In late 2022, the Federal Trade Commission (FTC) proposed a new ban on the noncompete clause. As a patent lawyer with over 20 years of helping startups establish the IP foundation, I face questions from many startups that have only a few people and each of whom has deep knowledge about company plans and resources. If some of the early-stage employees jump ship and use that knowledge without restriction, the FTC’s ban may add risks for startups and investors. This article addresses strategies to reduce risks arising from the FTC’s potential ban on non-compete clauses.
What is a non-compete clause?
A non-compete clause in an agreement is a legally binding contract between an employer and an employee in which the employee agrees not to work for a competitor of the employer for a certain period of time after leaving the company. These agreements are used to protect the employer’s trade secrets and confidential information, as well as to prevent employees from using their knowledge and skills gained at the company to compete against it. Non-compete agreements are typically enforced by courts and are subject to certain legal limitations.
Most startup attorneys view that noncompete agreements are necessary to protect trade secrets, which can include confidential information such as customer data as well as intellectual property such as technical formulas and processes. However, a few states such as California have banned non-competes, and that policy has not held back startups from success.
California has a strong public policy against non-compete agreements, and as a result, they are generally unenforceable in the state. Under California law, an employer cannot prevent an employee from working for a competitor or starting their own business, and any provision in an employment contract that purports to do so is void and unenforceable.
However, California employers can still protect their trade secrets and confidential information by using non-disclosure agreements and non-solicitation agreements. Non-disclosure agreements prohibit employees from disclosing the employer’s trade secrets or confidential information, and non-solicitation agreements prohibit employees from soliciting the employer’s customers or other employees for a certain period of time after leaving the company.
If an employer wants to protect their business in California, they should focus on using legal tools such as these and also consider implementing an intellectual property strategy and other compliance measures.
Also, it’s worth noting that some courts in California have found that non-competes are enforceable in some cases, such as when the employee had access to trade secrets, or when the employee is a high-level executive. So, it’s always best to consult a lawyer before including non-competes in an employment agreement.
why is the FTC looking at a national non-compete Ban?
The FTC views noncompete clauses as “an unfair method of competition” and a violation of a section of the Federal Trade Commission Act. FTC Chair Lina Khan said, “The freedom to change jobs is core to economic liberty and to a competitive, thriving economy. Noncompetes block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand.
The Federal Trade Commission claims that noncompetes are unfair methods of competition. In other words, they are depriving a worker of a competitive advantage, such as access to trade secrets or confidential information. These agreements also reduce competition in the labor market.
However, many commentators doubt that the FTC has the authority to issue such a rule. It lacks clear congressional authorization to do so. That said, the rule will certainly spark legal challenges. Some states may decide to enact their own non-compete laws. Others may be accommodating. Ultimately, the FTC will decide whether to issue the final rule.
The FTC released a fact sheet that explains the new rule. It provides a brief background on noncompetes, including a discussion of the potential impacts of the rule. Also, it gives a brief look at how a company can comply with the proposed rule.
Although the FTC has no formal legislative authority to ban noncompetes, it is leveraging its rule-making authority to attempt to do so. For example, the agency has cited Section 5 of the FTC Act, which grants it “the authority to regulate ‘unfair methods of competition’, which includes ‘noncompetes’.”
As the FTC moves forward with its proposed non-compete ban, it will seek public comment on its efforts. Companies can submit comments individually or in consortiums. Those that choose to do so will likely see a delay in the rule’s implementation.
While the FTC has been relatively aggressive in its attempts to ban noncompetes, there is no guarantee that its efforts will yield results. There will undoubtedly be a large amount of resistance during the comment period.
Employers could be scrutinized by the U.S. Supreme Court
The US Supreme Court recently ruled on a class of one-employment cases. In this decision, the Supreme Court sided with businesses and snubbed the public sector in the process.
Generally speaking, the public and private sectors are not equal when it comes to employee protection. Moreover, public employees are often afforded a bevy of different benefits and protections. This is especially true of workers who are part of the federal government. As such, a class of one theory of equal protection would have been impermissible. However, the Enquist decision effectively ended this theory.
One of the key questions in this debate was whether the class of one theory should be applied to all aspects of employment, including the judicial or regulatory. Many amici curiae briefs advanced the notion that the doctrine should be confined to the realm of doctrine.
While there may have been an ambiguous ruling in this case, there is a strong inclination that the court was attempting to do something more substantial. That is, the court was trying to determine whether or not a class of one theory of equal protection can be applied to a decision to hire, fire, or suspend an employee.
While the jury may not have been able to acquit the defendants, the court ruled that the “class of one” theory of equal protection does not apply to the public sector. Therefore, a rational basis review of the most exemplary public employment decision would likely have been unwarranted. A prudent government should be able to show a reasonable basis for a decision to make.
While this particular decision was a resounding “no,” it was certainly not the only time the Supreme Court threw in the horns to the public sector. Indeed, several federal circuits have concluded that a rational basis review of all government actions is a good idea.
Impact on wages and working conditions
The Federal Trade Commission (FTC) recently announced plans to ban noncompete clauses in worker contracts. If passed, the rule would supersede most state laws regulating the use of these clauses and would ban them on a national basis. This could lead to better working conditions for 30 million Americans, and raise wages by $300 billion each year.
Noncompete agreements have become an increasingly common form of employment contract, preventing workers from switching to a new job or starting a new business. They are used across a wide range of industries and job levels, including in white-collar, high-paying fields.
These restrictions impede innovation, degrade wages, and prevent workers from pursuing better opportunities. Some economists believe that they also contribute to stagnating wages. While noncompetes can still be challenged in private antitrust litigation, the FTC’s proposed rule would prevent employers from enforcing them.
In its Notice of Proposed Rulemaking, the FTC sought public comment on its plan. The rulemaking process could take up to a year. After receiving comments, the FTC will study them and make changes to the rules. It will then issue a final rule in about 180 days.
The rule would be applied to all workers and all employment contracts, including independent contractors. It would require employers to provide written notice to current and former employees when a non-compete is not enforceable.
The rule would also ban training repayments if they are not related to the cost of the employer’s employee training. Those repayments, which are currently common, could be deemed invalid by the rule’s “functional” test.
The FTC argues that these agreements are harmful to competition and consumer interests. They are often overly broad and intimidate workers.
Potential consequences for employers
If you’re an employer, you should pay close attention to the FTC’s new ban on noncompete clauses. It could have a major impact on your business.
A recent study by the Economic Policy Institute found that between a quarter and half of all workers are subject to such agreements. They prevent millions of people from moving up in their careers or taking a better job.
Noncompete agreements are also subject to challenge under state antitrust laws. The FTC has recently taken action against two companies based on their use of such agreements. Those companies were glass container manufacturers and a security guard company in Michigan.
As the FTC continues to take steps to reinvigorate Section 5 of the FTC Act, its new proposal to ban noncompetes is an indication that the agency is taking a more active role in protecting the public from unfair competition.
The proposed rule would impose a nationwide ban on noncompetes. It would apply to virtually all employees, including interns and independent contractors. The rule would not apply to agreements between employers and non-disclosing parties.
It is important to remember that the proposed rule is still in the early stages of the rulemaking process. Legal challenges and protracted litigation could delay the implementation of the final rule.
Nonetheless, this proposal represents a dramatic departure from precedent. Historically, the FTC has not regulated agreements between employers and workers. But the agency is now examining these contracts in detail.
In addition to prohibiting the use of noncompetes, the rule would also require employers to actively inform workers about their agreements. Employers would be required to rescind any existing contracts within 180 days of the final rule.
State law Alternatives to Non-compete clauses
Employers also have other options to protect information than non-compete agreements. These include nondisclosure agreements and trade secret laws, non-solicitation agreements that prohibit employees from poaching customers or employees from their previous firm, and nondisclosure agreements. However, once the employee moves to another company, they’re on the honor system as there is no way to know what information is being shared or not.
In more detail, potential alternatives to non-compete clauses that employers can use to protect their business interests include:
- Non-disclosure agreements (NDAs): NDAs prohibit employees from disclosing the employer’s trade secrets or confidential information. They can be used to protect sensitive information such as customer lists, business plans, and product development strategies.
- Non-solicitation agreements: These agreements prohibit employees from soliciting the employer’s customers or other employees for a certain period of time after leaving the company. This can help prevent an employee from using their knowledge of the employer’s customer base to compete against the company.
- Non-piracy agreements: These agreements prohibit employees from recruiting other employees from their former employer for a certain period of time after leaving the company.
- Trade Secret protection: Employers can also protect their business by implementing strict trade secret protection measures, such as limiting access to sensitive information and requiring employees to sign confidentiality agreements.
- Confidentiality agreements: These agreements prohibit employees from sharing any confidential information from the company with anyone outside of the company.
- Employee Invention Assignment Agreements: These agreements require employees to assign any inventions created during their employment to the company.
- Patents: Patents protect the company’s proprietary technology and can protect the company when former employees re-use such technology in their new work.
- Copyrights: Copyrights protect the company’s manuals and work such as business plans and can protect the company when former employees re-use such work in their new work.
It’s worth noting that each state has its own laws regarding non-competes and alternatives, so it’s always best to consult a lawyer before implementing any agreements or policies.
Federal Alternatives to non-compete clauses
To protect against the non-compete ban in a way that does not personally target an employee the way the non-compete clause does, you can consider patent protection and copyrights as federal-level alternatives to non-compete clauses that employers can use to protect their business interests.
- Patent protection: Employers can use patent protection to prevent competitors from making, using, or selling an invention for a certain period of time. This can be used to protect new products or processes developed by the company.
- Copyrights: Employers can use copyrights to prevent others from reproducing, distributing, or displaying original works of authorship, such as software, literature, music, or art, created by the company.
Both patents and copyrights are forms of Intellectual Property (IP) protection and can provide a strong legal defense against competitors who attempt to use or replicate the employer’s proprietary products or services. However, it’s worth noting that obtaining a patent or copyright can be a costly and time-consuming process, and it may not always be the best option for every business. Additionally, it’s important to consult with an IP lawyer to ensure that you get the best alternative.
Non-Legal ways to address the FTC Ban
Lawyers and businesses are now beginning to evaluate what the Federal Trade Commission’s proposal to ban noncompete clauses from employment contracts could mean for worker mobility and wages, and how future compensation agreements will be structured.
A partial or full ban on hiring could increase the pool of candidates, but it would also weaken an instrument that employers rely upon to retain talent, protect trade secrets, and protect other proprietary information, say lawyers. Many companies will likely turn to a variety of other mechanisms to prevent employees from leaving or taking valuable information, such as nondisclosure agreements or employment contracts that reward long-term loyalty.
According to the WSJ, The limitations on the clauses will force employers to be more creative in how they retain talent. Employers can use everything from career advancement and compensation to keep employees engaged and loyal. To encourage people to stay, some companies offer deferred compensation, such as rolling stock options or retention bonuses that vest after four years.