Non Compete Bans: What's the Real Story?
Front page new stories are heralding the death of non competition agreements. But what’s the real story? Politics, party lines, agency authority and judicial precedent … non competes have a nuanced and complicated history in the United States, and the legal issues underlying the debate are evolving quickly on local, state and federal fronts. What is certain, however, is that if you are an employer with intentions of requiring employees to sign a non compete, you should pause, consider the state of the law, understand benefits and risks, and proceed with caution.
1. The Federal Landscape.
There have been a number of updates since we last wrote about the patchwork of state and federal laws governing non-compete agreements. Before delving into recent state developments, let’s first look at what is going on at the federal level.
The Federal Trade Commission (FTC) Bans Non Competes
We reported last year that as part of its mission to stamp out “unfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce,” in January 2023 the FTC proposed a rule that would ban post-employment non-compete agreements with most employees and independent contractors, regardless of their compensation level. Originally, the only exceptions allowing for non-competes would be when the noncompete was entered into in the context of an employer acquiring a business in which the contracting individual had an ownership interest.
On April 23, 2024, the FTC voted to issue this rule, generally banning non-competes (the “Final Rule”). The Final Rule contains one significant change from the proposed rule: the Final Rule provides a carve-out for already existing non-competes against senior executives, defined as employees who are both in a “policy-making position” and earn more than $151,164 per year. “Policy-making” authority is defined as “final authority to make policy decisions that control significant aspects of a business entity and does not include authority limited to advising or exerting influence over such policy decisions.” Notably, the Final Rule will (once it takes effect) still ban new non-competes against senior executives, just as it does against all other workers. As of now, the Final Rule is set to take effect on August 21, 2024.
An additional requirement of the Final Rule provides that within 45 days of the Final Rule taking effect, employers must notify current or former employees with whom the employer maintains unlawful non-compete provisions that the non-compete provision is unenforceable. The Final Rule contains model language that employers may follow in drafting these notices.
The FTC clarified that while non-solicitation agreements and other restrictive covenants are generally not considered non-competes, they may qualify as a non-compete if they “function to prevent a worker from seeking or accepting other work or starting a business after their employment ends.”
The FTC also clarified that the Final Rule would not apply to “concurrent-employment restraints,” meaning that it would not prohibit an employer from restricting an employee’s ability to work for others during their term of employment with the employer. This also indicates that certain “garden leave” agreements may be permitted, such as those which keep an employee on the payroll for a period of time after they have completed work for the employer, in exchange for the employee not working for a competitor during that period of time.
The National Labor Relations Board (NLRB) General Counsel Opines that Non Competes Violate Worker Rights
As we reported last year, the NLRB General Counsel has opined that most non-compete agreements, as well as most non-solicitation of employee agreements, violate non-supervisory employees’ labor rights. Although this opinion does not constitute the current state of the law, the General Counsel has filed several complaints against employers for attempting to enforce agreements against former employees regarding obligations to not compete, not solicit customers, or not poach (or “raid”) employees. In addition to seeking a nullification of non-compete agreements, the General Counsel has also sought certain compensatory damages on behalf of such former employees. Although it remains to be seen whether the NLRB will adopt the General Counsel’s position, such a decision against non-competes would be in line with other pro-employee decisions the NLRB has taken in recent years.
Court Challenges to FTC Final Rule and/or NLRB GC Opinion?
The FTC vote was 3-2, along predictable party lines. Among other things, both Republican Commissioners indicated they believed the Final Rule would be struck down for any one of a number of reasons. The Chamber of Commerce immediately issued a statement which read in part: “The Chamber will sue the FTC to block this unnecessary and unlawful rule and put other agencies on notice that such overreach will not go unchecked.”
Currently, U.S. Supreme Court precedent under Chevron v. Natural Resources Defense Council holds that courts should defer to a federal agency’s interpretation of a statute that the agency is tasked with enforcing when the statute is reasonably open to interpretation. However, many legal scholars expect that the Chevron doctrine will come to an end this term—likely before July 2024. The expectation thereafter is that courts will only defer to an agency’s interpretation of a statute to the extent that it is persuasive. This would give courts much more latitude to overrule an agency’s action. Given the current makeup of the Supreme Court, it would not be surprising if courts eventually overrule the FTC’s and/or the NLRB’s actions against non-competes.
In the meantime, however, until such time as Federal courts rule against them, agencies will maintain the authority to file charges or complaints against employers. Even if such actions are ultimately overturned (and that is certainly no guarantee), the legal battle itself is something that employers may wish to avoid. Therefore employers should make nuanced decisions (preferably with the aid of legal counsel) about the risk vs. benefit of implementing, maintaining, or enforcing a noncompete agreements with employees.
2. The State and Local Landscape.
On July 1, 2023, Minnesota joined California, North Dakota, and Oklahoma in banning nearly all non-competes within their borders, though each state contains an exception allowing for non-competes entered into in connection with the sale of a business. Notably, California required employers to inform employees by Valentine’s Day 2024 that previously entered into non-compete agreements were void.
So far in 2024, at least four jurisdictions only allow non-competes against employees earning over certain six-figure salaries: Colorado ($123,750), the District of Columbia ($154,200), Oregon ($113,250), and Washington ($120,559.99). Be aware that higher thresholds may exist for particular types of employees or independent contractors. Additionally, these four jurisdictions, as well as Illinois, Maine, Massachusetts, and New Hampshire, require that the employee be provided a particular amount and type of advance notice regarding the non-compete agreement.
Generally, if an employee lives or works in California, Colorado, Massachusetts, Minnesota, or Washington, their employer cannot sidestep those states’ laws simply by including a different choice of law provision in the non-compete agreement. Although it is to some extent unclear whether the other jurisdictions mentioned above would respect a non-compete agreement’s choice of law or venue provisions, in most cases an employer should be wary of even attempting to sidestep such laws. In part, this is because some jurisdictions not only make certain non-compete agreements unenforceable, but also potentially penalize employers who proffer, enter into, or attempt to enforce unlawful non-compete agreements. At a minimum, for their choice of law provision, employers should select a jurisdiction with which they have significant ties, if it is not simply where the employee works or lives.
Several state legislatures and courts have further held that continued employment alone is insufficient consideration to uphold a non-compete entered into with an existing employee. The level of additional consideration required can vary greatly state to state: in 1992 a court opined that $1,000 by itself was likely insufficient consideration in Pennsylvania, whereas in Texas the additional consideration can come in the form of simply providing the employee with confidential information or trade secrets.
Another jurisdiction to keep an eye on is New York City. After the Governor vetoed a bill in December 2023 that would have banned virtually all non-competes state-wide, several non-compete ban bills were introduced in February 2024 in the New York City Council. One of these bills would ban virtually all non-competes city-wide (and require employers to rescind previously entered-into non-compete agreements), while others would either ban them for low-wage workers or for “freelance workers.” As of the publishing of this post, it is unclear which, if any, of these bills might pass.
Notably, while many of these jurisdictions’ statutes explicitly exclude non-solicitation provisions as being a type of non-compete provision, California and Colorado courts have interpreted non-solicitation of customers provisions as being a type of non-compete provision. And unlike the final FTC rule or potential NLRB efforts banning non-competes, there is no reason to think that these state and city non-compete bans might be overturned by the courts.
3. What’s Next?
Employers should be aware that where non-competes are permissible, virtually every jurisdiction requires that they be narrowly tailored to protect a legitimate business interest. Therefore, one size will not fit all. For example, while an employer’s desire to safeguard its trade secrets or goodwill with clients is often considered a legitimate interest, wanting to pressure employees into remaining employed is generally considered an illegitimate interest. Non-competes also generally must be reasonable in terms of their duration, geographic scope, and/or the scope of the restricted activity. For example, many states will find it unreasonable if the non-compete applies for more than one-year post-separation or if it would prevent the employee from holding a passive stock interest in a competitor.
Finally, when a non-compete is found to be unreasonably broad, the resolution can again differ greatly from state to state. Although many states allow their courts to simply modify the agreement to the extent necessary to make it enforceable (at least if the agreement allows for such modifications), some states will only allow their courts to modify the agreement to the extent that it can be done solely via deletions, while others will simply declare the non-compete unenforceable if it is even slightly overbroad.
For all these reasons, employers should always seek legal counsel when considering asking an applicant or employee to sign a non-compete agreement, especially if the employee in question lives or works in a jurisdiction in which the employer has not previously received legal advice. And even when an employer has previously received advice about the laws governing non-competes in a particular jurisdiction, they would still be well advised to periodically check for or ask for updates within that jurisdiction.