Lawyers, employers cast wary eyes on noncompete rule

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From staff reports

While there is skepticism as to whether it will survive immediate legal challenges, employers in the Carolinas should take steps to prepare for the possibility that the comprehensive federal ban on new noncompete agreements recently announced by the Federal Trade Commission becomes a fact of life, attorneys told Lawyers Weekly.

The FTC‘s final rule, announced April 23, adopts a comprehensive ban on new noncompetes with all workers, including senior executives, on the basis that they constitute an unfair method of competition in violation of Section 5 of the Federal Trade Commission Act.

Existing noncompete agreements with senior executives, defined as corporate leaders holding policy-making positions and earning at least $151,164, would remain effective once the rule takes effect. But with other employees, employers would be required to send notices informing them that the noncompete agreements they signed are null and void.

If left undisturbed, the rule would take effect 120 days after it is published in the Federal Register; that would make the effective date Sept. 4.

However, at least three challenges to the rule have been filed in federal court, with the judge in one of those cases issuing a scheduling order that seeks to ensure that at least one of those challenges is fully litigated before the rule takes effect.

That case, Chamber of Commerce of the United States of America v. Federal Trade Commission, was filed April 24 in the Eastern District of Texas, one day after the global tax services firm Ryan LLC filed suit in the Northern District of Texas.

A day later, ATS Tree Services, a tree service company in Perkasie, Pennsylvania, filed a similar suit in the Eastern District of Pennsylvania.

In the Chamber of Commerce case, the government filed a motion April 30 asking the court to limit the plaintiffs to litigating on behalf of only those members whom they have specifically identified and who have given them authority to do so, rather than millions of anonymous members. The Biden administration also asked to transfer the case to the Northern District of Texas under the first-to-file rule.

If U.S. District Court Judge J. Campbell Barker does not amend his scheduling order, briefing in the Chamber of Commerce case will be complete by June 19, with a hearing on preliminary relief and summary judgment and possibly a consolidated bench trial soon after.

“That should allow prompt resolution of the case with sufficient time, before the rule’s effective date, for any desired appellate review,” Barker wrote in his scheduling order.

Neither the nature of the final rule — the draft rule proposed in January 2023 had the same main thrust — nor the immediate legal challenges are a surprise, attorneys told Lawyers Weekly.

Long road to implementation

Legal action will likely see the rule delayed — and possibly overturned — two employment lawyers said in email interviews; however, a law professor, also reached by email, raised the possibility that it could be upheld as a lawful exercise of the FTC’s authority.

“My personal view is that the FTC exceeded its authority in issuing the final rule, and that the final rule likely will be struck down by a federal court,” said Will Oden, who practices at the Wilmington office of Ward and Smith.

Derrick Foard, who is licensed in North Carolina and South Carolina and practices at the Greensboro office of Ellis & Winters, agreed, saying: “In the short term, I would expect an injunction will prevent its immediate implementation. The FTC’s widespread ban of noncompete agreements is overbroad and overreaches other restrictive covenants that the rule was not likely intended to impact.”

But Scott Bauries, an employment law professor at the Joseph F. Rice School of Law at the University of South Carolina, was more ambivalent about the rule’s fate, at least in the long run.

“[It] depends on how aggressive the Supreme Court ends up being in extending its recent efforts to limit agency authority,” he said. “On one hand, the FTC is specifically authorized to issue regulations relating to unfair competition, including regulations ‘which define with specificity acts or practices which are unfair or deceptive acts or practices in or affecting commerce’ (15 U.S.C. §§ 46(g) and 47a(a)), which is exactly what this rule does. … On the other hand, this regulation both invalidates potentially thousands of existing contracts and places very significant limitations on freedom of contract going forward, which the court may find violates its recently enhanced ‘major questions doctrine.’”

He also pointed out that the agency followed the statute’s notice-and-comment procedure. Of the 26,000 comments it received, more than 25,000 favored the rule.

The issue will likely be settled by the Supreme Court, he said, a resolution that could be years away. Foard agreed, but he pointed to another time-sensitive issue.

“This process could take a long time and likely through the presidential election, which could shift the landscape depending on the winner,” he said.

Oden predicted the likelihood — “at least a 51% probability” — that a judge will issue a temporary restraining order or preliminary injunction before the final rule goes into effect.

Studied preparations

Oden and Foard’s clients are sitting tight for now, reviewing the order and weighing their options under it but not wanting to rush into action. Neither lawyer sees a way that noncompete agreements can be tailored or adapted for workers outside senior executives to still be enforceable after the rule goes into effect.

Bauries, who is licensed in Florida, said he is not advising South Carolina businesses on specific steps to take. However, he did say: “I would never suggest that an employer assume that a law will not be enforced or will be held invalid. Employers should assume that this law will go into effect 120 days after it is published in the Federal Register (or if it is stayed in court after the stay is lifted), so at least planning and preparing for its implementation seems prudent.”

The prospect of the FTC rule taking effect could prompt employers to review what information they believe is confidential or a trade secret to ensure they are taking appropriate steps to protect it, including limiting the individuals who have access to that information.

Oden, Foard and Bauries split on the value of other protective measures. Oden and Foard said that nondisclosure agreements could be of some value, but Foard pointed out, “A former employer rarely has direct insight into what its former employee is sharing with the new employer.”

Bauries raised doubts.

“Even contracts that are adjacent to noncompetes, such as most nonsolicitation agreements and even some NDAs, would not be enforceable under the new rule,” he said, “which bans both agreements not to compete and any other restrictive employment covenants that have the effect of preventing an employee from leaving to work for a competitor.”

In addition to not having a carve-out for senior executives, the original proposed rule limited the circumstances under which a noncompete could be connected to the sale of a business, requiring the sale to involve a specific amount of equity in the business to be exempt.

In the final rule, that provision is less specific, potentially providing more leeway for noncompetes connected to the sale of a business to remain enforceable.

Even playing field

The FTC has touted what it sees as the benefits of banning noncompetes. The agency estimated that the ban will result in the creation of 8,500 new businesses, lead to the issuance of an average of 17,000 to 29,000 more patents each year, increase wages and lower health care costs.

Another effect is that the rule creates a more even playing field. Foard pointed out that the rule eliminates a “patchwork framework” of state laws and regulations that forced companies with a nationwide footprint to adopt their policies to states with more restrictive rules.

Bauries ticked off a list of possible benefits to a single standard, including giving employers who hire workers once the rule takes effect a degree of certainty about whether he or she can be prevented by a former employer from competing. In the litigation process, the rule also eliminates many forum shopping incentives and will likely curb litigation.

Leveling the playing field could come at the cost of one state that attracts talent because it all but bans noncompetes.

“Until now, many scholars have thought California to have a significant advantage in the innovation economy due to the near-complete invalidity of noncompetes there,” Bauries said. “[I]f these scholars are right, then that advantage should become more widely dispersed throughout the nation under the new rule.”

Oden, however, cast doubt over any benefits.

“[A]ny benefit of having nationwide uniformity pales in comparison to the overly punitive nature of the final rule in interfering with two contracting parties, in my opinion,” he said.

To employers looking to avoid complications stemming from an outflow of staff members, Foard suggested trying something simple:

“I always advise employers the best way to avoid defections and the brain drain through employees moving around is to work to keep your existing employees happy.”

This report includes reporting from Kris Olson of Massachusetts Lawyers Weekly.