In a seismic move, the Federal Trade Commission (FTC) sent shockwaves through the business community with its January 2023 announcement of a proposed rule that, if adopted, would dramatically reshape the landscape of non-compete agreements nationwide. The FTC proposal to ban non-compete agreements nationwide marks a significant departure from the current realm of restrictive covenants in most states, including New Jersey.
According to the U.S. Government Accountability Office, nearly 20% of U.S. workers find themselves bound by non-compete clauses. In fact, an overwhelming 98% of private employers require executives and managers to sign such agreements. However, the looming possibility of change is palpable. The FTC’s proposed rule, now expected to be issued in April 2024, has the potential to render non-compete agreements illegal and unenforceable.
At its core, the rule seeks to establish a uniform federal standard, altering the drafting, usage, and practice of non-compete agreements across different states. The FTC’s expansive definition of a “non-compete clause” encompasses any contractual term that hinders workers from seeking or accepting employment elsewhere after their current employment. Notably, the proposed rule prevents not only the formation of new non-compete agreements; it also requires employers to rescind existing ones.
While there is a limited exception for non-compete provisions in business sales, the overarching goal of the FTC’s proposal is to establish a cohesive national standard that supersedes conflicting state laws or interpretations. If enacted, every employer currently using non-compete agreements would be significantly affected.
A crucial aspect of the proposed rule is its functionality test, which disregards labels and focuses on whether a contractual provision functions as a de facto non-compete. Employers are strongly urged to review existing agreements, considering the expansive definition of “worker” under the proposed rule (the rule defines “worker” broadly to include employees, independent contractors, interns, externs, volunteers, apprentices, and sole proprietors).
What Should Employers Do to Prepare for the FTC Proposal to Ban Non-Compete Agreements?
For employers seeking to safeguard their business interests, a thorough reassessment of current non-competition, non-solicitation, and non-disclosure agreements is imperative. Even in the face of a potential non-compete ban, employers can pivot by incorporating stringent confidentiality clauses into employment agreements. It is important to take proactive steps, such as surveying employees who are currently bound by restrictive agreements. Staying well-informed about the rule’s development and potential implications is equally crucial, prompting employers to engage legal counsel in navigating these rapidly developing matters.
The FTC’s definition of a “non-compete clause” is remarkably broad. It encompasses any contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with another entity or operating a business after their employment with the employer.
Crucially, the proposed rule’s reach extends beyond explicit non-compete clauses. It also covers any other contractual terms that “have the effect of prohibiting the worker from seeking or accepting employment with another person or operating a business after the conclusion of the worker’s current employment.” This sweeping and somewhat vague language might affect various restrictive covenants, including customer non-solicitation agreements and broadly drafted non-disclosure agreements.
The proposed rule adopts a functional approach; labeling does not matter, and workarounds will not be effective. The FTC’s non-compete definition is functional and prohibits agreement terms that have the “effect” of restricting work for a competitor following the termination of employment (e.g., broadly drafted non-disclosure or non-solicit provisions).
For example, a non-disclosure provision that prohibits the use or disclosure of confidential information may be acceptable. However, issues could arise if the definition of “confidential information” within the provision is overly broad, functioning as a de facto non-compete.
The potential implications of the proposed rule are vast, as it not only prevents the formation of new non-compete agreements but also requires employers to rescind existing ones within six months (180 days) after the FTC issues the final version of the rule.
Employers must provide notice of the rescission to current and former workers within 45 days after rescission.
With former workers, employers are required to send notices only to those individuals for whom readily available contact information exists.
When Will the New Rule Take Effect?
As stated above, the new rule is currently set to be issued in April of this year. The rule would become effective 60 days after being published in the Federal Register. Then the 180 period for employers to rescind existing non-competes begins.
However, several business trade groups, such as the U. S. Chamber of Commerce, may sue the FTC, seeking an injunction, delaying the effective date of the new rule. They will argue that the FTC is exceeding its authority in issuing a nationwide ban on non-competes.
Consequently, although the FTC intends to publish the new rule in April, it is difficult to say when it will become effective.
What Should Employers Do?
Considering these potential changes, employers should take proactive steps to assess and review any existing non-competition, non-solicitation, and non-disclosure agreements to find out their compliance with the proposed rule. Even if non-compete agreements face a ban, employers can still incorporate stringent confidentiality clauses into employment agreements to protect legitimate business interests.
Employers should strengthen their confidentiality and trade secrets agreements to conform with the new rule if it passes.
Furthermore, conducting an internal census to account for current and former employees subject to restrictive covenant agreements is essential.
Schiller, Pittenger & Galvin. P.C., Attorneys Can Help Employers Affected by the FTC Proposal to Ban Non-Compete Agreements
Given the likely legal challenges to the FTC’s proposed ban on non-compete agreements, it is unclear when and in what form the FTC’s final rule will become effective. Nevertheless, if the federal government does not ban non-competes, New Jersey may join the half-dozen states that have done so (the Assembly has passed a bill restricting non-competes but the bill has not yet passed the full Legislature).
We will keep track of the FTC proposal as we approach April and the expected issuance of the final rule. We will advise our business client base if and when the new rule becomes effective.
Consequently, businesses that extensively use non-competes should have experienced New Jersey employment and commercial lawyers review their non-compete agreements (as well as any other restrictive covenants they use) to see if they comport with the expected new FTC rule.
For guidance, please call us at our Scotch Plains office at 908 490 0444. You can also email us here.