What is a “noncompete”?

The rule defines “non-compete clause” as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (A) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (B) operating a business in the United States after the conclusion of the employment that includes the terms or condition.” It further defines “term or condition of employment” as including but not limited to “a contractual term or workplace policy, whether written or oral.”  Notably, non-solicitation of an employer’s clients or employees is not explicitly included in the definition of “non-compete clause.”

Employers should pay particular attention to the phrase “functions to prevent” in the above definition. As used here, it means that any term or condition that is so broad or onerous as to effectively (although maybe not explicitly) prohibit or penalize a worker from accepting other work or starting a new business after the conclusion of their employment will be considered a non-compete clause. A term that “functions” in such a way will be unenforceable against the worker. Per the comments to the rule, this scenario may arise if a non-disclosure or non-solicitation provision is so broad that it functions as a noncompete. Accordingly, it will be important for employers to review all of their existing employment agreements with post-employment restrictions.

When does the rule go into effect and what must an employer do?

The rule goes into effect 120 days after it is published in the Federal Register.

By the effective date, employers are required to notify workers that it is an unfair method of competition to enforce or attempt to enforce a non-compete clause, and that by the effective date the worker’s non-compete clause will not be, and cannot be, legally enforced against them. The notice must identify the person who entered into the non-compete clause with the worker. The notice can be delivered to the worker in one of four ways: (1) on paper delivered by hand to the worker; (2) by mail at the worker’s last known personal street address;  (3) by email at an email address belonging to the worker, including the worker’s current work email address or last known personal email address; or, (4) by text message at a mobile telephone number belonging to the worker. The notice must be clear and conspicuous. The FTC also states that mass communication, such as a mass email to current and former workers, is appropriate.

The rule contains model language for employers to use when notifying their workers. And while it does not appear that an employer must use this exact language, the rule contains a safe harbor provision which states that by following the model language the employer will comply with the rule.

Does this apply to all workers and all noncompetes?

No, there are a few exceptions to the rule.

First, the rule does not apply to current non-compete clauses for senior executives. With respect to senior executives, the rule only affects non-compete clauses entered into after the effective date of the rule. A senior executive is a worker who (1) was in a policy-making position; and (2) received a total annual compensation of at least $151,164 in the preceding year or its equivalent when annualized if the worker was employed during only part of the preceding year.

Second, the rule does not apply to a non-compete clause entered into pursuant to the sale of a business entity, the sale of the person’s ownership interest in a business entity, or the sale of substantially all of a business entity’s operating assets.

Finally, the rule does not apply where a cause of action related to a non-compete clause accrued prior to the effective date. In other words, if a worker violates his or her noncompete prior to the effective date of the rule, the employer can still pursue appropriate remedies for that violation even once the rule is in effect.

What about State laws?

The rule does not exempt any person from complying with state statutes and regulations regarding noncompetes. Nor does the rule limit a party’s authority or rights to bring a claim under state common law, antitrust law, and consumer protection law. However, the rule supersedes state laws to the extent that such laws would permit or authorize a person to engage in conduct that the rule deems unlawful.

Legal challenges are already here.

Merely one day after the final rule was announced, the FTC was sued by the US Chamber of Commerce and several other business groups seeking to invalidate the rule. A complaint filed in a Texas federal court alleges that the FTC lacks authority to issue rules defining unfair methods of competition. Felhaber will be monitoring this lawsuit and any other challenges to the rule that may arise. Stay tuned for more updates.

Bottom Line

Despite the pending legal challenge, employers should review their existing noncompete agreements and prepare to issue a notice to their workers. Employers should also review any current non-solicitation, non-disclosure, and other restrictive agreements because, if written broadly enough, such agreements may be unenforceable under the new rule. While this may seem like a daunting task, members of Felhaber’s labor and employment group are available and ready to help navigate this changing legal landscape.

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In her memo, Abruzzo says that noncompete agreements interfere with employees’ rights under Section 7 of the National Labor Relations Act (NLRA). Section 7 of the NLRA guarantees employees “the right to self-organize, to form, join, or assist labor organizations, to bargain collectively through representatives of their own choosing, and to engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection.” The NLRA makes it an unfair labor practice to interfere, restrain, or coerce employees in the exercise of their rights. Abruzzo says in her memo that, in essence, a noncompete limits an employee’s ability to find work elsewhere, therefore diminishing their bargaining power for the purpose of concerted action.

It is the job of the General Counsel to prosecute violations of the NLRA, and this statement from Abruzzo serves as a warning to employers that they may face an unfair labor practice charge if they require employees to sign non-competes.  However, Abruzzo’s memo is only a statement of her interpretation of the NLRA.  Until the Labor Board actually rules on a charge or issues an administrative rule adopting her interpretation of the NLRA, the statements in her memo are not binding descriptions of the law. It is important to note that the NLRA applies only to non-managerial, non-supervisory staff, so any non-compete agreements with managers and supervisors would not be impacted by this.

As a reminder, in January 2023, the Federal Trade Commission (FTC) proposed a rule along the same lines that would rest on its authority under Section 5 of the Federal Trade Commission Act. The public comment period has closed and the FTC is not expected to vote on the final version of its proposed rule until early 2024.

And do not forget the recently passed non-compete ban in Minnesota that goes into effect on July 1, 2023, and which we have previously reported on.  Notably, Minnesota’s non-compete ban does not apply to customer non-solicitation agreements or restrictions that protect a company’s confidential or trade secret information.  Nor does it prohibit a non-compete when executed in connection with the sale of the business.  Also, the new Minnesota law applies only to non-compete agreements entered into on or after July 1, 2023, leaving alone those that already exist. Abruzzo’s interpretation is much broader in that it seeks to ban all non-compete agreements and existing agreements would not be grandfathered in.

Bottom Line

The combination of the new Minnesota non-compete ban, the pending FTC rule, and this new memo from the NLRB, make it clear that legislatures and governmental agencies are committed to narrowing the use of non-compete agreements across the country and in Minnesota. At least for now, Minnesota employers can still protect their legitimate business interests via customer non-solicitation, confidentiality, and trade secret agreements, and non-competes remain enforceable as part of the sale of a business.

We will continue to monitor this situation as it develops.

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We previously reported on the Senate version and the scope of the non-compete ban here.  The omnibus bill has been sent back to the Senate to vote on a number of amendments passed by the House, none of which relate to the non-compete ban.

Once the legislature finalizes and votes on the combined omnibus bill, we expect the non-compete ban to be promptly signed into law by Governor Walz.

We will continue to monitor this and other legislative developments.

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Specifically, the FTC’s proposed rule finds that, in nearly all cases, noncompete agreements with “workers,” including independent contractors, are “an unfair method of competition” and, as a result, a violation of Section 5 of the Federal Trade Commission Act (“FTC Act”).  There is a limited exception in the “sale of business” context, which would exempt companies that want to require an owner or partner selling a business from immediately re-entering the field.

FTC Proposed Rule

The FTC’s proposed rule would define the term “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.  The proposed rule would also clarify that whether a contractual provision is a non-compete clause would depend not on what the provision is called, but how the provision functions.

As the FTC’s proposed rule makes clear, “the definition of non-compete clause would generally not include other types of restrictive employment covenants—such as non-disclosure agreements (“NDAs”) and client or customer non-solicitation agreements—because these covenants generally do not prevent a worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer.” However, the FTC’s proposed rule makes clear that the “definition of ‘non-compete clause,’ such covenants would be considered non-compete clauses where they are so unusually broad in scope that they function as such.”

The FTC’s proposed rule provides:

It is an unfair method of competition for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non-compete clause; or represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause.

There is no exemption for high-wage workers or for specific industries.  Again, the only exception is in the sale-of-business context.

In addition to prohibiting employers from entering into non-compete clauses with workers starting on the rule’s compliance date, which is 180 days after the final rule is published, the proposed rule would require employers to rescind existing non-compete clauses no later than the rule’s compliance date.

Under the FTC’s proposed rule, affected employers must provide notice to any affected worker of the rescission.  The proposed rule also includes the following sample communication that would comply with the proposed notification requirement:

A new rule enforced by the Federal Trade Commission makes it unlawful for us to maintain a non-compete clause in your employment contract. As of [DATE 180 DAYS AFTER DATE OF PUBLICATION OF THE FINAL RULE], the non-compete clause in your contract is no longer in effect. This means that once you stop working for [EMPLOYER NAME]:

• • You may seek or accept a job with any company or any person—even if they compete with [EMPLOYER NAME].
  • You may run your own business—even if it competes with [EMPLOYER NAME].
  • You may compete with [EMPLOYER NAME] at any time following your employment with [EMPLOYER NAME].

The FTC’s new rule does not affect any other terms of your employment contract. For more information about the rule, visit [link to final rule landing page].

The proposed rule also expressly preempts “any State statute, regulation, order, or interpretation to the extent that such statute, regulation, order, or interpretation is inconsistent with [the proposed rule].”

The proposed rule will be published in the Federal Register and will have at least a 60-day comment period.  The FTC will then review any comments before any final rule can be published.  Even then, any final rule could not be effective for 60 days after publication.

Bottom Line

The FTC’s proposed rule would be a sea change in states like Minnesota where noncompete agreements have long been enforced.  The proposed rule is not limited to low-wage workers and preempts any conflicting state or local laws.  Not only does the proposed rule prohibit new noncompete agreements (except in the sale-of-business context), but it also voids all existing noncompete agreements and requires employers to notify workers within 180 days of any final rule.

The proposed rule is not final.  It also will certainly be subject to legal challenge.  Nevertheless, because the FTC’s proposed rule is so sweeping, it is important that employers take note and begin planning for any potential final rule.

We will continue to monitor this situation as it develops.

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It is unclear when the FTC will begin to evaluate any proposed rules banning or limiting non-compete agreements, much less when any rule would go into effect.  The enforceability of non-compete agreements has historically been left to the courts and state legislatures.  Throughout the last decade, numerous states have enacted legislation outright prohibiting the use of non-competes or significantly restricting the circumstances in which they can be used.  There have also been several high-profile cases where companies have been scrutinized for requiring non-competes for low-wage workers (see Jimmy John’s former non-competes with its “sandwich artists”).  President Biden’s Executive Order follows this trend at the federal level.

Bottom Line

So should employers read the writing on the wall and toss their non-compete agreements into the trash bin?  Not necessarily.  It seems unlikely that the FTC will enact a rule that bans all non-competes outright, as that would lead to a storm of legal challenges by business groups.  It is more likely that the FTC will focus on prohibiting non-compete agreements with low-wage workers, or potentially seek to limit the circumstances in which they can be used and the length of the restriction.  Our advice to employers looking to have non-competes will continue to be the same – only use them when they are necessary to protect your legitimate business interests, trade secrets, and customer relationships (as opposed to blanket non-competes that every employee must sign), and limit the scope of your non-competes to the geographic area in which the employee works and lean towards using customer-based restrictions for most employees.  Following these general principles will likely lead to having a court enforce your non-compete agreement if ever necessary and, if the FTC outright bans or severely restricts non-competes, the silver lining may be that it will be just that much easier for you to hire your competitor’s employees.

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Employee is going, going, gone

Bartley Kyte took a job with Oberfoell Auctioneers, a live auction operator, right when Oberfoell began to operate an online-auction. In time, Kyte assumed responsibility for all of the computer work related to the online-auction aspect of the business. After working for Oberfoell for just under year, Kyte signed an “Association Agreement” with a non-compete clause imposing a five-year restriction on Kyte’s ability to engage in general auction and real estate sales within a 150-mile radius of Mt. Iron, Minnesota.

After working for Oberfoell for roughly six years, Kyte left and created his own auction business. Two other Oberfoell employees also left and began working for Kyte. Oberfoell then sued Kyte, alleging that he violated the non-compete agreement and the Minnesota Uniform Trade Secrets Act, among other claims. The trial court a sided with Kyte, prompting Oberfoell to appeal to the Minnesota Court of Appeals.

Court Not Sold on Employer’s Argument

The Appeals Court ruled that Kyte did not violate his non-compete agreement, finding first that Oberfoell had no legitimate business interest protected by the non-compete. Oberfoell provided no evidence that customers left to follow Kyte, or that this was a realistic possibility since Kyte worked behind the scenes and was not the “face” of Oberfoell’s online business.

Similarly, the Court rejected Oberfoell’s claim that the non-compete clause should be enforced to bar Kyte’s access to their customer lists, training manuals, and other similar documents.  They found that for the reasons stated below, Oberfoell had not taken reasonable steps to protect their secrecy so Kyte should not be prohibited from accessing them.

The Court of Appeals also found that the non-compete agreement was unreasonable in scope and therefore unenforceable. For one thing, barring Kyte from working within a 150-mile radius was unreasonable because there was no evidence that Oberfoell’s customers lived within those parameters. Indeed, in the context of an on-line auction, the court found the 150-mile restriction to be “arbitrary.”

The five year restriction also was too much for the court, so much so that they simply invalidated that provision rather than using their “blue pencil”, the colloquialism for a court’s right to edit down the scope of a non-compete to more reasonable parameters.

Court Doesn’t Buy Trade Secret Claims

Oberfoell also contended that Kyte violated the Minnesota Uniform Trade Secrets Act by appropriating their client list, training manuals, processes, and documents.

To have information protected as a trade secret, the information must (1) not be generally known or readily ascertainable by others, (2) derive independent economic value from secrecy, and (3) be the subject of efforts that are reasonable under the circumstances to maintain secrecy.

In this instance, the Appeals Court found that Oberfoell’s business information “is not overly complex, is generally known and is readily ascertainable” and that they did not take reasonable steps to protect its secrecy.  For example:

– The client list was available to all employees, as well as independent contractors and an outside vendor who provided services to Oberfoell;

– Copies of the seller list were available on front desk computers, which were accessible without passwords, and all salespeople had access to this list upon request;

– Hard copies of the seller list were available in the reception areas of its offices, where members of the public had access and might see the list;

– Employee and independent contracts were never asked to sign a confidentiality policy; and

– Training manuals, processes, and documents were never marked “confidential,” were distributed to Oberfoell’s employees and its affiliates, and were not password protected.

 Bottom Line

This case reminds us of several important factors in the enforceability of non-compete agreements.  First, non-competes cannot be used for just any job.  There must be some interest that the employer needs to protect in order to maintain a fair competitive position against the departing employee (e.g. the chance for a new sales employee to build a relationship with customers before the departed sales employee can solicit them).

In addition, for information to be a protectable trade secret, it must be treated like a secret by identifying it as confidential, restricting access to it and insuring that others understand their obligations to maintain its confidentiality.

Finally, as always noncompetes must be reasonable in their duration and geographic scope.

If an employer tries to enforce an agreement that does not satisfy these requirements, a court is likely to just consign it to the dustbin.

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