By Paul E. Starkman
and Daniel V. Kinsella
Historically, enforcement of noncompete agreements has been a subject of state law, not federal law. States have taken many different approaches to the agreements. A few states have enacted laws that ban the enforcement of noncompetes entirely, such as California, Minnesota and legislation passed in New York that was recently vetoed by the New York Governor. Others, such as Illinois, Colorado, and Washington, have restricted noncompetes to highly compensated employees by statute, while most continue to regulate noncompetes on a case-by-case basis through the courts.
Recently, however, the federal government, through several agencies, has tried to impose a nationwide one-size-fits-all approach that would have the effect of banning all noncompetes throughout the United States. Unlike the actions of the states, the actions of the federal government have been undertaken by executive agency action without input from the legislative branch, Congress, and have not yet been reviewed by the courts.
Federal efforts to invalidate noncompetes can be tracked to Executive Order No. 14036, “Promoting Competition in the American Economy,” on July 9, 2021, which called on federal agencies to “curtail the unfair use of non-compete clauses and other clauses or agreements that … unfairly limit worker mobility.” Following the issuance of Executive Order No. 14036, several federal agencies, specifically the Federal Trade Commission (FTC), the Department of Justice (DOJ), and the National Labor Relations Board (NLRB) have taken action on employment non-competition agreements in one form or another.
However, the current status of these federal initiatives is that none of the agency actions has become effective yet. It appears highly likely that all three will be challenged in the courts and there remains serious doubt as to whether any of them will survive.
The FTC’s Attack on Noncompetes
The FTC is the primary federal regulatory agency to initiate action against employment noncompetes. On Jan. 5, 2023, the Federal Trade Commission (“FTC”) proposed a new rule that would make it illegal for most private employers in the US to enter into covenants – not to compete (“noncompetes”) and require employers to rescind existing noncompetes. The proposed rule would make it an “unfair method of competition” in violation of the FTC Act for an employer to: (1) enter into or attempt to enter into a noncompete clause with a worker (which includes an independent contractor); (2) maintain a noncompete clause with a worker; or (3) represent to a worker that the worker is subject to a noncompete clause where the employer lacks a good faith basis to believe that the worker is subject to an enforceable noncompete clause. The proposed rule exempts noncompetes arising out of the sale of a business if the individual owns 25% of the business.
The proposed rule also could prohibit “de facto noncompete clauses,” which are defined as any clause that has the “effect” of prohibiting a worker from seeking or accepting employment or operating a business at the end of employment. The proposed rule states that a “functional test” will be used to determine whether a contractual term is a “de facto noncompete clause.” However, the proposed rule fails to define the test further.
The FTC’s proposed rule has been published in the Federal Register and the public has had the opportunity to submit comments to the FTC. The period in which the public could comment expired on April 19, 2023. During the comment period, the agency received more than 26,000 comments. Following a review of the comments, the FTC will need to vote on the proposal or any changes prior to the issuance of a final rule. Bloomberg Law reports, per an undisclosed source, that the FTC will not vote on its final rule until April 2024. If made final, the proposed rule would become effective 60 days thereafter. However, employers would have 180 days after the rule becomes final to comply.
It is very likely that any final rule will be challenged in court. Any final rule will likely be challenged in court. In January 2023, the U.S. Chamber of Commerce threatened to file a lawsuit attacking the FTC’s final rule. Legal challenges to any final rule issued by the FTC will be made on many grounds. One challenge that will certainly be made is that the FTC’s final rule should be stricken under the so-called “Major Questions” doctrine. Under that doctrine, the U.S. Supreme Court has held that an administrative agency cannot “assert a highly consequential power beyond what Congress could reasonably be understood to have granted.” The “major questions” doctrine holds that courts should “hesitate” and refrain from deferring to agency statutory interpretations on questions of “vast economic or political significance” unless Congress “clearly” authorized such agency action.
Under the FTC Act, the Commission’s authority has been defined as enforcing the antitrust and consumer protection laws. During the past 110 years since the FTC Act was passed, no court has upheld the FTC’s argument that noncompetes violate the Act, including in cases brought by the FTC itself.
Thus, if the FTC issues a final rule, regardless of whether the final rule is similar to its proposed rule, the final rule is likely to be subject to immediate judicial scrutiny. It is currently unclear what form the FTC’s final rule will take and whether it will survive legal challenges once it emerges.
In the months since the proposed rule was issued, the FTC also issued complaints against three large manufacturers as well as a security guard services company, to force the companies to drop widely used noncompete agreements. The companies each entered into consent orders with the FTC that, among other things, prohibit the companies from enforcing noncompete agreements involving hundreds of employee positions, including both rank and file and managerial positions. The consent orders also require the companies for the next 10 years to provide clear notices to new employees that they may freely compete with the company following their employment. Contrary to the blanket ban on noncompetes in the FTC’s proposed rule, its more recent complaints applied a more selective approach that did not attempt to ban the use of noncompetes with high-level executives.
Cooperation Among Federal Agencies On Noncompetes
On July 9, 2023, President Biden issued an Executive Order on noncompetes. The Executive Order directs all federal agencies to cooperate with the Department of Justice or the FTC in the oversight and investigation of the enforcement of noncompete agreements.
On Sept. 21, 2023, the FTC announced a new cooperation agreement with the U.S. Department of Labor, to share additional information to help police noncompetes. The FTC already entered into such an agreement with the National Labor Relations Board.
The Department of Justice and Noncompetes
In relatively rare instances, the U.S. Department of Justice (DOJ) has dealt with restrictive covenants on a case-by-case basis. The DOJ’s efforts have primarily involved what are known as “no-poach” agreements, in which two entities agree not to “poach” (or solicit for employment) each other’s employees.
In one example of a case involving a “no-poach” agreement, the DOJ obtained a guilty plea in 2022 in a criminal antitrust prosecution. The charges stemmed from an agreement that the company pleading guilty had with a competing company—both of which were providing contract nursing services to a school district in Nevada—not to hire each other’s nurses or to raise their wages.
Occasionally, however, the DOJ has intervened in cases involving true noncompete agreements between an employer and its employees to prevent them from going to work for a competitor of the employer. Here too, it has done so only in individual cases. Recently, in 2023, the DOJ announced that it had entered into consent decrees with three companies to invalidate their noncompetes with certain low-wage-earning employees. Currently, there is no reason to think that the DOJ’s case-by-case attacks on noncompetes have ended.
There is a clear difference between prohibiting anti-poaching agreements and prohibiting noncompetes under antitrust law. Anti-poaching agreements would be considered classic horizontal trade restrictions and more likely subject to antitrust enforcement. Noncompetes would be considered vertical agreements that could have a horizontal effect. Antitrust law generally recognizes differences in the economic effect on commerce.
Noncompetes Under the Current NLRB
The NLRB has taken an approach that is different from the FTC or the DOJ. The NLRB General Counsel Jennifer Abruzzo announced in her May 30, 2023 memorandum that, in her view, noncompetes generally violate federal labor law. The General Counsel takes the position that, in most instances, these types of agreements will unlawfully interfere with employees’ right to engage in protected concerted activity. The NLRB’s General Counsel has said that the focus will fall on noncompetes with “low-wage or middle-wage workers,” particularly those who lack access to their employer’s trade secrets.
First, any NLRB ruling would be limited to employees who are not supervisors, managers, or confidential employees as those terms are defined by the National Labor Relations Act and the case law. Second, since a noncompete would, arguably, only affect an employee who is no longer employed, the basis for an NLRB finding that such an agreement interferes with a current employee will be subject to challenge.
The NLRB itself has not yet ruled on the General Counsel’s position and when the NLRB does rule, a federal court of appeals will decide whether or not to enforce it.
Two NLRB regional directors have brought unfair labor practice complaints targeting noncompetes, including one alleging that a noncompete agreement violated the National Labor Relations Act by forbidding low-wage workers from acting in concert to leave their employer and go to work for a competitor in the same state for two years after separation. In Berry Green Management, Inc., N.L.R.B. Reg’l Dir., Case 07-CA-296276, the NLRB brought its first enforcement action against a Michigan cannabis processor alleging that its noncompete agreement constituted an unfair labor practice, but the case ended in May 2023 with a private settlement. Nonetheless, the NLRB could issue a ruling in the near future that bans most noncompetes (and nonsolicitation agreements) in the U.S., but such an NLRB ruling would be subject to appeal to a federal appellate court.
In conclusion, federal regulatory initiatives to restrict noncompetes are still in preliminary stages. Moreover, such efforts by federal regulatory agencies, such as the FTC, DOJ, and NLRB, may ultimately be unsuccessful after judicial review. However, there is no indication that the federal government is done trying to ban employment noncompetes.
————————
Paul E. Starkman and Daniel V. Kinsellaare attorneys with Clark Hill.
and Daniel V. Kinsella
Historically, enforcement of noncompete agreements has been a subject of state law, not federal law. States have taken many different approaches to the agreements. A few states have enacted laws that ban the enforcement of noncompetes entirely, such as California, Minnesota and legislation passed in New York that was recently vetoed by the New York Governor. Others, such as Illinois, Colorado, and Washington, have restricted noncompetes to highly compensated employees by statute, while most continue to regulate noncompetes on a case-by-case basis through the courts.
Recently, however, the federal government, through several agencies, has tried to impose a nationwide one-size-fits-all approach that would have the effect of banning all noncompetes throughout the United States. Unlike the actions of the states, the actions of the federal government have been undertaken by executive agency action without input from the legislative branch, Congress, and have not yet been reviewed by the courts.
Federal efforts to invalidate noncompetes can be tracked to Executive Order No. 14036, “Promoting Competition in the American Economy,” on July 9, 2021, which called on federal agencies to “curtail the unfair use of non-compete clauses and other clauses or agreements that … unfairly limit worker mobility.” Following the issuance of Executive Order No. 14036, several federal agencies, specifically the Federal Trade Commission (FTC), the Department of Justice (DOJ), and the National Labor Relations Board (NLRB) have taken action on employment non-competition agreements in one form or another.
However, the current status of these federal initiatives is that none of the agency actions has become effective yet. It appears highly likely that all three will be challenged in the courts and there remains serious doubt as to whether any of them will survive.
The FTC’s Attack on Noncompetes
The FTC is the primary federal regulatory agency to initiate action against employment noncompetes. On Jan. 5, 2023, the Federal Trade Commission (“FTC”) proposed a new rule that would make it illegal for most private employers in the US to enter into covenants – not to compete (“noncompetes”) and require employers to rescind existing noncompetes. The proposed rule would make it an “unfair method of competition” in violation of the FTC Act for an employer to: (1) enter into or attempt to enter into a noncompete clause with a worker (which includes an independent contractor); (2) maintain a noncompete clause with a worker; or (3) represent to a worker that the worker is subject to a noncompete clause where the employer lacks a good faith basis to believe that the worker is subject to an enforceable noncompete clause. The proposed rule exempts noncompetes arising out of the sale of a business if the individual owns 25% of the business.
The proposed rule also could prohibit “de facto noncompete clauses,” which are defined as any clause that has the “effect” of prohibiting a worker from seeking or accepting employment or operating a business at the end of employment. The proposed rule states that a “functional test” will be used to determine whether a contractual term is a “de facto noncompete clause.” However, the proposed rule fails to define the test further.
The FTC’s proposed rule has been published in the Federal Register and the public has had the opportunity to submit comments to the FTC. The period in which the public could comment expired on April 19, 2023. During the comment period, the agency received more than 26,000 comments. Following a review of the comments, the FTC will need to vote on the proposal or any changes prior to the issuance of a final rule. Bloomberg Law reports, per an undisclosed source, that the FTC will not vote on its final rule until April 2024. If made final, the proposed rule would become effective 60 days thereafter. However, employers would have 180 days after the rule becomes final to comply.
It is very likely that any final rule will be challenged in court. Any final rule will likely be challenged in court. In January 2023, the U.S. Chamber of Commerce threatened to file a lawsuit attacking the FTC’s final rule. Legal challenges to any final rule issued by the FTC will be made on many grounds. One challenge that will certainly be made is that the FTC’s final rule should be stricken under the so-called “Major Questions” doctrine. Under that doctrine, the U.S. Supreme Court has held that an administrative agency cannot “assert a highly consequential power beyond what Congress could reasonably be understood to have granted.” The “major questions” doctrine holds that courts should “hesitate” and refrain from deferring to agency statutory interpretations on questions of “vast economic or political significance” unless Congress “clearly” authorized such agency action.
Under the FTC Act, the Commission’s authority has been defined as enforcing the antitrust and consumer protection laws. During the past 110 years since the FTC Act was passed, no court has upheld the FTC’s argument that noncompetes violate the Act, including in cases brought by the FTC itself.
Thus, if the FTC issues a final rule, regardless of whether the final rule is similar to its proposed rule, the final rule is likely to be subject to immediate judicial scrutiny. It is currently unclear what form the FTC’s final rule will take and whether it will survive legal challenges once it emerges.
In the months since the proposed rule was issued, the FTC also issued complaints against three large manufacturers as well as a security guard services company, to force the companies to drop widely used noncompete agreements. The companies each entered into consent orders with the FTC that, among other things, prohibit the companies from enforcing noncompete agreements involving hundreds of employee positions, including both rank and file and managerial positions. The consent orders also require the companies for the next 10 years to provide clear notices to new employees that they may freely compete with the company following their employment. Contrary to the blanket ban on noncompetes in the FTC’s proposed rule, its more recent complaints applied a more selective approach that did not attempt to ban the use of noncompetes with high-level executives.
Cooperation Among Federal Agencies On Noncompetes
On July 9, 2023, President Biden issued an Executive Order on noncompetes. The Executive Order directs all federal agencies to cooperate with the Department of Justice or the FTC in the oversight and investigation of the enforcement of noncompete agreements.
On Sept. 21, 2023, the FTC announced a new cooperation agreement with the U.S. Department of Labor, to share additional information to help police noncompetes. The FTC already entered into such an agreement with the National Labor Relations Board.
The Department of Justice and Noncompetes
In relatively rare instances, the U.S. Department of Justice (DOJ) has dealt with restrictive covenants on a case-by-case basis. The DOJ’s efforts have primarily involved what are known as “no-poach” agreements, in which two entities agree not to “poach” (or solicit for employment) each other’s employees.
In one example of a case involving a “no-poach” agreement, the DOJ obtained a guilty plea in 2022 in a criminal antitrust prosecution. The charges stemmed from an agreement that the company pleading guilty had with a competing company—both of which were providing contract nursing services to a school district in Nevada—not to hire each other’s nurses or to raise their wages.
Occasionally, however, the DOJ has intervened in cases involving true noncompete agreements between an employer and its employees to prevent them from going to work for a competitor of the employer. Here too, it has done so only in individual cases. Recently, in 2023, the DOJ announced that it had entered into consent decrees with three companies to invalidate their noncompetes with certain low-wage-earning employees. Currently, there is no reason to think that the DOJ’s case-by-case attacks on noncompetes have ended.
There is a clear difference between prohibiting anti-poaching agreements and prohibiting noncompetes under antitrust law. Anti-poaching agreements would be considered classic horizontal trade restrictions and more likely subject to antitrust enforcement. Noncompetes would be considered vertical agreements that could have a horizontal effect. Antitrust law generally recognizes differences in the economic effect on commerce.
Noncompetes Under the Current NLRB
The NLRB has taken an approach that is different from the FTC or the DOJ. The NLRB General Counsel Jennifer Abruzzo announced in her May 30, 2023 memorandum that, in her view, noncompetes generally violate federal labor law. The General Counsel takes the position that, in most instances, these types of agreements will unlawfully interfere with employees’ right to engage in protected concerted activity. The NLRB’s General Counsel has said that the focus will fall on noncompetes with “low-wage or middle-wage workers,” particularly those who lack access to their employer’s trade secrets.
First, any NLRB ruling would be limited to employees who are not supervisors, managers, or confidential employees as those terms are defined by the National Labor Relations Act and the case law. Second, since a noncompete would, arguably, only affect an employee who is no longer employed, the basis for an NLRB finding that such an agreement interferes with a current employee will be subject to challenge.
The NLRB itself has not yet ruled on the General Counsel’s position and when the NLRB does rule, a federal court of appeals will decide whether or not to enforce it.
Two NLRB regional directors have brought unfair labor practice complaints targeting noncompetes, including one alleging that a noncompete agreement violated the National Labor Relations Act by forbidding low-wage workers from acting in concert to leave their employer and go to work for a competitor in the same state for two years after separation. In Berry Green Management, Inc., N.L.R.B. Reg’l Dir., Case 07-CA-296276, the NLRB brought its first enforcement action against a Michigan cannabis processor alleging that its noncompete agreement constituted an unfair labor practice, but the case ended in May 2023 with a private settlement. Nonetheless, the NLRB could issue a ruling in the near future that bans most noncompetes (and nonsolicitation agreements) in the U.S., but such an NLRB ruling would be subject to appeal to a federal appellate court.
In conclusion, federal regulatory initiatives to restrict noncompetes are still in preliminary stages. Moreover, such efforts by federal regulatory agencies, such as the FTC, DOJ, and NLRB, may ultimately be unsuccessful after judicial review. However, there is no indication that the federal government is done trying to ban employment noncompetes.
————————
Paul E. Starkman and Daniel V. Kinsellaare attorneys with Clark Hill.
