What is a Non-Compete Agreement?

            Non-Compete Agreements, or Covenant Not to Compete, are legal agreements that prevent an employee or an ex-employee from seeking employment that competes with the past or current employer either during or following the termination of the past employment. They are often accompanied by additional agreements prohibiting the solicitation of customers or clients,  as well as agreements prohibiting the disclosure of business secrets to other future employers. They are very common in employment, contracting, and consulting contracts. Not only do they limit who a worker may work for, but they also often prohibit them from starting their own competing business. Non-compete agreements are generally limited to a certain distance and time. 

The validity of these agreements varies based on jurisdiction and reasonableness. Often, jurisdictions either refuse to enforce non-compete agreements entirely or impose very restrictive standards on those they do accept. This is because they limit where, when, and in what market an individual can work. These restrictions on employment are undesirable for workers. 

At the same time, non-compete agreements often protect the legitimate business interests of the employer, especially when the employer has spent significant resources training the employee. Employees have access to confidential and proprietary information, and intellectual property relating to the company, the use of which during work with a competing entity may cause an unfair business advantage to the competitor. 

 

New Proposed Rule 

            Due to the impact of non-compete agreements on workers and the development of new businesses and novel innovation, the Federal Trade Commission (FTC) has proposed a new rule that would prevent the imposition of non-compete clauses on workers. According to the FTC, around 30 million people are currently bound by non-compete clauses in the United States. The FCT recognizes that non-competes prevent workers from pursuing employment opportunities with higher pay and better conditions and prevent employers from being able to hire more qualified candidates who are bound by them. The FTC has not clarified who are the workers that may be covered by this rule. The question arises, will senior executives, contractual workers, part-time employees, or any other similar employees/workers be covered under this rule. That clarification is required in order to ascertain the full implications of the rule. 

The goal of the FTC’s new rule is to do away with the serious anticompetitive harm caused by non-competes to labor, products, and service markets. They reference Section 5 of the Federal Trade Commission Act, which states that “unfair methods of competition” are unlawful and that Section 5 tasks the FTC with preventing the use of unfair methods of competition that may affect commerce. The new rule proposed by the FTC would classify non-compete clauses as unfair methods of competition, making it a violation of Section 5. This rule would be applied to all clauses, making it a violation to not only use non-compete clauses in the future but also to maintain a currently in-place clause. Current non-compete agreements would need to be voided.

The Federal Trade Commission has determined that non-competes are, “unfair methods of competition,” which prevent workers from pursuing employment opportunities with higher pay and better conditions. The new rules proposed would make it a violation to use non-compete clauses in the future as well as invalidate any agreements currently in place. 

However, the proposed rules will only affect non-compete clauses and will have no effect on Non-Disclosure Agreements (NDAs) and Non-Solicitation Agreements, since these agreements do not create restrictions on the free movement of workers. Does the fundamental right to trade and the profession of workers have supremacy over the right of an organization to protect confidential and proprietary information? 

The rules are set to take effect within 60 days after they are finally published by the FTC, sometime after March 2023.

For business owners who invest heavily in their employee’s training, the end of the non-compete seems like a Catch-22: either you don’t give your employees the training they need, or they learn all your skills and then steal your clients. It also limits the freedom of the business owners to confide in workers/employees with confidential information, and trade secrets, thereby creating an embargo on the business owners’ rights. When assessing the legality of challenged non-compete agreements, state and federal courts (and English courts before them) have examined the duration and scope of non-compete clauses, as well as the asserted business justifications, to determine whether non-compete clauses are unreasonable and therefore unenforceable.

 

How Will the New Rule Work? 

            The proposed rule defines a “non-compete clause” specifically as “a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.” It also clarifies that the definition will be based on how one would determine if a clause is a non-compete rather than on what the clause is named. It will define an “employer” as “a person that hires or contracts with a worker to work for that person,” and a “worker” as a natural person who works, whether paid or unpaid, for an employer.” The proposed Rule would also expand upon that to show that workers include those classified as “independent contractors, externs, interns, volunteers, apprentices, or sole proprietors.”

As stated above, the Rule would prohibit the use of non-compete clauses in employment contracts moving forward and require that employers revoke priorly contracted non-compete clauses following the implementation of the Rule. As of now, the intent is that the Rule would take effect 60 days after publication in the Federal Register and compliance would be required within 180 days of publication.

 

How Will This Affect You?

            If this rule passes as proposed, healthcare practices like all other employers will no longer be permitted to use non-compete clauses in their employment contracts, regardless of the form those contracts take. It is intended to increase competition in labor markets by allowing employees to move between jobs more freely. The FTC estimates that the proposed Rule will increase workers’ earnings by $250-$296 billion annually. There would be an increase in business competition and market prices may fall. They also estimate that the cost of compliance and contract updating will result in a total of $1.02 to $1.77 billion nationwide in one-time costs but that firm investments needed for worker training and capital assets will fall.

While these changes will enable employees to move between companies or start their own companies that are in direct competition with past employers, it also has its benefits. Allowing workers this freedom broadens the pool of market employees and fills it with workers with more experience and skills that your business can benefit from. Additionally, while the compliance numbers seem high, it is important to remember that those numbers are for all businesses nationwide, not your business individually. 

To demonstrate the costs associated with direct compliance, the FTC used the median wage for an HR specialist which was $29.95 per hour. It estimates that  the cost of compliance for that employee would be one-third of their hourly rate. Therefore, $29.95/3 = $9.98 per specialist. Overall, not an exorbitantly high cost per employee. While costs would be a concern to smaller businesses, it is likely that the smaller the business the lower compliance costs will be, as few contracts and regulations will need to be adapted. As for the costs of updated contracts, the FTC cannot make exact estimates as they would be based on attorney rates for edits but it would be a simple matter to remove non-compete clauses and send documents out for signing. Depending on the number of employees this transition should take no more than a few hours, less even with fewer employees.

 

How You Can Have an Impact

            This proposed rule is currently in its comment period. During this time frame, the public is permitted to submit inputs before the agency makes a final decision on a proposed rule. Comments made during this period will be considered by the FTC when developing the final rule. It is important to know that this system is not a ballot-style voting system on whether or not you approve of the rule. Comments with sound reasoning and conclusions on the subject will be given more consideration than one that simply says that they don’t like the rule. The comment period for this proposed rule was posted on 01/09/23 and comments are due by 03/12/23. The comment form may be found by following this link: https://www.regulations.gov/docket/FTC-2023-0007/document

 

Will Other Restrictive Covenants Still Be Enforceable?

            Beyond non-compete clauses, there are other restrictive covenants that limit what a worker can and cannot do following the termination of their employment. These include, but are not limited to: non-disclosure agreements (NDAs); non-solicitation agreements; no-business agreements; liquidated damages agreements; and training-repayment agreements (TRAs). 

The FTC explains that generally, the alterations made by this proposed rule will only affect non-compete clauses and will have no effect on NDAs, non-solicitation agreements, or TRAs. NDAs and client or customer non-solicitation agreements will not be affected because they create no restrictions on the free movement of workers. These types of restrictive covenants do not prevent the seeking of work or acceptance of alternative positions. 

However, these agreements are sometimes written so broadly that they can function as non-competes despite not being called such. This situation is why, as stated above, the FTC specifies that non-competes will be defined by their function rather than what they are labeled as. The FTC does clarify that in such situations where these restrictive covenants are so broad that they function as non-compete clauses, they will fall under the definition of non-compete expressed in the proposal and, as such, would be labeled as unlawful and unenforceable.

*This blog post is for informational purposes only and does not constitute legal, financial, or medical advice, or the forging of an attorney-client relationship. Please retain the services of an attorney licensed in your state to receive counseling on the ways the law applies to your business.