Proposed FTC Rule Limiting Non-Compete Clauses

The Federal Trade Commission (“FTC”) is proposing a set of rules which, if passed and deemed constitutional would severely limit the use of non-compete clauses between employers and their employees. The proposed rule would, among other things, provide that it is an unfair method of competition for an employer to enter or attempt to enter into a non-compete clause with a worker; to maintain with a worker a non-compete clause; or, under certain circumstances, to represent to a worker that the worker is subject to a non-compete clause.

An Overview of Restrictive Covenants and Their Current Enforceability

A non-compete clause is a contractual term between an employer and a worker that typically blocks the worker from working for a competing employer, or starting a competing business, within a certain geographical area and period after the workers employment ends. Currently, there is no federal legislation governing the use and enforcement of restrictive covenants. Rather, their enforceability depends on the application of state law.

All fifty states currently restrict and curtail their use to some degree. Three states – California, North Dakota, and Oklahoma — have adopted statutes rendering non-compete clauses void for nearly all workers. Among the remaining forty-seven states where non-compete clauses may be enforced under certain circumstances; eleven states and the District of Columbia have enacted statutes making non-compete clauses void or unenforceable – or have banned employers from entering non-compete clauses – based on the workers earnings or other similar factors. Additionally, most states limit non-competition clauses for certain professions.

In the states where restrictive covenants are legal, Courts employ a reasonableness inquiry when determining whether the provision is enforceable. Generally, courts first consider whether the restraint on the former employee is greater than needed to protect the employers legitimate interest. If the employer can demonstrate a legitimate interest, then the employer must show that the non-compete clause is narrowly tailored to achieve that purpose. In doing so, Courts consider whether the geographical and time scope provided for in the restrictive covenant is reasonable. Some states, like Pennsylvania require that the employer provide some for of consideration in exchange for the restrictive covenant.

Current state law in the states where restrictive covenants are enforceable requires a deeper analysis weighing the employers right to protect its investment in their business and employees versus the employees right and need to support themselves. In other words, restrictive covenants are not enforced haphazardly or without these important considerations.

In addition, some industries, like the securities industry have created an option-in industry agreement, called the Broker Protocol which limits the applicability of non-competition agreements. The Broker Protocol is a voluntary program where employers may opt into a series of rules which allows their employees to almost move from one firm freely to another firm, provided both the former and current employer are both members and the employee only take their clients names, addresses, phone numbers, email addresses and account title information. The purpose of the Broker Protocol is to minimize litigation between member firms.

The Proposed Federal Legislation.

The FTC has sought public comment on several sweeping changes which, if enacted and deemed constitutional would nearly eliminate the use and enforceability of restrictive covenants. The proposed rule would broadly define the term “non-compete clause”as a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with person, or operating a business, after the conclusion of the workers employment with the employer. Further, the proposed rule would require employers to rescind almost all existing non-compete clauses no later than the rules compliance date and tell their employees that they are no longer subject to the restrictive covenant. To facility compliance, the proposed rule would include model language to satisfy this notice provision and establish a safe harbor whereby employers inform their employees that they are no longer subject to the restrictive covenant. The proposed rule includes a limited exception permitting the use of a restrictive covenant if it is included in the buy-out of a member, partner, or shareholders interest if they owned at least 25% ownership interest in the business entity.

What’s Next?

At this point, the FTC is seeking public comment on the rule. It is possible that the FTC could find that the existing state laws already provide a “good” framework for both protecting an employers legitimate business interests along with the employees right to find new employment and not enact this proposed sweeping legislation.

Even if the FTC were to enact this legislation, it is unclear whether it could survive a constitutional test. The FTC’s purported power comes from Section 5 of the Federal Trade Commission Act. It is unclear whether the federal courts would broadly interpret the FTC’s power to supersede state laws on the subject.

Nevertheless, these developments are important. The Securities and Employment Lawyers at Stark & Stark are closely monitoring these developments.

Assuming the legislation is adopted and is deemed to be constitutional, employers should consider the use of narrowly tailored, non-disclosure, confidentiality and “garden leave” agreements to protect their legitimate business interests.