FTC non-compete ban has broad impact, but faces multiple challenges

The FTC recently published its final rule prohibiting just about all non-compete agreements for all employees, with very limited exceptions.

So what does this rule do, how does it affect the government services business and will the rule survive legal challenges?

The rule is fairly straightforward in that it imposes a national ban against all non-compete agreements with workers (employees, consultants, even interns) regardless of the worker’s position, title or status and regardless of who hired the worker. The final rule takes effect 120 days from April 23 (around Aug. 25).

FTC estimates the rule covers at least 101 million workers having some sort of non-compete agreement or similar provision in other agreements. (How FTC found this number since these agreements go largely unpublished is a mystery).

In short, the ban would retroactively invalidate tens of millions of existing non-compete agreements. There are two limited exceptions to the new ban.

The first is for “senior executives” defined as workers “in a policy-making position” earning at least $151,164 annually. The rule defines policy making as covering the president, CEO or another officer (such as VPs, CFOs, etc.) or anyone having “policy making authority” meaning final authority to make policy decisions beyond providing advice or even influencing those decisions.

Think C Suite and 1-2 levels below. The term “policy” is not defined directly but it seems to cover almost any material decision made in the organization that affects its workers.

For senior executives meeting this standard, existing non-competes remain in force, but existing non-competes with other workers are not enforceable.

The second exception covers non-compete agreements executed as part of a transaction involving the sale of a business. The sale must be bona fide -- in plain English this means an actual sale involving independent parties. So forget about anything that might look like a sham deal just to evade the ban.

To avoid having to formally rescind existing non-compete agreements, the rule has a safe harbor provision allowing employers to only provide a “clear and conspicuous” notice to workers that such agreements are not valid. The rule even provides “model language” for this purpose.

But here’s the problem (among others): the rule broadly defines a non-compete clause as one that “penalizes” a departing worker for or “prevents” the worker from “seeking or accepting” employment elsewhere or operating a business in the U.S.

Potentially, that’s virtually boundless coverage. In the government services business, I’ve seen just about every variety of non-competes, from the most stringent one preventing the departing worker from working anywhere else (what I call the “off-the-street” clause) to a middle ground approach that restricts working on the same government programs or tasks or with the same government customers in competition or conflict with the former employer (some of which may be reasonable), to a much lighter version preventing the worker only from disclosing confidential information to new employer in order to compete with the former employer (what I call the “NDA-plus” clause), and a few in between.

Can all of these restrictions fall under the new FTC ban?

I would say arguably yes and even if arguably not with the less stringent restrictions, workers may still use the ban’s broad language to argue against clauses that don’t at all prevent other employment opportunities but do serve a company’s legitimate interests such as protecting the misappropriation of bid and proposal data, customer domain knowledge or other know-how to benefit another competitor looking to beat the incumbent on the follow-on contract.

Besides, these clauses are already subject to scrutiny under state laws which mostly require a case-by-case review of the restriction’s reasonableness. Conversely, the FTC rule is a straight ban.

For example, the off-the-street clause would very likely be invalid under the FTC ban but the same would apply under most state laws including the DC area (DC, VA, MD), and would certainly be invalid under the laws of California, North Dakota, Oklahoma and Minnesota which totally ban these clauses.

The FTC ban may very well cover the middle ground restriction if the worker shows or even argues persuasively that it prevents finding another job, especially with a worker’s limited experience with one or a few agency customers.

But the enforceability of that type or any type of non-compete clause under state laws not imposing a total ban may depend on a variety of factors. Even the NDA-plus restriction may be subject to the FTC ban because, after all the worker may argue, the NDA covers so much information that it may be impossible not to use some of it in a later job situation.

As stated, up to now these matters were decided at the state level, where courts have considered various circumstances to determine the enforceability of non-competes.

In Virginia, for example, non-competes with employees are enforceable if an employer can show that the restriction (1) is narrowly tailored to protect the employer’s legitimate business interest; (2) is not excessively severe or oppressive in restricting the employee’s ability to find another job or make an income; and (3) doesn’t violate a Virginia public policy.

In some cases, Virginia courts have validated non-competes meeting this test where the clause was narrow in scope and overall reasonable; in some cases not. Other states not imposing total or near-total bans have similar standards. Federal antitrust law also takes a similar approach used by, you guessed it, FTC in previously invalidating some non-competes.

Further, some states avoid outright bans but still restrict the scope of non-competes. For example, since July 2020, Virginia outlawed non-competes with “low wage employees” -- currently about $73,000 annually or about $1,400 per week. In any event, a determination of enforceability of these clauses, like with any contract, is -- as it should be -- on a case-by-case basis depending on the contractual terms and competing interests of the parties.

But that matters not here since FTC is imposing a near total ban on non-competes regardless of the employer’s legitimate business interest. And this ban would effectively supersede any inconsistent state law.

Also, the new rule is noticeable for what it doesn’t include as an exception. For example, in this and many other types of businesses, non-senior executives routinely have non-compete agreements as part of a severance package where the employee leaves the organization with a boat-load of money in exchange for not competing with the former employer for a time period usually commensurate with or even more than the pay that time covers.

Sometimes, it’s entirely reasonable to use this method as part of a golden parachute arrangement. But not under the new FTC ban.

Of course, the rule may be subject to additional White House scrutiny (fat chance since the president provoked this action in the first place by issuing an executive order) and GAO will set its hooks into it at some point, but that doesn’t matter because as of this writing at least three federal lawsuits have been filed challenging the ban, two in Texas (what a surprise) and one in Pennsylvania.

 More are likely to follow. Basically, the actions are looking to invalidate the rule because FTC doesn’t have the statutory authority to pass this type of ban and invalidate thousands of private non-compete agreements (which as I said in many cases may be invalid anyway under various state laws), with one of the plaintiffs likening FTC’s overreaching action as pulling “an elephant out of a mousehole.” The lawsuits also challenge the constitutionality of the ban.

I’m not always a fan of non-competes, especially the off-the-street kind, but some may indeed be warranted under the circumstances and critical to a company’s legitimate business interests (e.g., a really big severance payout or sale of a business interest). And in any event I’m attracted to the legal theories in these lawsuits.

First, the principal basis used by FTC in addressing private non-compete clauses is its statutory authority to regulate and restrict “unfair methods of competition” and that non-compete clauses are competitively unfair basically because they are coercive-type agreements that burden interstate commerce and negatively affect competitive conditions in labor markets.

But do they?

FTC claims these clauses demonstrably affect the opportunities of all workers and will materially reduce wages but provides no real support for this claim. In fact, in considering the rule, FTC admitted that the “effect of an individual worker's non-compete clause on competition in a particular labor market may be marginal or may be impossible to discern statistically.” So just out of the gate, it seems FTC doesn’t even have its facts straight.

Second, Congress, in passing the Federal Trade Commission Act, and specifically Section 5 cited by FTC, allows FTC to regulate and enforce actions that constitute “unfair or deceptive acts or practices in or affecting commerce,” but I seriously doubt that even comes close to covering the ability of FTC to ban all non-compete arrangements between private parties.

Federal agency actions are limited by what statutes issued by Congress actually authorize. I’d say the authority here seems slim at best. That poor elephant!

Whatever the outcome, the new ban, if it sticks, will cause unwanted litigation and, at the very least, unnecessary legal squabbles requiring even more lawyers than you already need in this heavily regulated business.

Stay safe.

James C. Fontana is the managing member of Fontana Law Group, PLLC. He can be reached at jfontana@fontanalawgroup.com. The firm’s website can be found at www.fontanalawgroup.com.