the employee qualifies as a senior executive and entered into a noncompete before the effective date of the Rule, that noncompete will be outside the scope of the Rule.

Notice Requirement

The rule requires employers to send “clear and conspicuous” notice to all employees with a noncompete (except senior executives) “that the worker’s non-compete clause will not be, and cannot legally be, enforced against the worker.” Specifically, assuming the company has a way to reach the employee, the notice must:

(i)  Identify the person who entered into the non-compete clause with the worker;

(ii) Be on paper delivered by hand to the worker, or by mail at the worker’s last known personal street address, or by email at an email address belonging to the worker, including the worker’s current work email address or last known personal email address, or by text message at a mobile telephone number belonging to the worker.

The Rules includes a sample notice that will satisfy the requirement.

When the Rule takes effect: 

The rule will not take effect for over four months, and will have no direct, immediate impact. The process is as follows:

  • The Rule must be published in the Federal Register. Nothing happens until the final rule is published in the Federal Register. Based on the timing of the original Notice of Proposed Rulemaking, this will likely take about two weeks.
  • The rule will become effective 120 days from publication.

Note that even though there is time, the rule will have retroactive effect, meaning that once it becomes operative, it will invalidate existing agreements. So, while we can continue to hope for the best, it’s time (if you haven’t already) to prepare for the worst.

What to do now protecting your information and customer relationships in light of the Rule:

The Rule will be facing multiple legal changes. The U.S. Chamber of commerce announced their intent to challenge the rule shortly after the initial version of the rule was first announced back on January 5, 2023, and then again yesterday. Separately, Ryan, LLC, a global tax services company, just filed suit in the United States District Court for the Northern District of Texas this evening. Others will follow.

There are strong arguments that the FTC lacks authority to issue the Rule and that the Rule itself is unconstitutional.

However, until we know the outcome of these challenges and whether the rule will even become effective, it makes sense to proceed on dual tracks.

First, be prepared to remove noncompetes from your agreements — but don’t do it yet. Once the Rule becomes effective, you’ll need to stop using them within 120 days of publication and notify employees that their noncompetes are void. (As we know from our California experience, that can be an involved process — and this time it will cover the whole country.) So, I would be prepared, but would not pull the trigger unless and until required.

Second, in the meantime, take the steps needed to review and take advantage of available protections for your company’s trade secrets, other confidential information, customer relationships, and workforce on the assumption that the ban will be enforceable.

Two good resources for ensuring you consider available options are:

In short, the following are some of the immediate things to be thinking about:

  • Reviewing and updating agreements and policies that are not compliant with all of the new state-law developments. This includes, in particular, noncompetes, broad confidentiality agreements, and other agreements in the crosshairs (including no-recruit agreements, nonsolicitation agreements, anti-moonlighting provisions, and training repayment agreements), as well as internal policies that my be treated like impermissible restrictions on employee competition.
  • Reviewing and updating procedures (including the use of data loss prevention software) for protecting trade secrets, other confidential information, and goodwill (see trade secret protection program primer and checklist).
  • Using supplemental agreements and approaches to mitigate the impact of the tightening restrictive covenant laws. For example:
    • Notice provisions (“true” garden leave clauses) may, to the extent enforceable, offer meaningful protection for a short term. Even the FTC’s new Rule acknowledges that these agreements fall outside the scope of the Rule.
    • Springing noncompetes (a court-ordered noncompete as a remedy for a violation of other restrictive covenants or obligations) may create both a deterrence effect and provide a partial remedy for wrongdoing that is discovered early enough. This is a tool created years ago for a client who did not want to use a noncompete, but was worried about the impact of employees violating the other restrictive covenants. It has since been incorporated into Massachusetts noncompete law (MNAA, G.L. c. 149, § 24L(c)).
  • Emphasizing training. Never lose sight of one of the easies and most effective tools you have is to educate and train employees, especially at onboarding and off-boarding, and with special attention to employees working remotely.

As you consider the above, it is often helpful to think of the strategies from how they might be implemented at each of the three stages of the employment lifecycle:

Note:  In the past, I have suggested considering what I’ve called “compensation-for-noncompetition-choice agreements,” i.e., paying a former employee for and while they voluntarily refrain from competing. It is similar to a mandatory noncompete where the former employee is paid during the restricted period, but the noncompete is voluntary and entirely left to the employee’s choice. It’s also the inverse of a compensation-for-competition agreement, where the employee pays the former employer if/when the former employee competes. Because of the change of approach (both its voluntary nature and that the payment is to the employee, as opposed from the employee), it should have a greater chance that a court would not deem it to be a noncompete or penalty. Indeed, compliance would be completely voluntary, so there should be no need to challenge it. However, the FTC has expressly identified agreements like this as functional noncompetes under the Rule — and independently a likely violation of antitrust law. As a consequence, unless operation of the FTC’s Rule is enjoined, I would refrain from implementing these types of agreements at this time.

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Additional resources: 

We know how hard it is to keep up with the ever-changing requirements around the country. To help, we have created the following resources (available for free):

We hope you find all of these resources useful. More are coming.

And please note that we are grateful for all of the input we’ve received over the years, and welcome any suggestions for improvements that you may be willing to share.

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*A huge thank you to Erika Hahn for all of her extraordinary help in tracking and monitoring all of the bills around the country and helping me make sure that all of our resources are current and accurate. 

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[1] Some of the research (assuming you accept it, as the policymakers have) finds that noncompetes reduce spillovers of knowledge and technology, which is somehow touted as a bad outcome from the use of noncompetes. But that is precisely what noncompetes are designed to do — protect trade secrets. A rule banning noncompetes, thus runs directly contrary to the Congressional mandate reflected in the DTSA.