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 court in Texas issued a preliminary injunction against the ban, holding it exceeds the FTC’s powers. But, so far, the court’s injunction applies only to parties in that case.

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

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.” But even if the ban is struck down, the national legal tide is running against noncompetes.

Here are eight 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.

2. The FTC might not back down even if courts invalidate the ban. 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. The law in some states also prohibits overbroad confidentiality and nonsolicitation agreements.

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 exploit 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.

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. 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 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 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. There are many tools an employer can deploy to protect trade secrets beyond using noncompetes and nonsolicitation agreements. While the list of tools 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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