There’s good news for job seekers and entrepreneurs today.
That previous sentence sounds pretty dry, but the effect would be substantial: it would bar non-competition clauses generally. There’d be a relatively narrow exception for owners selling their equity interests in a business entity, or other economic equivalents of such a transaction, if the amount of equity being sold is 25% or more of the total equity in the entity.
This would pre-empt a lot of state laws permitting restrictive covenants under a variety of circumstances. According to the FTC, it would affect about 30,000,000 people in the United States — about one in eleven people in the country as a whole, and about one in five people who are currently employed. So this is a pretty big deal.
More interesting, the FTC proposes a “functional test” for determining whether a term of an employment contract is a non-competition clause. It would be based upon the effect of enforcement. Specifically included as examples of terms of employment agreements that would not be permitted include:
i. A non-disclosure agreement between an employer and a worker that is written so broadly that it effectively precludes the worker from working in the same field after the conclusion of the worker’s employment with the employer.
ii. A contractual term between an employer and a worker that requires the worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specified time period, where the required payment is not reasonably related to the costs the employer incurred for training the worker.
What’s more, employers could not represent to employees that they are subject to a non-compete, and if a non-compete exists in an employee’s terms and conditions, the employer would be required to give individualized notice to that employee that the non-compete is no longer in effect and may not be enforced. This affirmative notice requirement would also apply to any former employee who would putatively be subject to enforcement.
The rule would not necessarily disrupt the enforcement of reasonable trade secrets agreements or other protections for proprietary information (as I read the FTC’s summary very briefly today), unless they were so broadly written, or enforced in generalized economic circumstances, as to effectively prohibit a former employee from re-entering an industry.
The “functional test” as proposed includes any “…contractual term that … has the effect of prohibiting 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.” As I read this, this includes restrictive covenants that are incorporated into the terms of a severance agreement or of a settlement of litigation between a former employer and employee, because it refers to any “contractual term,” not just terms of a document explicitly labeled an “employment contract.”
So this is good news for people who are looking for work within industries where they have recent experience. If this rule goes into effect, a prior employer could not prohibit you from seeking work with a competing entity. It’s good news for entrepreneurs too. If this rule goes into effect, a prior employer could not prohibit you from going into business for yourself in a way that competes with that former employer. Given that the skills and knowledge and familiarity with the work one has done in the past are among the best indicators of the direction of that person’s future employability, this removes an impediment some people feel to get work.
As of today, the proposed rule is not yet law. It needs to go through a public comment process and then a second vote of the members of the Federal Trade Commission; this could take several months and the rule might be amended between now and the time it is adopted. Like a lot of significant administrative agency rules, it will probably be subject to court challenges on both the way the rule is navigated through the administrative rulemaking process as well as its substantive effect.
Employers should watch this space closely, and would be well-advised to prepare for the eventual adoption of this rule, in some form, by reviewing their onboarding and employment processes, and any employment contracts. If there are restrictive covenants in those documents, consultation with an employment attorney and assessment of the economic realities of enforcing those covenants need to be carefully and soberly evaluated, because 180 days after the rule takes effect, there may well be a requirement to provide notice to current and former employees.
Employees, particularly those who know restrictive covenants are in their portfolios, should also pay close attention to what happens. If the rule is adopted, they will likely find the effect of those restrictive covenants relieved — and that will leave them relieved, as well.