The legal landscape is shifting. In 2023, the Federal Trade Commission proposed a new rule which, if passed, will make non-competition agreements unlawful in employment contexts. Back in April 2023, Darkhorse partner Jacob East addressed the proposed regulation. Now, over a year later, the FTC will hold an Open Commission Meeting on April 23, 2024 to vote on the Non-Compete Clause Rule.
The FTC’s Proposed “Non-Compete Clause” Rule.
The FTC’s proposal would make it unlawful “for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non- compete clause; or, under certain circumstances, represent to a worker that the worker is subject to a non- compete clause.” 16 C.F.R. Part 910 (2023). Pursuant to Section 6(g) of the Federal Trade Commission Act, the FTC retains the authority “make rules and regulations” in order to carry out the Commission’s purposes under the Act. 15 U.S.C. § 46(g). The Non-Compete Clause Rule, if passed, would define non-compete agreements as unfair methods of competition subject to FTC regulation under Section 5 of the Act. See 15 U.S.C. § 45. According to the FTC, a non-compete clause is “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.” Notably, the proposed rule purports not to apply to other types of restrictive covenants that are not overly broad, such as non-disclosure agreements (NDAs) and client non-solicitation clauses.
The Effects of a Federal Ban on Non-Competes.
Many states, including Virginia, have long held that non-competes constitute disfavored restraints on trade, and the FTC’s proposal agrees, stating that non-competes restrict employee mobility within relevant markets. Though, it merits note that the Supreme Court has deemed any contractual provision, by its binding nature, a restraint on trade, and the determinative question regarding restrictive covenants is whether the provision would suppress fair competition in the market. See Chicago Bd. of Trade v. United States, 246 U.S. 231, 238 (1918). Accordingly, many states have banned non-competes as applied to low-wage workers and otherwise upheld non-competes that are narrow in scope and related to legitimate business purposes.
A categorical ban on non-competes under the FTC’s proposed rule, however, would raise new concerns. Practically, the new rule would take effect 60 days after the final rule publishes in the Federal Register. Businesses would be subject to a compliance date 180 days after the rule’s publication. If enacted the Non-Compete Clause Rule would not apply retroactively to businesses who, prior to the compliance date, entered a non-compete. Those businesses would only violate the rule once the compliance date passes and they have not amended the contracts.
If the rule is enacted, the Supremacy Clause of the Constitution would nullify any contradictory state laws upholding non-competes. However, constitutional challenges against the FTC are sure to be raised. The “Major Questions Doctrine” includes a presumption that regulatory agencies do not have the power to create law on vital political or economic questions absent clear and direct congressional authority to do so. Here, the Non-Compete Clause Rule is sure to receive a number of challenges based on this principle. In short, the legitimacy of the Non-Compete Clause Rule, even if passed, will likely be uncertain for years as litigation unfolds.
Practical and Economic Effects.
The economic principles underlying the FTC’s proposal are also not without complaint. An article by legal economics scholars in the Harvard Journal of Law & Public Policy Per Curiam, for example, notes that non-competes can actually promote market innovation and competition because employers feel safe to “provide more general training to employees to improve their productivity, protecting proprietary knowledge and thereby encouraging more investment in innovation, and providing employers with more effective tools to rein in employee shirking.” The FTC argues, however, that non-competes restrict competition and unfairly create imbalance in the vertical bargaining power between employees and employers.
Functionally, the rule would create significant issues for employers, especially small and highly specialized businesses where employees already retain significant bargaining power. For example, assume we have a small medical practice in Virginia, John Smith Dentistry, that is well known in a local, rural region. The dentistry then hires Jane Doe, a new dental school graduate, offering a $100,000 salary. Jane’s employment contract includes a provision that states “For a period of one year following the termination of this Agreement, Employee agrees not to provide dental or dental hygienic services which directly compete Employer’s services within a radius of fifteen (15) square miles of Employer’s principal address.” Under existing Virginia laws, this non-compete is likely enforceable and helps to protect the dentistry from client-poaching, disincentivizes Jane’s potential leaving, and encourages investment by the dentistry in Jane’s development. If the FTC’s rule passes, the clause would be unenforceable and Jane would be free to join the dentistry, build a book of clients under the well-known John Smith name, leave the business, and set up shop next door. Jane then can hold the business over a barrel until her demands are met or become so high that the business simply must eat their investment costs and suffer new competition. So, what can employers do to prevent poaching and fruitless personnel investments if non-competes become a thing of the past?
How Businesses Can Adapt to World Without Non-Competes.
As we stated in our 2023 analysis of the FTC’s proposal, the business world may not look much different without non-competes. Virginia, among many other states, already use statutory and case law that heavily scrutinize the effects of restrictive covenants like non-compete clauses. If the Non-Compete Clause Rule goes into effect, businesses are still generally permitted to use NDAs to protect confidential information and to use non-solicitation clauses to protect their clientele… so long as the clauses are not “so unusually broad in scope that they function as [non-competes].” The line of demarcation between other types of enforceable restrictive covenants and clauses that are functional equivalents of non-competes is unclear, and businesses should always consult an attorney when crafting employment contracts. However, the new rule will permit, to some degree, NDAs and non-solicitation clauses, and businesses will be able to reclaim some economic protections through these alternative means.
If the FTC votes to approve its Non-Compete Clause Rule, the action will certainly disrupt most businesses and the legal landscape. Employees will gain significant leverage, and, in industries where demand for employees is high and supply is low, businesses will likely have to eat increased retention costs as well. Businesses will be forced to rely on alternative methods of economic protectionism, and the already crucial NDA and non-solicitation clauses will also face greater scrutiny. If the rule passes, businesses should sprint to legal counsel for an assessment of their employment contracts and be prepared to amend their existing agreements to preserve protections over their clientele and resources.
If you need help drafting or assessing a non-compete, NDA, or non-solicitation agreement, contact Darkhorse Attorneys today to schedule a consultation.
The contents of this post do not constitute legal advice, and no client-attorney relationship is formed. The contents of this post are offered for educational purposes only. Every situation is unique. If you require legal assistance, submit an inquiry through our website or call our firm at 540-553-8149.
