How employers can prepare for a possible non-compete ban

Employee non-compete agreements have faced mounting scrutiny in recent years. Proponents say non-competes are indispensable for protecting trade secrets and other business interests. Critics say they hurt employee mobility and wage growth.

Now the federal government has stepped into the fray. On Jan. 5, the Federal Trade Commission proposed a new rule that would ban employee non-competes outright. A nationwide ban could take effect as early as September. Employers that rely on non-compete agreements should get ready now.

Trade secrets and non-competes

A non-compete forbids an employee from working for a competitor in a certain geographic area for a certain period after the employment ends. The idea is to keep the employee from using the employer’s own assets to compete against it.

Most notably, employers use non-compete agreements to protect trade secrets. Trade secrets — engineering plans, software, unreleased products, and customer lists, to take a few examples — can be among a company’s most treasured assets. Unfortunately, trade secrets can also be easy to steal. For example, a wayward employee may transfer company data to a flash drive in a matter of seconds.

Crucially, non-compete agreements are preventative. By prohibiting an employee from working for a competitor for a limited time, a non-compete can keep an employer’s trade secrets from winding up in a competitor’s hands in the first place.

By contrast, trade secret laws address misappropriation after the fact. These laws provide powerful remedies once a company discovers that its secrets were stolen. The problem is that the horse is out of the barn at that point. The damage is done and often cannot be reversed. And in some cases, the company is unable to prove in court who stole its information — but its business is damaged all the same.

Businesses also use non-competes to protect customer relationships, investment in training, and company goodwill. Employers across a range of industries regard non-compete agreements as a vital tool for protecting innovation and investment.

Non-competes in the crosshairs

The law treats non-compete agreements as “restraints of trade.” That is, they are restrictions on free market competition that demand close scrutiny. Nevertheless, with a few exceptions — California being the most notable — most U.S. jurisdictions have decided that non-competes are acceptable under certain conditions.

Reasonableness is key. While requirements vary, states that allow non-compete agreements generally require them to be reasonable in scope and to protect a legitimate business interest. However, abuse is rampant. Too often, companies use overreaching non-competes to harass departing employees and squelch competition.

A famous example is Jimmy John’s. A few years ago, the attorneys general of Illinois and New York challenged the sandwich chain for allegedly imposing an unreasonable non-compete on all employees, even sandwich makers. For these and other hourly workers, there seemed to be no trade secrets or other genuine business interests at stake. Jimmy Johns reached a settlement with both states in 2016.

Since that time, critics have grown louder and many states have tightened or overhauled their non-compete laws. In the past two years alone, around a dozen states have enacted new statutes, and several more have bills currently pending.

Non-competes are now in the federal government’s crosshairs. In 2021, President Biden issued an executive order calling on the Federal Trade Commission to rein in non-compete agreements. While some doubted the FTC would seek to impose a total ban, it is now doing exactly that. This January, the agency proposed an administrative rule that would prohibit all employee non-compete agreements, with only negligible exceptions. This sweeping rule would also nullify all existing employee non-competes and require employers to tell this to their employees.

The FTC is taking public comment until early March. After that, it will publish a final version of the rule. Enforcement of the rule begins 180 days later.

What businesses should do to get ready

In could be months or years before the ultimate outcome of the FTC’s proposed rule is known. It faces fierce opposition, and it may or may not be published in its present form. Once the rule is published, legal challenges are likely to follow. Courts could potentially strike down the rule or limit its reach. But that is far from certain.

In the meantime, employers must make sure that their trade secrets and other legitimate interests are protected. Here are five actions employers should consider:

Review standard non-compete agreements and update them as needed to conform to current state law and best practices. Notably, the FTC has already begun taking legal action against employers it alleges are using non-competes unfairly. It has done so even without the proposed rule in place.

Review and revise non-solicitation agreements as appropriate. The FTC has excluded customer non-solicits from its proposed rule. But non-solicits must be carefully drafted to avoid being construed as de facto non-competes.

Review nondisclosure and confidentiality agreements with employees and revise them as appropriate. The FTC has warned that an overly broad NDA may constitute a de facto non-compete and run afoul of the rule.

Step up other protective measures. For trade secrets, employers might enhance their security measures, for example. Keep squarely in mind that existing non-compete agreements could be nullified or severely curtailed.

Stay informed of new legal developments and adjust as needed. Even before the FTC stepped in, non-compete law required close monitoring due to the constant changes in law and variation among states. With the proposed rule and challenges on the horizon, timely information is more important than ever.

One thing seems certain: Disruption is coming. Employers that act proactively and stay informed will be in the best position to handle whatever changes may come.

Maxwell Goss is a litigation partner with Fishman Stewart. He handles trade secret and intellectual property matters in Michigan and around the country.