The FTC's Proposed Ban on Non-Compete Agreements: The Effect on Trade Secret Protection
Many employers in Massachusetts use non-competes to protect their intellectual property. Non-compete agreements may be overly broad for that narrow purpose but their virtue is that it is much easier to detect their violation than it is to detect the violation of non-disclosure agreements and non-solicitation agreements.
The breach of a non-disclosure agreement is sometimes difficult to prove since violations may take the form of oral conversations or other forms of communication that are difficult to detect or discover. Theft of a trade secret can be also difficult to prove, especially if the secret involves a manufacturing process or software code that is not obvious upon an inspection of a finished product. Businesses contend that non-compete agreements give them greater confidence in training their employees without the fear of losing the confidentiality of their intellectual property.
The proposed FTC rule
On January 5, 2023, the Federal Trade Commission (FTC) proposed a new rule that would ban employers from entering into non-competition agreements with their employees or even enforcing existing non-compete agreements. This rule would require employers to rescind existing non-competes and to actively inform workers that the existing non-competes are no longer in effect. The proposed rule does not affect non-disclosure or non-solicit agreements, which employers would still be free to use.
The purpose of this rule is to increase career opportunities for workers in the United States. The FTC estimates that 1 in 5 workers in the United States, or about 30 million employees, have signed non-compete clauses and that eliminating these non-competes would increase employee wages by nearly $300 billion per year.
The FTC’s proposes to definite a “non-compete clause” as “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 the conclusion of the worker’s employment with the employer.”
Whether or not an agreement between a worker and their employer is a non-compete does not depend on what the agreement is called, rather it depends on the function of that agreement. For example, “clawback” provisions, which require employees to forfeit stock or accrued financial benefits if they go work for the employer’s competitor, may be interpreted as creating “functional non-competes” that would be illegal under the regulation.
California, North Dakota and Oklahoma currently have strict bans on non-compete clauses between employers and employees. All three of these states still allow for non-competes between buyers and sellers of businesses. The FTC rule would allow for non-competes to be used in the same circumstances as long as the person selling is an owner of at least 25% of the business. The threshold would allow workers who hold a small amount of company stock to sell their stock in the context of a larger transaction without being exposed to the possibility of a being burdened by a non-compete.
The FTC lacks jurisdiction over banks, savings and loan institutions, federal credit unions, common carriers, air carriers, and meatpackers. These industries would be unaffected by the proposed FTC rule.
How does the FTC rule compare to the Massachusetts’ rules on non-competes?
Massachusetts adopted a statute governing non-competes in October 2018. (Other Massachusetts laws bans non-competes in certain professions, including physicians, nurses, psychologists, social workers, employees in the broadcast industry, or lawyers.) The 2018 statute forbids non-competes with employees who are classified as nonexempt under the Fair Labor Standards Act; full-time students who take internships with employers; employees who have been terminated without cause or laid off; and employees age 18 or younger. In other circumstances, however, non-competition agreements may be enforceable in Massachusetts. Unlike the FTC rule, the Massachusetts law did not apply retroactively.
The Massachusetts law states that non-compete agreements signed after the effective date of the legislation must have a "garden leave" provision or other mutually-agreed consideration for the non-compete. Garden leave means that the employee will be paid 50% their base salary for the length of the non-compete period. Non-compete agreements may not have a duration of longer than one year, and will only be enforceable if they protect a legitimate business interest such as the trade secrets and confidential information.
In summary, the FTC rule is a nearly blanket ban on non-compete agreements, while the Massachusetts statute is more nuanced.
Potential legal challenges to the FTC rule
The FTC rule is based upon an interpretation of the FTC Act which concludes that the FTC has authority to promulgate rules prohibiting “unfair or deceptive acts or practices” and “unfair methods of competition.” This interpretation was upheld 50 years ago by the D.C. Circuit Court of Appeals in National Petroleum Refiners Ass'n v. F.T.C.
Recent Supreme Court opinions have questioned regulatory agencies that purport to have broad grants of power. Such grants of power may invoke the “major questions” doctrine and the non-delegations doctrine.
The major questions doctrine states that Congress, not administrative agencies, are the more appropriate bodies to resolve major questions. This doctrine gained traction in 2022 in West Virginia v. EPA, a case involving the Clean Power Plan, a rule that was adopted in 2016 under authority that the agency believed to have been granted to it under the 1970 Clean Air Act. That Act generally authorized the EPA to establish pollution standard for new power plants. The Clean Power Plan purported to impose requirements for shifting energy production from coal to cleaner energy sources.
In West Virginia v. EPA, the Supreme Court ruled that Congress did not (and could not) grant the EPA the authority to regulate emissions from existing plants and to require a shift to cleaner energy sources without more specific guidance from Congress. The Court held that Congress cannot grant administrative agencies authority to fill in the gaps of legislation that implicate major economic or political questions. Similarly, the FTC rule banning non-competes may be challenged by arguing that Congress could not have intended to grant the power of such a major question to the FTC through a generally worded statute giving the agency the power to regulate unfair trade practices and methods of competition.
The non-delegation doctrine is based on the principle that that one branch of the federal government should not be able to pass its work off or delegate its authority to other branches of government. The purpose for this doctrine is to maintain clear separation of powers. The Supreme Court last considered the non-delegation doctrine in 2019, when, in a 5-3 decision, it upheld the power of the Attorney General to adopt rules regarding a sex offender registry.
The Court has shifted towards the right since 2019, and may be eager to strengthen the non-delegation doctrine. When it comes to the FTC, the Court may be willing to conclude that Congress sloughed off its legislative obligations by granting an administrative agency broad powers over the economy by regulating what it perceives to be unfair methods of competition. In order to placate opponents of the current regulation and lessen the chance of having its jurisdiction curtailed by the Supreme Court, the FTC may choose to make the final regulation less radical.
Potential modifications to the FTC rule
An obvious alternative is to make the FTC rule prospective rather than retroactive. That’s the approach that the Massachusetts Legislature took in writing its law on non-competes. This might placate concerns of those who are wary of overreach by administrative agencies.
Another possible alternative would be to ban non-competes for most employees but to allow their use for highly compensated and/or high level employees. Here again, the Massachusetts statute could provide an example. In addition, non-competes might be allowed with respect to employees who have exposure to an employer’s significant intellectual property.
Employers should place new emphasis on non-disclosure and non-solicitation agreements. Non-competition agreements that are valid today might be unenforceable in the future if the FTC rule is adopted in its current form.
This is especially true given the growing sentiment that non-competition agreements do more harm than good, sentiment that may evolve into restrictive legislation. For example, a bipartisan group of U.S. Senators has reintroduced a bill called the “Workforce Mobility Act of 2023” that would largely ban the use of employer non-compete agreements nationwide as a matter of federal law. Such legislation would not be vulnerable to attack under the major questions or non-delegation doctrines. As far as those doctrines go, it would merely be Congress doing the work and exercising the authority that it should.
The comment period for this proposed rule has been extended to April 19, 2023. The FTC has received over 374,000 comments so far. While there is no telling whether or when the final rule will be passed, employers should keep a watch out for any revisions or publication as a final rule once the comment period ends in April. There is no need to panic yet, but employers should place more emphasis on non-solicit clauses, non-disclosure agreements and the Defend Trade Secrets Act in protecting their trade secrets.
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The FTC's Proposed Ban on Non-Compete Agreements: The Effect on Trade Secret Protection