Kilies and Ben Moussa: FTC proposal to ban noncompetes: What employers need to know

On Jan. 5, the Federal Trade Commission published a proposed rule, “Non-Compete Clause Rulemaking,” that if finalized would effectively prohibit the use of noncompete agreements in employment contracts (with limited exceptions) and preempt all state laws that provide less protection to workers. In that same vein, on Feb. 7, the Indiana Senate passed a bill to ban noncompete agreements between doctors and their health care provider employers, potentially demonstrating Indiana’s pursuit to join the FTC’s crackdown on noncompete restrictions. So what does this mean for Indiana employers, and what should employers do with any noncompete provisions they currently have in their employment contracts?

What exactly is the FTC proposing?

To answer these questions, we need to first provide an overview of the FTC’s proposed rule. The rule provides a sweeping definition of “non-compete clause” and broadly defines what would constitute a “de facto” noncompete clause within the ban. The proposed rule defines a “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.” § 910.1(b)(1). In addition, it contains a functional test to determine whether a contractual term is a noncompete clause under the rule (i.e., a de facto noncompete clause). A contractual term is a de facto noncompete clause if it “has the effect of prohibiting 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.” § 910.1(b)(2). The FTC provides two examples of terms that may be de facto noncompete clauses under §910.1(b)(2):

1. A nondisclosure 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.

2. 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.

Beyond the umbrella of people and terms encompassed in the proposed rule’s definitions are new mandates related to what constitutes unfair methods of competition and existing noncompetes clauses. As currently drafted, the FTC provides it is an unfair method of competition for an employer to enter into or maintain with a worker a noncompete clause or represent to a worker that the worker is subject to a noncompete clause where the employer has no good faith basis to believe the worker is subject to an enforceable noncompete clause. § 910.2(a).

It goes on to provide for a rescission and notice requirement pertaining to existing noncompete clauses. To comply with § 910.2(a), employers will be required to rescind all preexisting noncompete clauses by the proposed rule’s compliance date. Somewhat confusingly, the notice requirement requires employers to provide notice of rescission to both current and former employees within 45 days of the rescission.

In sum, the FTC is proposing a sweeping prohibition on noncompete clauses with minimal covered exceptions. The narrow exception exempts noncompete clauses for the sale of a business when entered by a person who is selling a business entity or otherwise disposing of all their ownership interest, or selling all or substantially all of a business’s assets and is a substantial owner, member or partner in the business at the time they entered the noncompete clause.

Status of the proposed rule

The proposed rule is open for public comment through April 19; however, members of the public may request additional time (which has already happened and we fully anticipate happening again). The proposed rule would take effect 60 days from the final rule and allow employers 180 days to comply. However, litigation will likely ensue, delaying the finalization of the rule. Typically, legal challenges concerning an agency’s rulemaking take place after a final rule is issued (but before it takes effect). Challenges to the FTC through litigation are to be expected if the final rule ultimately mirrors the proposed rule. The nature of anticipated challenges will surely concern the FTC’s authority to enact such a rule, the constitutionality of the proposed rule and the “major questions doctrine,” which says an agency may not create a rule or regulation that has a major social, political and/or economic impact without Congress’ explicit grant of authority to that agency.

How will the proposed rule impact Indiana employers?

If the proposed rule takes effect, the doctrine of federal preemption kicks in, allowing the proposed rule to supersede any inconsistent state laws. However, Indiana seems to have already followed suit. Given the Indiana Senate’s passage of a bill to ban noncompete clauses for doctors (which still must be approved by the Indiana House of Representatives), Indiana is already taking considerable strides toward limiting employers’ ability to impose noncompete restrictions on workers.

The FTC proposal in conjunction with Indiana’s disfavor for noncompete clauses stands to bar entering or enforcing noncompetes with any worker, which may consequently fuel more trade secret litigation and disrupt the confidentiality dynamics present in an array of employment industries.

What should Indiana employers do considering these proposed bans?

Despite this recent shift, there is no reason for employers to sound the alarm just yet, as we wait to see if the proposed rule faces and ultimately survives any legal challenges. However, given Indiana’s recent legislation already restricting the use of noncompete clauses, it is critical that businesses plan accordingly. Employers should implement stricter confidentiality provisions surrounding trade secrets, client lists or other proprietary information to protect against disclosure in lieu of noncompete or de facto noncompete clauses. Also, do not forget about the rights and protections afforded to a company under Indiana’s Uniform Trade Secrets Act.

Further, employers should review their existing employment agreements to determine whether all employees need to be subject to restrictive covenants. For example, a line worker who does not have access to confidential company information may not need restrictive covenants included in their employment agreements. Compare that to an executive or an employee with specific or confidential knowledge about the business, where a reasonably tailored confidentiality provision could protect the business’s needs.

Employers can also engage in proactive measures by considering improving employee loyalty by increasing wages. Incentivizing works in that if you can get employees to stay, the issue of the validity or legality of a noncompete goes away.

Bottom line: There are significant moves toward banning noncompetes, on both the state and now federal levels, so Indiana employers need to be prepared to find suitable substitutes to protect their confidentiality and trade secret concerns. In the meantime, how this proposed rule and Indiana’s legislation on this issue will come out when challenged in court remains to be seen.•


Janelle Kilies is a partner and Azza Ben Moussa is an associate at Lewis Wagner LLP in Indianapolis. Opinions expressed are those of the authors.

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