Employers Beware! New FTC Regulations May Render Certain Restrictive Covenants Illegal

Ryan M. Billings
rbillings@kmksc.com
(414) 962-5110

A new proposed rule announced by the Federal Trade Commission, if it becomes final, will make employee non-compete agreements unenforceable and illegal, and will also outlaw certain non-disclosure and non-solicitation agreements. Employers should follow this evolving situation closely. 

Restrictive covenants (non-compete, non-disclosure and non-solicitation agreements) have traditionally been regulated by state law. Certain states (like California) have been extremely hostile to restrictive covenants and have made employee non-compete agreements unenforceable across the board. Other states (like New York) have been more lenient, generally enforcing such agreements if they are reasonable and support a legitimate business interest. Wisconsin is very much a special case, in that it both has very particular rules governing restrictive covenants, and Wisconsin statutory law provides that if an employee restrictive covenant is overbroad in any respect, the entire agreement is unenforceable. However, a new FTC rule would displace the various state laws and flatly prohibit employee non-compete agreements, as well as broad non-solicitation and non-disclosure agreements. 

The Biden Administration has repeatedly expressed a desire to limit employee non-compete agreements, and directed both the FTC and the Department of Justice to review the issue. Following a few test-case enforcement actions, the FTC recently announced a proposed rule, under its broad authority to prohibit “unfair or deceptive acts or practices,” that would fundamentally change the law concerning restrictive covenants. 

The proposed rule would prohibit employers from: (1) entering into or attempting to enter into employee non-compete agreements; (2) maintaining employee non-compete agreements already in place; or (3) representing to an employee that the employee is subject to a non-compete agreement. Moreover, the proposed rule would also prohibit what it calls “de facto” non-compete agreements, namely non-disclosure or non-solicitation agreements that are so broad that they effectively act as non-compete agreements. Further, the proposed rule would prohibit employers from requiring employees to repay training costs (for instance, if they leave employment immediately after training is completed) if those costs are not reasonably related to the employer’s actual expenditures. Covering all employees, the new rule would also apply to independent contractors, interns and volunteers. 

Under the laws of many states (like Wisconsin), restrictive covenants that are entered into in connection with the sale of a business are viewed more leniently by the courts, even if the individuals in question will maintain an employment relationship with the buyer after the sale, and the proposed rule has a carve-out for non-compete agreements incident to the sale of a business, which would remain permissible. However, this carve-out would apply only to an individual who owns 25% or more of a business, so many owners would not qualify. 

Because the proposed rule would prohibit employers from “maintaining” non-compete agreements, if the proposed rule becomes final, employers will have to act swiftly to undo non-compete agreements that are already in place. Companies that violate the rule would be subject to all the penalties available to the FTC under Section 5 of the Fair Trade Commission Act.

What does this proposed rule mean for businesses? It is a fundamental sea change. If the rule becomes final, every business will have to take immediate steps to undo its non-compete agreements in place, stop utilizing non-compete agreements as part of its business practices, and review every non-disclosure and non-solicitation agreement in place to ensure that they do not qualify as (or could be considered by hostile regulators to be) “de facto” non-compete agreements. This would require a soup-to-nuts review of all contracts with employees, independent contractors, interns and volunteers to ensure compliance with the law. Simply put, if the proposed rule becomes final, businesses and their counsel will have an enormous amount of work to do in very short order. 

When could the proposed rule become final? This remains somewhat murky. Because it is a rule adopted by the FTC, not legislators, the proposed rule can be enacted only after a notice and comment period, followed by publication, a waiting period and then enactment. Here, the notice and comment period is set to expire April 19, 2023. The rule could in theory be published soon after that, and become effective 60 days after publication. Under the language of the proposed rule, businesses would be required to comply within 180 days after publication. That could be as early as fall 2023. 

However, it is likely that this new rule would be considered a “substantial” change under the Administrative Procedure Act that applies to agency-made rules, which could further delay implementation. Moreover, heavy pushback to the proposed rule is expected, from businesses, legislators and in the courts. Major court battles or a shift in power in Congress or the Presidency could prevent the rule from becoming final, or delay implementation into 2024 or perhaps even later. But, given its scope and impact, businesses should carefully monitor developments regarding the proposed rule and consult with competent counsel concerning evolving law on this subject.

If you have questions concerning your restrictive covenants, would like a review of your restrictive covenants in place or would like to discuss the proposed rule in further detail, please contact KMK Attorney Ryan M. Billings at rbillings@kmksc.com or (414) 962-5110.