The landscape surrounding restrictive covenant agreements (i.e., non-competes, non-solicits and even non-disclosure or confidentiality agreements) is experiencing a whirlwind of changes and developments on both the federal and state level. To stay ahead of the storm, it is imperative that companies reevaluate their employment agreements now, before more stringent rules and regulations come into effect.
The Federal Trade Commission’s Proposed Rule and Recent Enforcement Actions
Earlier this year, the Federal Trade Commission (FTC) proposed a new rule that would result in a sweeping ban on non-compete agreements nationwide. (Members of our firm, along with dozens of other trade secrets lawyers around the country, submitted comments raising numerous concerns about the proposed rule.) Although a formal vote on the proposed rule is not expected until April 2024, its potential impact cannot be ignored. If implemented, the proposed rule would prohibit employers from imposing non-compete agreements on their employees and would further require employers rescind all existing non-compete agreements. Employers would additionally have affirmative obligations to notify their workers that the previously executed non-compete agreements have been rescinded.
Moreover, while other kinds of employment agreements, such as non-disclosure and non-solicitation agreements, are not explicitly prohibited under the proposed rule, the rule takes a strict stance against overbroad provisions that have “the effect of prohibiting the worker seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer.” Such provisions are treated as “de facto” non-compete clauses and also banned under the proposed rule.
The scope of the FTC’s proposal cannot be overstated. If passed, the rule would invalidate any agreement, including those already in place, that limit a former employee’s ability to work for a certain employer or engage in a similar type of business post-employment, with very narrow exceptions. And the ban would apply categorically to all United States workers and employers, regardless of salary or job function.
Not waiting for the rule change, earlier this year, the FTC also took unprecedent legal action against four (4) companies after finding the companies had illegal non-compete agreements with their employees. In each case, the FTC held that the companies’ non-compete agreements constituted an unfair method of competition under Section 5 of the FTC Act. According to the agency’s orders, the challenged non-compete restrictions illegally prevented former employees from obtaining higher wage jobs and impeded other businesses’ ability to engage in fair competition. The FTC further emphasized that the companies’ legitimate interests could have been protected through significantly “less restrictive means”, such as confidentiality agreements that prohibited disclosure of any confidential information.
Accordingly, in light of these FTC enforcement actions and the potential for a draconian rule being put into place, it is imperative that all employers reevaluate the language and scope of their employment agreements now. By taking proactive measures, employers will be better equipped to withstand FTC scrutiny both now, and in the future should these regulatory changes become implemented. Employers should pay particular attention to any agreements which could potentially qualify as a “de facto” non-compete, which would be unenforceable under the proposed rule. Additionally, employers should work with counsel and consider alternative ways to protect their legitimate business interests, such as trade secrets, that would comply with the FTC’s proposal.
The National Labor Relations Board
In addition to the FTC’s proposed rule and enforcement actions, another regulatory body, the National Labor Relations Board (NLRB) also recently took an aggressive stance against non-compete agreements. On May 30, 2023, NLRB’s General Counsel, Jennifer Abruzzo, issued a memo outlining her position that non-compete agreements violate Sections 7 and 8 of the National Labor Relations Act (NLRA) and create a chilling effect which hinders the NLRA’s objectives.
Sections 7 and 8 of the NLRA are most often associated with union organizing. Under Section 7 employees are guaranteed “the right to self-organization, to form, join or assist labor organizations, to bargain collectively through representatives of their own choosing, and to engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection.” Section 8 makes it an unfair labor practice for employers to interfere with these rights.
Specifically, according to Abruzzo, non-compete agreements deter employees from freely exercising their rights under Section 7 out of fear that they will not be able to find alternative employment under the terms of their non-compete should they be discharged. Alternatively, Abruzzo opines that employees could find the exercise of their Section 7 rights “futile… given their lack of access to other employment opportunities.”
While Abruzzo recognizes that some non-compete provisions may not necessarily violate the NLRA, she cautions that they must be “narrowly tailored to special circumstances justifying the infringement on employee rights.” And, like the FTC’s enforcement orders, Abruzzo’s memo emphasizes that employers can typically protect their legitimate business interests through other means, such as confidentiality and trade secret agreements.
Abruzzo’s memo does not have the effect of law and the NLRB itself has not ruled on the general counsel’s position. Nevertheless, employers should consider Abruzzo’s position as an indication of potential legal challenges to come, further underscoring the need to closely review restrictive covenant agreements now.
In addition to changes at the federal level, employers must also remain vigilant of the rapidly evolving state landscape. Currently, noncompetition provisions are currently banned in Washington, D.C., California, North Dakota and Oklahoma. Next month, Minnesota will join those jurisdictions with its law banning noncompete agreements set to go into effect July 1, 2023. And on June 20, 2023, the New York State Assembly voted in favor of a bill banning non-compete agreements that was passed by the New York Senate earlier in the month.
Minnesota’s new law banning non-compete agreements has limited exceptions. Under the soon-to-be law, omnibus bill SF3025, employment agreements that restrict when and where a former employee can work, or the type of work a former employee can engage in, post-employment will be unenforceable in Minnesota. Unlike the FTC proposed rule, Minnesota’s law is not retroactive, meaning already existing noncompete agreements will remain valid in the state for now. Additionally, SF 3025 does not prohibit “reasonable” non-competes in the sale of a business and allows for post-employment confidentiality and non-solicitation agreements. Despite these exceptions, the law broadly bans companies from using forum selection and/or choice of law provisions in most employment agreements. In other words, employers that employ Minnesota residents cannot simply “avoid” Minnesota’s ban on non-compete agreements by stipulating that the laws of another state will govern the agreement. Critically, the ban on foreign choice of law and forum selection applies to all types of employment agreements, not just those containing non-compete provisions.
The New York bill, A01278, would likewise bans non-compete agreements with limited exceptions. The bill is now on the desk of New York Governor, Kathy Hochul, who is expected to sign it into law. If so, non-compete agreements entered into or modified 30 days after the bill’s effective date would be invalid. Notably, like in Minnesota, the New York bill does not prohibit confidentiality and non-solicitation agreements. However, unlike the Minnesota law, New York’s bill does not include a carve-out exception for non-competes in the sale of business context.
These developments reflect a dramatic shift the states’ employment landscape and significantly impacts companies with Minnesota, and likely New York, employees. However, employers everywhere should prepare for the possibility that other jurisdictions will enact similar laws in the future.
Accordingly, it is imperative that employers who utilize restrictive covenant agreements actively monitor state-level developments in any jurisdictions in which they operate (or have employees) to ensure their employment agreements are in compliance with current, and future, noncompete laws.
In light of the FTC’s proposed rule and enforcement actions, the NLRB’s recent memo, and the evolving state laws, employers must proactively review and analyze their current employment agreements before more stringent rules and regulations come into effect. The urgency is real, and the potential risks are too significant to ignore. Given the complexities of the current legal landscape it is strongly encouraged that companies work closely with legal counsel to review existing agreements and to remain current on the rapidly shifting legal developments in this area.