• The Federal Trade Commission has issued a final rule essentially eliminating all new non-compete agreements.
• Non-competes may deter prospective employees.

A non-competition or non-compete agreement is a written contract between employers and employees that restricts certain employee activities when they leave the organization to work elsewhere. An employer may want to have a non-compete in place to:

• Protect sensitive business information or trade secrets, or
• Limit the employee from working in the same field within a given geographical area or time period.

Imagine this scenario: Last month, an employee left to join a competitor, and curiously, this competitor is now setting up a state-of-the art sales system akin to the one the former employee had been working on.

Issues like these may compel a company to require non-compete agreements, with the aim of prohibiting former employees from:

• Contacting customers with whom they had contact while employed;
• Working for direct competitors, which may include self-employment; or
• Sharing trade secrets after leaving the company.

However, even when allowed, non-competes won’t hold up just because an employee agreed to the terms and signed an agreement. The agreement must be reasonable.

Some states have limited or banned non-competes

Four states — California, Minnesota, North Dakota and Oklahoma — have banned non-compete agreements entirely. New York is considering such a ban. Colorado, Illinois, Maine, Maryland, New Hampshire, Oregon, Rhode Island, Virginia, and Washington state prohibit non-compete agreements unless the worker earns above a certain threshold.

Federal restrictions on non-competes

The Federal Trade Commission (FTC) released a proposal in January 2023 to prohibit non-compete agreements. The FTC said non-competes constitute an unfair method of competition and therefore violate Section 5 of the Federal Trade Commission Act.

On May 7, 2024, the FTC moved forward and published a final regulatory rule that, if it takes effect, will invalidate and bar virtually all non-compete agreements in the U.S. The ban is scheduled to take effect on September 4, 2024, but several lawsuits challenging the ban have been filed.

The final rule provides that: With respect to a worker other than a senior executive, it is an unfair method of competition for a person (i) to enter into or attempt to enter into a non-compete clause; (ii) to enforce or attempt to enforce a non-compete clause; or (iii) to represent that the worker is subject to a non-compete clause.

With respect to a senior executive, it is an unfair method of competition for a person (i) to enter into or attempt to enter into a non-compete clause; (ii) to enforce or attempt to enforce a non-compete clause entered into after the effective date; or (iii) to represent that the senior executive is subject to a non-compete clause, where the non-compete clause was entered into after the effective date.

In other words, once the final rule takes effect, virtually all preexisting and future U.S. non-compete agreements are and will be banned and unenforceable, with the exception of preexisting non-compete agreements with “senior executives.”

The FTC final rule also includes an exception for certain non-compete agreements between the seller and the buyer of a business.

In addition to the FTC ban, in May, 2023, the National Labor Relations Board (NLRB) General Counsel announced that some non-compete agreements violate the National Labor Relations Act (NLRA). The announcement, which applies to non-unionized and unionized employers, may result in unfair labor practice charges for employers that use non-compete agreements.

The reasonableness factor

Even if the federal rules on non-compete agreements are overturned, their legality will vary by state. Some states will continue to prohibit non-competes, but most require that they be reasonable to be enforceable. This reasonableness standard applies to:

• The extent of the restriction on the former employee, and
• The duration of the restriction.

The agreement must balance the organization’s legitimate business interests while still allowing employees to work in their chosen field. For example, a beauty salon might have good reason to prohibit former stylists from working within 15 miles of the business for at least six months after their employment ends. Without such an agreement, a stylist’s clients may follow them to a new place of employment, taking business away.

However, requiring stylists to sign an agreement promising not to work within 60 miles for at least two years would make it very difficult for them to earn a living in their chosen field. This type of non-compete probably wouldn’t be enforceable in most states because:

• It’s not reasonable in scope, and
• It’s probably not necessary to protect the company’s interests.

Even if employees sign the agreement, a court may not uphold it if the non-compete is not clear and reasonable. To be valid, a non-compete agreement must be narrowly tailored to meet state law and the needs of the employer while still balancing the needs of the employee.

Non-competes are not for all organizations

Before adopting a non-compete, employers should consider federal and state laws, along with the pitfalls of such an agreement. Even if the agreement legally restricts former employees, it may deter potential employees who don’t want to deal with such limitations if the job doesn’t work out. Current employees may feel resentful of the control imposed by a non-compete, and those who aren’t happy may feel bound by it, resulting in unhappy, unproductive employees with the organization long term.

If the company decides that a non-compete is necessary, they should work with an attorney to draft an agreement that will hold up in court. Non-competes can work to protect an organization’s interests, but only if they’re carefully set in a way that satisfies applicable state and federal requirements.