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White & Case Global Non-Compete Resource Center (NCRC)

What you need to know about the current issues surrounding the enforceability of employer-employee non-compete provisions

16 min read

Although antitrust enforcers' concern for anticompetitive effects in labor markets has been escalating for some time (read our 2022 article about labor market developments here), the focus on perceived anticompetitive effects of employer/employee non-compete provisions has recently become much more acute.

Table of Contents

Proposed US FTC Rule Banning Non-Competes

On January 5, 2023, the U.S. Federal Trade Commission announced a Notice of Proposed Rulemaking (NOPR) that would ban non-compete clauses in employer-employee contracts. (You can read the FTC's FAQs press statement here).

While the vote to issue the rule had three votes by the Democrat-appointed commissioners, Commissioner Christine Wilson (now former Commissioner) dissented. Commissioner Wilson's dissent, (which you can read here), notes that the proposed rule would be a "radical departure from hundreds of years of legal percent." It also explains that the appropriateness of non-compete clauses deserves a "fact-specific inquiry" and that enactment of the proposed rule would have "a much larger raft of unintended consequences."

Indeed, in former-Commissioner Wilson's Wall Street Journal Op-Ed published on the day she announced her resignation, Wilson highlighted the FTC's proposed non-compete rule as an example of the FTC's policy agenda causing her to resign. She explained: "In January, 2023, the commission launched a rulemaking that would ban nearly all noncompete clauses in employee contracts, affecting roughly one-fifth of employment contracts in the U.S. This proposed rule defies the Supreme Court's decision in West Virginia v. EPA (2022), which held that an agency can't claim ‘to discover in a long-extant statute an unheralded power representing a transformative expansion in its regulatory authority." Former Commissioner Wilson's WSJ Op-Ed is here.

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What you need to know:

  • What are the key features of the proposed rule?

    • The proposed rule is broad. It would prohibit employers from imposing non-competes on workers (including independent contracts and unpaid workers), and the ban would extend to all contract provisions that create "de facto" non-compete clauses; i.e., any other contractual clause that may have the "effect" of prohibiting workers from seeking or accepting other employment. This means that an NDA that has the "effect" of limiting a worker's mobility may also be banned. (Proposed Rule § 910.1(b)(1)-(2) is here.)
    • The rule would apply retroactively. Should the rule be enacted in its current form, not only would preexisting non-compete agreements become unenforceable, but the rule would also require employers to proactively rescind the non-compete, i.e., to tell individual employees that such provisions no longer applied. **The proposed rule would not affect any other provisions negotiated for in exchange for the non-compete, like a severance package. (Proposed Rule § 910.2(b) is here.)
    • There is a narrow exception to allow non-competes in "sale-of-business" agreements, but the exception only applies where the individual has at least 25% ownership in the business. (Proposed Rule § 910.3 is here.)
    • It would supersede all contrary state laws.

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  • If issued, what happens if you violate the proposed rule?

    • The proposed rule provides that the use of non-competes is an "unfair method of competition" that violates Section 5 of the FTC Act. Violations of the FTC Act can result in fines, penalties, and other injunctive relief.
  • What employers would be bound by the proposed rule?

    • Most employers will be subject to the proposed rule if issued. Certain entities, however, are exempt form the FTC's jurisdiction under the FTC Act (pursuant to which the FTC purports to be issuing the proposed rule), so it follows that those exempt entities should also be exempt from the proposed rule. Those entities generally include certain financial institutions (banks, credit unions, savings and loans), some non profit organizations, and air carriers.
    • As explained below, however, the FTC and Department of Justice Antitrust Division have separately raised concerns about non-competes as an antitrust violation under Section 1 of the Sherman Act.

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  • How would the proposed rule impact non-competes entered as part of an M&A transaction?

    • The proposed rule would apply to, and therefore ban, employee non-competes with entered as part of a merger or acquisition. The only exception, as explained above in the "key features" question, is for non-competes entered as part of the sale of a business for a person holding 25% or more of the company.
  • How would the proposed rule impact executives and executive compensation?

    • The proposed rule would ban non-competes for executives; there is no carve-out for C-suite, and no salary threshold. This may also impact the calculation of "parachute payments" for tax purposes.
  • Does the proposed rule ban garden leave?

    • Under the proposed rule, garden leave may or may not be prohibited depending on how it is structured. The proposed rule defines a "non-compete clause" as one that prevents the worker from seeking or accepting new employment "after the conclusion" of the current employment. Therefore, a garden leave provisions whereby the employee remains employed (i.e. with full salary and benefits) but is simply not allowed to access the business during the garden leave period should be permissible, but the proposed rule is not clear.

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  • What happens next with the proposed rule, and when could it go into effect?

    • The process to implement a rule can take quite a while. The public comment period closed on April 19, 2023. A total of 16,459 comments were lodged. Leading themes included (1) the adverse impact on the protection of intellectual property (IP) and the absence of any IP exception to the proposed non-compete ban; (2) the proposed rule's tendency to disincentivize investments in worker training; and (3) concerns that non-profit healthcare providers would be unfairly advantaged by the proposed rule since they are exempt from it.
    • The proposed rule is an extreme departure from historic business practice and even broader than the EU principle of free movement between countries and jobs—but without the EU structure that allows non-competition clauses, limited in geography and time, for certain classes of employees (e.g., key-person and IP related) that are compensated separately (e.g., garden-leave).
    • Before the FTC can enforce the rule, it must publish a final version in the Federal Register, which contains all government agencies' rules and regulations. There is no specific date by which the FTC must publish the final rule. If issued, the final rule would go into effect 60 days following publication in the Federal Register and companies would have to be in compliance 180 days after publication. Still, enforcement could be further delayed by legal challenge.
    • As of May 25, 2023, the FTC has not made any public statements indicating what its next steps are or when it intends to publish the final rule. However, a group of U.S. senators and house representatives led by Senators Elizabeth Warren (D-MA) and Richard Blumenthal (D-CT) urged the Commission "to resist calls for additional postponement and act quickly to protect as many workers under this rule as possible." The letter from these lawmakers to FTC Chair Lina Khan is here.

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Recent Wave of US FTC Enforcement Actions Against Worker Non-Compete Agreements

The FTC's proposed new rule announcement came within 24 hours of the FTC signaling its intention to achieve its anti-non-compete clause views through enforcement.

  • On January 4, 2023, the FTC announced that it had filed suits—for the first time—to stop companies from enforcing non-compete restrictions. The FTC's press release is here.
    • The suits involved three companies with non-competes for a range of workers, including low-wage workers, which lasted for one to two years. As a result of the suits, the companies were ordered not to enforce the non-competes, as well as put other remedies into place, such as providing notice for the next 10 years to employees that they may freely seek any job following their employment.
  • In these actions, the FTC sued under Section 5 of the FTC Act, which governs unfair methods of competition. The FTC argued that the non-competes harmed employees because they result in lower wages, lower salaries, and less favorable working conditions. The FTC also argued that the non-competes harmed new competitors in the glass food and beverage containers industry, noting that the non-competes would impede entry and expansion of new competitors in a concentrated market.

Both the rulemaking and enforcement actions are in line with the FTC's November 2022 policy statementannouncing that the FTC would invoke Section 5 to challenge conduct beyond that covered by the Sherman Act.

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White House and US Antitrust Enforcers' Commentary on Non-Competes

In the midst of these events, individual enforcers at both the FTC and the Antitrust Division of the Department of Justice, as well as at the White House, have been vocal about their perceptions and goals for the future of non-compete enforcement:

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Changes at the State Level: Spotlight on New York’s Pending Legislation

State legislatures have also shown a growing interest in new proposals to ban or limit non-compete agreements.

On June 20, 2023, the New York State Legislature passed a bill that would prohibit almost all new non-competes. The bill now sits on Governor Kathy Hochul's desk for her signature. If signed into law by the Governor, the proposal would prohibit almost all new non-compete agreements for workers in New York.

  • What are the key features of the bill?

    • The bill adds a new section to New York State Labor Law that would prohibit any employer from seeking, requiring, demand, or accepting a non-compete agreement from any covered individual. Section 191-d(2). The bill defines "covered individual" broadly to include employees as well as "any other person who . . . performs work or services for another person on such terms and conditions that they are, in relation to that other person, in a position of economic dependence on, and under an obligation to perform duties for, that other person." Section 191-d(1)(B).
    • The bill would also void any other contracts "by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind." Section 191-d(3).
    • The bill expressly exempts agreements that (1) establish "a fixed term of service," (2) prohibit disclosure of "trade secrets" and "confidential and proprietary client information," and (3) prohibit "solicitation of clients of the employer that the covered individual learned about during employment," provided that such agreement does not otherwise restrict competition in violation of Section 191-d. Section 191-d(5).
  • When would the law become effective?

    • The law would become effective 30 days after being signed into law by Governor Kathy Hochul and will be applicable contracts entered into or modified on or after that date.
  • If enacted, what happens when you violate the law?

    • A covered individual subject to a non-compete can sue to void their non-compete and to receive payment for liquidated damages, lost compensation, damages, and reasonable attorneys' fees and costs. Section 191-d(4)(A). Additionally, the bill provides that courts "shall award liquidated damages" of not more than ten thousand dollars "to every covered individual affected under this Section, in addition to any other remedies permitted by this Section." Section 191-d(4)(B).
    • A covered individual can bring such an action "within two years of the later of: (1) when the prohibited non-compete agreement was signed; (2) when the covered individual learns of the prohibited non-compete agreement; (3) when the employment or contractual relationship is terminated; or (4) when the employer takes any step to enforce the non-compete agreement." Section 191-d(4)(A).
  • How does the NY bill differ from the FTC’s proposed rule?

    • New York's bill would not apply retroactively, unlike the FTC's proposed rule. New York's bill would only be applicable to contracts entered into or modified on or after its effective date, whereas the FTC's proposed rule would apply to pre-existing non-competes and require employers to proactively rescind their non-competes.
    • The New York bill does not exempt non-competes in "sale-of-business agreements" like the FTC's proposed rule does.
    • Though the FTC's proposed rule would supersede inconsistent state law, the proposed rule also provides that any state law that affords a worker protection "greater than the protection provided" under the rule will not be pre-empted. (Proposed Rule § 910.4 is here.) Since the NY bill grants enhanced protections by way of its damages provisions, it is likely to survive the proposed rule's implementation.

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UK Proposed Stricter Approach to Non-Competes

In a policy paper on "Smarter Regulation to Grow the Economy," the UK government has announced proposals to limit the duration of non-compete clauses in employment contracts to three months.

This proposal reflects the growing concern worldwide concerning the use of non-competes. As discussed above, earlier this year, the U.S. FTC took even more extreme action than the UK, by publishing a proposed rule to ban non-compete clauses completely.

  • What is the approach to non-competes in the UK?

    • There are currently no statutory restrictions on non-compete provisions in the UK.
    • Under case law, non-competes will only be enforceable if they are no wider than reasonably necessary to protect a legitimate interest (e.g. protection of confidential information or customer contacts) and are not contrary to the public interest.
    • The UK courts have in the past enforced up to 12 month non-competes in employment contracts in certain sectors, particularly in case of non-competes imposed on founders or senior management. In other contexts, including partnership agreements and shareholder agreements, non-competes that apply for a longer duration have been enforced by the UK courts.

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  • What are the proposals?

    • The UK government proposes to limit the duration of post-termination non-compete clauses in employment contracts to three months.
    • The three month limit will only apply to non-competes in contracts of employment and the contracts of certain other workers who benefit from certain protections under UK employment law. The UK government does not propose to apply the limit to wider workplace contracts, such as partnership or shareholder agreements. This is on the basis that there are fundamental differences in the balance of bargaining power with these wider workplace contracts. Based on the consultation document, it appears that equity incentive documents, such as employee share option agreements, would be considered a wider workplace contract as well.
    • There are carve-outs. The proposal will not limit or interfere with the employer's use of:
      • non-solicitation clauses;
      • paid notice periods or gardening leave; or
      • confidentiality clauses.
    • The proposal also will not affect the restrictions on former UK public sector employees under the UK business appointment rules.
    • The proposal follows a consultation period between 4 December 2020 and 26 February 2021 that explored and ultimately rejected the following two alternatives:
      • the complete prohibition of post-termination non-compete clauses; and
      • making post-termination non-compete clauses permissible only when the employer provides compensation for the period of restraint.
  • What are the drivers behind the UK reform?

    • The UK government estimates that there are around 5 million employees subject to non-compete clauses in Great Britain and that a typical duration is around 6 months.
    • Whilst recognising that non-compete clauses "can play an important role in protecting businesses who invest in their staff", the proposal claims that, "unnecessarily burdensome clauses have become a default part of too many employment contracts, including where they fulfil no purpose." The proposal states that non-compete clauses "can inhibit workers from looking for better paying roles, and limit the ability of businesses to compete and innovate".
    • The proposal's stated aims are to give "UK workers greater freedom to switch jobs, apply their skills elsewhere and even earn a pay rise." They also aim to "provide a boost to the wider UK economy, supporting employers to grow their businesses and increase productivity by widening the talent pool, and improving the quality of candidates they can hire."

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  • Why no complete ban on non-competes?

    • In contrast to the US FTC's proposal, the UK government has ruled out a complete ban of non-competes. Following a review of "available evidence, research, and literature", the UK government considers that the risks and potential for unintended consequences could outweigh the potential benefits of a complete ban. While the UK government recognises that a complete ban could have "a positive effect on competition and innovation", it considers that "there is some evidence to suggest that in certain circumstances, non-compete clauses can act as a mechanism to align incentives between workers and employers, and enable investments."
  • What should employers do?

    • Employers should start to consider other ways they can protect their business interests once the proposed limit comes into force.
    • In the UK, the most robust way of protecting an employer's business interests in an employment contract of a senior employee who holds valuable trade secrets is a long notice period combined with an express garden leave clause. A 12 month notice period is fairly typical for a C-suite executive.
    • Where a long notice period is not appropriate or cannot be agreed, then employers may consider including non-competes in wider workplace contracts. In particular, if equity incentive documents will ultimately be considered a "wider workplace contract" under the final legislation, then granting an option or other equity interest which includes a carefully drafted (and longer) non-compete in its terms might well be a sensible and enforceable alternative.
  • What is the proposed timetable?

    • The proposal states that the UK government intends to legislate "when parliamentary time allows." There is currently no clarity as to whether, if legislation does pass in this area, it will apply retroactively to existing employment contracts and contracts with workers and if so, whether pre-existing non-competes that apply for longer than 3 months will only be enforceable for 3 months after termination, or whether such non-competes will be unenforceable and void in their entirety.

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