FTC’s Proposed Rule to Ban Noncompete Agreements – Initial Reactions
On January 5, 2023, the Federal Trade Commission (“FTC”) created a stir when it released a 218-page Notice of Proposed Rulemaking and a Proposed Rule that if implemented will prohibit the use of post-employment, noncompete provisions. The Proposed Rule extends to all workers, whether paid or not, and would require employers to rescind existing noncompete agreements within 180 days of publication of the Final Rule. The FTC estimates that approximately 30 million workers are bound by a post-employment noncompete provision.
Much has been said about the Proposed Rule, but these are several initial observations in advance of a webinar Gentry Locke will host in February 2023 to discuss in more detail these and other related issues:
- The Proposed Rule is simply “proposed” and is unlikely to be adopted without changes and will not become effective during calendar year 2023. The 60-day comment period now runs through March 20, and the FTC is then required to evaluate and respond to these comments, which will take time. Once the FTC issues a Final Rule later this year, companies will then have 180 days to challenge the new provision or comply. During this six (6) month period a broad range of legal challenges will be made to the FTC’s ability to issue a nationwide ban on this agreement, e.g., the U.S. Chamber of Commerce has already announced that it is “blatantly unlawful.” In short, there is no reason to panic.
- Setting aside the FTC’s Proposed Rule for a moment, businesses with employees working in Virginia must be mindful of and comply with Virginia Code § 40.1-28.7:8, a state law that already limits the ability to use noncompete agreements. Since July 1, 2020, Virginia has prohibited all employers from entering into or attempting to enforce noncompete provisions with “low-wage” employees, and also requires employers to post a copy of the statute or a notice summarizing its provisions in the workplace. Virginia’s law has real consequences now, and defines a “covenant not to compete” to include any agreement that restricts an employee from providing a service to a customer or client of their former employer, if the employee was not the one who initiated the contact with or solicited the client or customer. The statute’s definition of “low-wage employee” is a moving target. “Low Wage” means average weekly earnings during the twelve (12) month period before termination are less than the average weekly wage for Virginia as determined annually. In other words, the standard used for who is a “low-wage” employee will change and likely increase every year. The statute provides for civil penalties for violations from Virginia’s Labor Commissioner, as well as a civil action by the employee where the court has jurisdiction to not only void the covenant, but to order all other appropriate relief, including an award of lost compensation, damages, liquidated damages, litigation costs and reasonable attorney’s fees. Likewise, an employer’s failure to post a copy of this statute (or a summary approved by the Department of Labor) will also subject an employer to civil penalties.
- In light of the Proposed Rule, it does makes sense to review and create an inventory of all existing agreements (and templates) your company uses and identify those that involve a post-employment “noncompete clause” regardless of the context. The FTC’s Proposed Rule defines a “noncompete clause” to be “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 conclusion of the worker’s employment with the employer.” On its face this definition is somewhat limited in that it only applies to post-employment restrictions in contracts between employers and workers; however, the Proposed Rule goes on to say that a functional test will be used to determine whether a contractual term is a “de facto non-compete clause because it has the effect of a “noncompete clause.’”
The Proposed Rule includes two examples of a de facto noncompete clause that will be prohibited: (i) an overbroad non-disclosure/confidentiality agreement that prevents the worker from working in the same field after separation, and (ii) a provision that requires a worker to repay training costs if termination occurs before expiration of a fixed period, and required payment is deemed to unreasonable related to the costs for the training. Since some form of the FTC’s Proposed Rule will be adopted, even if it’s later invalidated, it makes sense to prepare now, especially since you may already have a Virginia statutory obligation to meet.
- The FTC’s Proposed Rule states that its ban does not apply to a contract that restricts competition entered into between two (2) companies, and the Proposed Rule contains an express exception for a noncompete agreement made by a person selling a business entity or otherwise disposing of all or substantially all of an ownership interest in a business or substantially all of the business’ assets. However, under the FTC’s Proposed Rule is if the buyer wants a restrictive covenant with the seller’s key executives and/or with minority shareholders there is a problem. The current version of the FTC’s proposed ban on noncompete provisions contains no carve out for senior executives, and the shareholder exception will only apply to those deemed to be a “substantial” owner, member or partner in the business at the time the person enters into the noncompete clause. The FTC’s definition of who is considered to have “substantial” ownership interest is someone who holds “at least a 25% ownership interest in a business entity.”
This aspect of the Proposed Rule is particularly problematic and would be a marked departure from long-standing legal precedent. In many, if not all, mergers and acquisitions one of key provisions to making the deal happen is to ensure that former executives of the acquired business as well as prior owners do not compete against the business post-closing. Absent the ability to prevent competition from key members of management post-closing, the value of transaction is likely to be greatly diminished, assuming there is a deal at all. Likewise, it is common in many privately held businesses that a number of people, e.g., key executives, directors, etc., to have stock ownership in a company that falls well below the 25% threshold. In Virginia, noncompete provisions that are tied to the sale of a business are generally enforceable and are viewed much more liberally than employee restrictions. This part of the Proposed Rule is particularly troublesome and warrants comments to be sent to FTC from businesses and business associations.
- Nondisclosure and confidentiality agreements, which are used to protect trade secrets and other confidential business information, will, in most cases, be outside the scope of the FTC’s Proposed Rule and are not governed by Virginia’s noncompete statute. The FTC observed that research suggests that between 33% and 57% of US workers are parties to at least one NDA. The FTC highlighted California’s “alternative” approach, where noncompete provisions have been banned, but companies are still able to protect their trade secrets and competitive advantage through the enforcement of confidentiality agreements. The FTC also noted that 47 states, including Virginia, have adopted a version of the Uniform Trade Secrets Act and in 2016 Congress enacted a comprehensive trade secrets law to provide robust protection of confidential information that qualifies as a “secret” and provide access to federal courts to prevent and remedy criminal and civil misappropriations.
The Proposed Rule is an important word of caution to all companies to review their non-disclosure and confidentiality agreements (templates) and policies to make sure they actually protect the company’s trade secrets and other information that is critical to the business’ operations. There are a number of issues to be evaluated:
- Make sure that the business is actually limiting access to confidential information and trade secrets to the right people, and that there are appropriate nondisclosure agreements in place with third parties, as needed.
- If the company makes use of one or more share drives, evaluate what steps are being taken or may need to be implemented to regulate which employees have access to the information on those drives, such as, financial and R&D projects.
- Determine if the company needs to revisit its policy to allow employees to use personal devices for business purposes, and if so, what additional steps or protocols, if any, may need to be taken to reclaim confidential information from personal devices.
- Identify situations at work where key information is accessed or downloaded and make sure the company knows where all of the information is actually stored in the cloud, on flash drives, etc., and determine if there are additional protective measures that can or need to be taken.
- Make sure your agreements provide the remedies that the company will want in the event of a breach and consider including as a remedy a court-ordered injunction to prevent working for a competitor when the employee has violated the agreement or misappropriated a trade secret.
- Keep in mind the FTC’s Proposed Rule currently will apply retroactively to all severance agreements entered into where an executive has been paid a significant severance, as well as an agreement to redeem stock options and stock grants given to employees upon termination, if those agreements contain a noncompete clause. As a result, those noncompete provisions would become invalidated unless the Proposed Rule is changed to prevent retroactive application and/or to exclude those types of agreements. If you anticipate in 2023 needing a severance agreement with a high paid executive, consider using a garden leave provision opposed to simply relying on a traditional noncompete that might have a liquidated damage provision in it if there is a violation. These situations will require careful consideration of the options at the time.
- All businesses and members of the public should submit comments and concerns to the FTC through March 10. Consider how the proposed rule might impact your business or industry and consider organizing with others in your industry or lobbying organization to submit public comments objecting to the FTC’s jurisdiction or right to issue such a nationwide ban, the FTC’s proposal to make the ban retroactive, the “de facto” functional approach to defining the noncompete provision, and the inclusion of certain agreements that should not be banned: (i) sale of business; (ii) agreements with owners (shareholders, members or partners), even if the person is also an employee; (iii) senior executives – top 5 employees in the organization; (iv) key employees who are paid above a specific dollar amount, i.e. $150,000 (v) severance agreements; (vi) ownership redemption agreements even if the owner is also a “worker”; (vii) confidentiality and NDA agreement; (viii) agreements that prevent the worker from providing services to a company’s customer post-termination if it is a customer was one the worker serviced during employment; and (ix) an agreement to pay damages if the employee is provided or is reimbursed for specialized training within a reasonable period of time.
For more information, please feel free to contact any member of our Labor & Employment team, and plan to sign up for the webinar we are planning in February 2023.
 Some industries and companies are exempt from FTC jurisdiction, i.e., certain banks, savings and loan institutions, federal credit unions, common carriers, air carriers, and persons subject to the Packers and Stockyard Act of 1921, and those entities that are not “organized to carry on business for its own profit or that of its members.” 15 U.S.C. §44. Additionally, certain private entities covered by the state action doctrine may claim to be exempt. Goldfarb v. Va. State Bar, 421 U.S. 773791-92 (1975)
 Unlike the FTC’s Proposed Rule, Virginia law does not invalidate noncompete agreements entered into before July 1, 2020.
 The Virginia statue, like the FTC’s Proposed Rule, allows employers to continue to use a non-solicitation provision that is designed to prevent a former employee actively soliciting customer in an effort to disrupt or divert existing business. There have been no reported cases involving this part of the Va. statute as most existing litigation over traditional nonsolicitation agreements also prohibit a former employee from providing services to the customer (regardless of who initiates contact/solicitation) were entered into prior to July 1, 2020.
 The Virginia statute provides an exclusion for a low-wage employee whose earnings are “wholly or predominately derived” from sales commissions or bonuses, but this would apply under the FTC’s Proposed Rule and the federal rule would supersede this provision of state law.
 The statute, however, does apply to interns, students and trainees, regardless of whether they are being paid, and also extends to an individual who is treated as an independent contractor, if that person is compensated at an hourly rate that is less than the median hourly wage for the Commonwealth for all occupations as published annually by the U.S. Department of Labor.
 For 2022, the “low-wage” amount was $1,290/week or $67,080 a year with a separate threshold for independent contractors. The 2023 figure has not yet been released by the Va. Dept of Labor and Industry (VDOLI). A copy of the summary notice with the 2022 wages provided by VDOLI is attached. Employers are encouraged to update this posting annually, so the notice has the most current “low-wage” calculation.
 Keep in mind that severance agreements negotiated at the time of termination that contain post-employment noncompete clause will be covered by this definition, unless a change is made. However, the FTC has indicated that the Proposed Rule would not apply to concurrent employment restraints, i.e., restrictions on what the worker may do while employed.
 FTC NPRM, Non-Compete Rule, Subchapter J, 16 CFR § 910.1, Definitions, pp.211-12 (Jan. 5, 2023) (“FTC NPRM”)
 The term “worker” is broadly defined to be anyone who works for an employer, regardless of whether s/he is paid or not and includes those classified as independent contractors and sole proprietors who provides services to a client or customer.
 For example, the FTC notes that state courts generally treat restrictions that require an employee to pay damages if they compete as the functional equivalent to a prohibition. FTC NPRM, p. 107.
 It is not just Virginia that has passed laws restricting the use of or prohibiting noncompete provision. In the past decade, 28 states plus the District of Columbia have changed their noncompete laws and enforcing a noncompete has become increasing difficult.
 Since no “worker” is involved, the Proposed Rule does not apply. However, the FTC also made it clear that the use of such agreements, including anti-poaching agreements, will continue to be subject to federal anti-trust law and all other applicable law. FTC NPRM, pp.107, 128-131.
 FTC NPRM, §910.3, p. 215.
 The FTC made it clear that the Proposed Rule is a categorical ban on all noncompete clauses with any worker but has invited comment on whether there should be a carve out for “high wage” earners or “senior executives.” FTC NPRM, pp. 150-152.
 FTC NPRM, §910.1(e), p, 212,
 Enforcement of Restrictive Covenants in Business Sale (Aug. 20, 2015) https://www.gentrylocke.com/article/enforcement-of-restrictive-covenants-in-business-sales/
 The FTC noted that non-disclosure agreements (NDA) can contain post-employment restrictions can be enforceable unless they are overbroad and found to be a de facto noncompete provision. FTC NPRM, p. 10-11
 There are two (2) other states, like California have banned the use of employment noncompete provisions for close to 100 years, North Dakota and Oklahoma.
 The FTC noted that in 2021 alone, 1,382 trade secret lawsuits were filed in federal court. This federal law is the Defend Trade Secrets Act of 2016, 18 USC §§1836, et seq. The criminal statute often used to prosecute the misappropriation of trade secrets where a foreign entity is involved is the Economic Espionage Act of 1996. 18 USC §§1831 – 1832.
 Garden leave is a transition period for employees who have been given notice of termination which keeps them on the payroll, but away from the workplace. During such leave the employee is prohibited from working for the competition or for themselves. Garden leave can be an effective, but it also carries with it legal risks which will need to be reviewed with the company’s attorney.