The FTC’s Ban on Noncompetes Might Die in Court

But the Legal Tide Still Runs Against Them

You’ve almost certainly heard that the Federal Trade Commission (“FTC”) issued a rule banning noncompetes. The rule is scheduled to take effect on September 4.

On July 3, a federal district court in Texas issued a preliminary injunction against the ban, holding it exceeds the FTC’s powers. But the court also held that its injunction applies only to parties in that case, so it didn’t stop the ban from coming into effect against anybody else. It might later issue a nationwide injunction against the ban.

A federal district court in Pennsylvania is also considering a challenge to the ban. The plaintiffs have requested a nationwide injunction against it, and the court promised to decide by July 23.

The clock is ticking down to September 4, and we don’t know if the ban will go into effect.

Courts are likely to strike down the FTC rule nationally on the basis that it does not have the power to write substantive rules regulating business but, instead, has the power only to punish individual businesses for violating section 5 of the FTC Act, which prohibits “unfair or deceptive acts or practices affecting commerce.” But even if the ban is struck down, the national legal tide is running against noncompetes.

Here are eight important things to know:

1. The FTC rule requires employers to notify employees who signed covered noncompetes by September 4 that they will become illegal starting that day.

Employers should consider preparing now to give notice in case the FTC ban is not struck down beforehand. Because the FTC ban will likely be struck down, there may be no consequence for employers failing to give notice.

2. The FTC might not back down even if courts invalidate the ban.

Undeterred, in the Texas case, the FTC signaled that if courts strike down its ban, it may use its FTC Act section 5 powers to attack noncompetes in individual cases.

Typically, the FTC acts only against major industry players, not small and medium-sized businesses. Still, it could act against smaller businesses in individual cases to set an example and intimidate.

3. The FTC ban isn’t limited to noncompetes with employees.

It also covers independent contractors, interns, externs, volunteers, apprentices, and others. The same is also generally true for state bans and limitations on noncompetes.

4. The FTC Rule also attacked overbroad confidentiality and nonsolicitation agreements.

It stated that if a confidentiality or nonsolicitation agreement is broad enough to be a de facto noncompete, it violates its ban. Thus, even if the FTC ban is struck down, it could also go after overly broad confidentiality and nonsolicitation agreements in individual cases. The law in some states also prohibits overbroad confidentiality and nonsolicitation agreements.

A nonsolicitation agreement can be written to address either or both of two situations: (i) soliciting current customers of a business to take their business elsewhere, such as to a new employer, and (ii) soliciting current employees to leave and accept employment with another employer.

5. Some states ban noncompetes, and others sharply limit them.

States that ban them entirely include California, Minnesota, North Dakota, and Oklahoma. These states usually permit giving a noncompete as part of the sale of a business.

Other states ban noncompetes for employees below a certain compensation level, such as Colorado, Illinois, Maine, Maryland, Massachusetts, Nevada, New Hampshire, Oregon, Rhode Island, Virginia, Washington, and Washington D.C. Virginia bans noncompetes for employees earning an average weekly wage of $1410 or less, which is $73,320 annually.

Some states impose significant administrative and notice requirements for using noncompetes, such as Colorado and Massachusetts.

6. Where they are legal, noncompetes must be narrowly tailored to a specific employee’s circumstances.

For example, in Virginia, a noncompete must be no more extensive than necessary in three aspects:

First, the noncompete cannot last longer than is necessary to protect the employer’s legitimate interests.

Second, the noncompete cannot be any geographically broader than necessary. If the business’s real competition is within a limited geographic area, the noncompete must be limited to that area.

Third, the noncompete must be restricted to preventing the employee from taking another job that would tap into the employee’s customer contacts or insider knowledge at the old employer. For example, if the employee worked as a software architect, a noncompete can’t ban that person from working as a CFO elsewhere.

In addition, in Virginia, courts may not rewrite noncompetes to make them legal. A court must either uphold or invalidate the noncompete.

7. Sometimes, employees looking to escape noncompetes leverage noncompete bans in other states to break them.

This often involves the defecting employee or new employer being the first to file a lawsuit seeking to void the noncompete and filing it in a state that bans them.

A good noncompete agreement should specify which state’s law applies and where disputes must be litigated. Yet, you can’t rely on courts applying such choice-of-law provisions. A court in a state that bans noncompetes might refuse to apply the choice of law provision because doing so would violate that court’s home-state public policy against noncompetes.

The legal machinations of how this could happen get into the weeds. The key takeaway is don’t presume a noncompete will stand just because the state where the employee lives or works permits them.

8. What should a business do in this legal environment that’s increasingly hostile to noncompetes and overly broad confidentiality and nonsolicitation provisions?

First, know that, beyond the FTC’s action, the tide in state legislatures is running against noncompetes. Some states that have not banned them are considering doing so, and others may further restrict them. Don’t rely on any noncompete remaining valid.

Second, a noncompete must be narrowly tailored by an experienced employment attorney to fit the specific circumstances of an individual employee. One-size-fits-all noncompetes are unlikely to be sufficiently tailored to pass legal scrutiny.

Third, these kinds of agreements (noncompete, nonsolicitation, confidentiality) aim to protect the employer's trade secrets. A trade secret is information that has value to the employer because the employer has kept it confidential. If such confidentiality is maintained, trade secrets might include business plans, research and development, customer information, and internal financials.

There are many tools an employer can deploy to protect trade secrets beyond using noncompetes and nonsolicitation agreements. While the list is long, it is critical to limit access to information to a need-to-know basis and to have laser-focused, well-drafted confidentiality agreements signed by those who have access to trade secrets.

Written on July 17, 2024

by John B. Farmer

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