Another turning point, a fork stuck in the road

Time grabs you by the wrist, directs you where to go

So make the best of this test, and don’t ask why

It’s not a question, but a lesson learned in time

It’s something unpredictable

But in the end, it’s right…

            Good Riddance (Green Day)

I have a complicated relationship with my favorite Green Day song. Why is a song most often played as the backdrop to graduation videos hoping you “had the time of your life” called, “Good Riddance”?

I am similarly conflicted about the topic of covenants not to compete. Most non-compete disputes have this in common: they juxtapose legitimate business interests for employers against compelling equitable interests for former employees (and the businesses that desire their services). As a mediator, I have a front row seat to the reality that months or years of non-compete litigation generally benefits no one but the parties’ respective lawyers. I might not ever have to fully reconcile my internal struggle with non-competes, in light of the federal government’s attempt to silence the battle over their enforceability.

On April 23, 2024, the Federal Trade Commission (FTC) announced a rule (the “Rule”) that seeks to eliminate most post-employment covenants not to compete – a striking departure from over 200 years of state regulation of these covenants.

The Rule attempts to implement a priority articulated early in the Biden Administration and comes almost three years after President Biden signed an executive order directing the FTC to take action to curtail the use of non-compete clauses. The Rule already faces formidable legal hurdles and may be barred from ever going into effect; however, whether or not it becomes the law of the land, it signals an evolution in perceptions about covenants not to compete that has been percolating through state legislatures and courts for some time.

State Regulation of Post-Employment Restrictive Covenants

States have traditionally regulated the enforceability of post-employment restrictive covenants – a term that includes a myriad of different possible covenants, including covenants not to compete, covenants not to solicit the former employer’s customers and personnel, and covenants focused on protecting a former employer’s confidential business information.

On a state-by-state basis, the law governing these covenants vary wildly. Over the last several years, there has been legislation promoted in most states to limit or even eliminate covenants restricting post-employment competition. As of the writing of this article, only California, North Dakota, and Oklahoma have broad bans on covenants not to compete, but 30 states, plus Washington D.C., have modified their non-compete laws since 2011. (The Changing Landscape of Trade Secrets Laws and Noncompete Laws Around the Country.) These state statutes have implemented measures such as banning non-competes for hourly workers or workers under a certain wage threshold or limiting the maximum duration of a non-compete. We anticipate that more states will join this bandwagon on the heels of the federal efforts.

The FTC has recognized the myriad of conflicting state positions on covenants not to compete. Its response … “Hold my beer.”

 The FTC Rule

The FTC Rule is scheduled to go into effect on September 4, 2024. As drafted, it would eradicate most traditional covenants not to compete for all workers, at all pay levels, in all industries. The Rule defines “non-compete clause” as “a term or condition of employment that prohibits, penalizes, or “functions to prevent” a “worker” from “accepting work” or “operating a business” after the conclusion of the worker’s employment. Accordingly, the Rule would also bar covenants with a “buy-out” provision that would allow an employee to compete upon the payment of liquidated damages, or severance agreements conditioning severance pay on an employee’s adherence to a covenant not to compete. The Rule makes clear that the definition of “worker” extends to independent contractors, interns, and volunteers.

The Rule grandfathers a small percentage of existing covenants not to compete. For agreements already in place when the Rule goes into effect, non-competes will remain valid (assuming they are enforceable under the applicable state’s law) for “senior executives” earning more than $151,164 a year who are in a “policymaking” position. The Rule would void existing non-competes for any other employees, and employers would be required to provide notice to employees who were no longer bound by their existing covenants not to compete.

FTC Chair Lina Khan stated: “The FTC’s final rule to ban noncompetes [sic] will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.” The FTC estimates that the rule will impact 101.79 million domestic workers and produce an average increase in worker earnings of $524/year.

What Types of Restrictive Covenants are Not Impacted by the Rule?

• The Rule does not regulate non-disclosure/confidentiality agreements. However, it does indicate that an NDA so broad that it would preclude the employee from working in the same field could be viewed as a de facto non-compete prohibited by the rule.
• The Rule does not prohibit covenants not to solicit or hire the former employer’s personnel.
• The Rule does not preclude covenants not to solicit or work with a former employer’s customers/clients. However, if such a provision was so broad that it could be construed to “function to prevent” employment for the particular worker, it would be problematic.
• The Rule does not apply to business owners executing a non-compete in a sale of business context, franchisees in the context of a franchisor-franchisee relationship, or non-profits.
• The Rule does not preempt state laws that provide greater protection to employees.

Legal Challenges to the Rule

The Rule faces considerable legal hurdles, including a fast-moving lawsuit filed in the United States District Court for the Eastern District of Texas seeking to enjoin the implementation of the Rule on a nationwide basis. (Ryan, LLC v. Federal Trade Commission, Case No. 3:24-CV-00968 (N.D. Tex April 23, 2024). As of the publication of this article, the United States Chamber of Commerce’s parallel litigation has been stayed, and the Chamber has joined forces with Ryan Homes as an intervenor. (Chamber of Commerce of the United States of America et al. v. Federal Trade Commission and Linda Khan, Case 6:24-CV-00148 (S.D. Tex April 24, 2024).) The Ryan court is currently on track to issue its ruling by July 3 on the pending preliminary injunction motion to temporarily stay the Rule. Most legal scholars anticipate that the pending litigation will result in – at a minimum – a delay of the Rule’s implementation.

In the interim, employers nationwide are evaluating their existing restrictive covenant agreements to ensure that they would not be left unprotected if the Rule was implemented. This includes confirming that businesses with legitimate protectable interests have enforceable restrictive covenants in place with the appropriate employees that would survive the Rule’s implementation, such as covenants that protect their customer and employee relationships and confidential information in a manner enforceable under their state’s law.

It’s something unpredictable, and in the end it’s right?

 Whether or not the Rule survives, we are likely at a “turning point, a fork stuck in the road” with respect to post employment restrictive covenant jurisprudence. The increased federal scrutiny and the proliferation of statutes in other states restricting post-employment restrictive covenants could signal an impending end to, or at least a significant curtailment of, covenants not to compete as we know them. Whether your clients would view the demise of non-competes as a devastating blow to their ability to protect legitimate business interests or would bid non-competes Good Riddance, they will likely be waiting quite a while for final direction.