FTC Waging War on Non-Compete Restrictions in Employment
Topics: Non-Compete and Trade Secrets
The Federal Trade Commission (FTC) proposed new Federal regulations to ban non-compete clauses from employment agreements nationwide. The ban will include non-solicitation and other restrictions that are currently designed to deter employees from competing with an employer after the employment relationship concludes. While this has been the law in California (and a handful of other states to varying degrees), the FTC’s proposal will have an even broader reach than California law. The FTC is targeting any contractual term that has the effect of prohibiting a worker from seeking employment or operating a business after termination, including prohibiting employers from seeking to recoup their investment in training where an employee departs within a specified period of time.
Further, the FTC’s ban will expand well beyond traditional employment to impact relationships with independent contractors, externs, interns, volunteers and even sole proprietors providing service to a client. § 910.1(f).
The regulations identify two exceptions to the non-compete ban: (1) a franchisee in a franchisee-franchisor relationship, and (2) sale of all or substantially all of a business to preserve the goodwill of the business. §§ 910.1(f) & 910.3.
Rule of Reason
The franchisee-franchisor exception is consistent with the “rule of reason” exception to anti-trust restrictions recognized by the FTC in conjunction with prosecuting anti-poaching cases. In essence, a franchisor-franchisee agreement against poaching employees from other franchisees actually increases competition against other brands, and will not be presumed to decrease competition.
The goodwill exception, however, only applies if the person subject to the non-compete owned at least a 25 percent interest in the business at the time of entering into the non-compete. § 910.1(e). This standard appears to be well beyond the goodwill exception under California law. California courts hold that a company cannot create sham ownership in order to enforce a covenant not to compete. Bosley Medical Group v. Abramson, 161 Cal.App.3d 284 (1984). However, a non-compete with an employee is enforceable when the employee sold all of his equity (even though it was less than 3% of the total equity in the business) in order to allow the sale of a company to be completed. Because the acquisition could not have occurred without the sale of that stock, the Court concluded that the sale, in totality, was “substantial” and therefore the non-compete could be enforced. Vacco Industries v. Van Den Berg, 5 Cal.App.4th 34 (1992). The FTC’s proposed regulations appear to hold quantification over need which will result in fewer enforceable non-competes that are designed to preserve the goodwill of a business for the prospective purchaser.
Retroactivity, Notice and Scope
The FTC’s regulations will not simply ban non-competes in employment going forward, but will require employers to give individualized notice to employees that any existing non-competes are rescinded. §§ 910.2(b)(1) & (2). Moreover, the Regulation will supersede any state law or regulation that is inconsistent with the FTC’s regulations. However, states will be entitled to create greater worker protections in this area. § 910.4.
The FTC is not waiting for the regulations to take effect. Since the outset of 2023, it has prosecuted a handful of cases asserting that non-competes represent unfair competition. In March, the FTC reached a settlement against Anchor Glass which had entered into 1-year non-competes with over 300 of its employees against working for another company in the same or substantially similar line of work. The FTC’s complaint took the position that such agreements created anti-competitive barriers to entry into that market, reduced employee mobility and decreased wages and benefits, similar to allegations in the FTC’s no-poach cases. Anchor and the FTC reached a Consent Agreement that resolved the litigation but enjoined Anchor from entering into or attempting to enforce non-competes, deliver notices to many employees that non-competes were not going to be enforced, and to give notice to new hires that employment would not be subject to any non-compete as well as years of compliance reporting and access to books and records on five days’ notice.
Enforcement and Next Steps
While a private right of action does not, yet, appear to exist within the regulations, if enforced, such regulations will strip employers of the ability to enforce non-compete clauses and may give employees the power to claim that non-compete agreements constitute some type of actionable conduct such as a violation of public policy, a breach of the implied covenant of good faith and fair dealing or a predicate element to support a claim of unfair business practices. All employers should be mindful of the FTC’s proceedings and actions with respect to this proposed regulation.
The public comment period was extended to April 19, 2023. Once the comment period concludes, businesses should be prepared that the regulations will follow in due course. Should the FTC effectuate the current version of the regulation, it will go into effect 180 days after the regulation is published.
For several years, the FTC has advocated against and criminally prosecuted (thus, far without success) anti-poaching agreements among employers. Therefore, once the new regulations come to fruition, employers should expect rapid enforcement efforts by the FTC.
To protect a company’s trade secrets and other valuable confidential information, check with your favorite CDF attorney so that the business is not reliant on non-competes which will likely become extinct in the near future. Likewise, if the FTC or any other regulatory agency approaches your business give Dan M. Forman a call.