The non-competition clause may not be long for this world. On January 5, 2023, the Federal Trade Commission (FTC) announced a proposed rule to ban non-competes for most workers nationwide,1 which underwent a 90-day public comment period that ended April 19, 2023.2 The ball is now in the FTC's court to publish a final rule and announce an effective date. Much remains uncertain. It is unclear when the final rule will become effective. It is unclear whether the FTC will publish the rule in its proposed form or if the FTC will amend the final rule based on public comments. Although the final rule will almost certainly face stiff legal challenges, it is not clear whether those challenges will succeed, or if any federal court will issue a nationwide stay of the final rule while the challenges play out in court.
Employers, workers, and their respective counsel are left to guess what comes next. The non-competes' future is uncertain, although legal consequences for misapplying the law remain. Regardless of the outcome of the FTC process, what is clear is that this is a good time for employers to explore other measures to protect business interests.
The non-compete, generally.
At its core, a non-compete is a contractual provision between an employer and worker that restricts the worker from competing against the employer after the relationship ends. A properly tailored non-compete is an effective tool for businesses to protect confidential information, business expectancy, and customer goodwill. An overly broad non-compete, however, unnecessarily restricts workers from earning a living without justification.
Like courts in many states, Virginia courts disfavor non-competes.3 In Virginia, the employer bears the burden to prove a non-compete is enforceable. To meet this burden employers must show that the restriction (1) is no broader than necessary to protect the employer's legitimate business interests, (2) is not so severe as to restrict the workers ability to find work or earn a living, and (3) does not violate Virginia public policy.4 Virginia courts assess non-competes on a case-by-case basis, and, based on the unique circumstances of each case, consider several factors to determine if the non-compete is properly limited to legitimate business interests. These factors are (1) the functional scope (the activity prohibited), (2) geographic reach, and (3) duration of the restriction.5
Also important, Virginia courts will not rewrite a non-compete to make it enforceable, otherwise known as "blue penciling."6 If a non-compete prohibits too much activity, covers too large an area, or lasts too long, it will likely fail in Virginia. If an employee can articulate any activity prohibited by the non-compete that the employer has no legitimate interest in restricting, a Virginia court will likely decline to enforce it.
What does the FTC's proposed rule prohibit?
Although the date of publication of the final rule is not known, the proposed rule states that compliance is required 180 days after publication.7 If the proposed rule goes into effect as drafted, the following requirements will apply as of the compliance date:
1. Employers cannot enter into or maintain any non-compete.
The proposed rule prohibits employers from entering into, attempting to enter into, or maintaining a non-compete with a worker.8 The proposed rule also prohibits an employer from representing to any worker that the worker is subject to a non-compete.9
The definitions related to this prohibition are broad. The term "worker" includes employees, independent contractors, sole proprietors, volunteers, interns, and any other person who works for an employer, with or without pay.10 Notably, there are no exceptions based on an employee's position, access to confidential information, or compensation level. The term "employer" means any natural person, partnership, corporation, association, or other legal entity, including any person acting under color or authority of state law that hires or contracts with a worker to work for that person.11 Of particular importance for employers, this definition implicates that an individual could be deemed personally liable for violations.
If a non-compete prohibits too much activity, covers too large an area, or lasts too long, it will likely fail in Virginia.
The proposed rule defines a non-compete 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."12 So, if one person works for another, regardless of compensation or whether the worker is classified as an employee, a non-compete after the end of that work is likely prohibited. Due to the broad scope of this rule, if the proposed rule becomes final as drafted, nearly any employer contract action restricting a worker from working could be a violation.
2. Employers must rescind existing non-competes and notify all affected workers.
The proposed rule also mandates that employers rescind all existing non-competes.13 When an employer rescinds any non-compete, it must notify all affected current and former employees that the noncompete is no longer in effect.14 The proposed rule provides sample language for the notification, which must be made by employers within 45 days of rescission.15
The proposed rule notes only one exception to the non-compete ban: the rule does not apply to a non-compete clause entered into as part of certain sales of businesses or ownership interests in a business.16
3. Overly broad restrictive covenants are de facto non-competes.
The proposed rule also addresses other restrictive covenants common in employment agreements such as non-solicitation of customers, non-disclosure of information, and training reimbursement. The FTC notes that such agreements may constitute de facto non-competes when the clause is broad enough in scope as to restrict a worker for working.17
The proposed rule provides a "functional test" for assessing whether a contractual term operates as a de facto non-compete. **Under the test, if a clause "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[,]" it is a non-compete.**18 The proposed rule sets out specific examples of de facto non-competes, including overly broad non-disclosure clauses and training reimbursement clauses not limited to the cost the employer incurred in training the worker.19 Although Virginia case law recognizes the concept that restrictive covenants may functionally act as a non-compete, the proposed rule indicates that the FTC will also target such clauses with federal enforcement action.
If the proposed rule becomes effective in its current form, violations may result in FTC investigations and/or enforcement actions. The Federal Trade Commission Act ("FTC Act") provides the FTC the power to investigate unfair competition, issue violations, issue fines, and pursue judicial enforcement.20 These processes can result in significant legal fees, civil fines, and sizeable judgments, so employers must consider all effective agency rules when operating.
The FTC's justification for the proposed rule.
The proposed rule is based on the FTC's finding that non-competition clauses are unfair methods of competition in violation of the FTC Act.21 In support of this finding, the FTC cites several studies finding that non-competes suppress wages, decrease the number of jobs, and increase the cost to consumers of products and services.22 The FTC also takes the position that, largely due to other legal protections available to employers, that the negative impact of non-competes outweighs the overall benefit to employers of maintaining non-competes.23 Based upon this finding, the FTC issued the proposed rule to carry out the purpose of the FTC Act and combat what it deems to be a method of unfair competition. This interpretation of the FTC's rulemaking authority is not without controversy.
Anticipated legal challenges to the proposed rule.
The proposed rule was announced by a 3–1 vote of the participating FTC Commissioners. 24 The lone dissenting Commissioner, Christine S. Wilson, issued a dissenting statement that sets out a road map for possible legal challenges.25 Of note, the FTC's rulemaking authority on unfair competition matters itself may be challenged. The FTC may have exceeded its rulemaking authority under the "major questions doctrine" by deciding matter of such significance where express Congressional authorization is needed, and thus the final rule, especially its retroactive application, may be unconstitutional.
The outcome and timing of any such legal challenges remains to be seen. It is also not certain whether any federal circuit will issue a nationwide stay on the effective date of the final rule while these challenges are litigated. These challenges will play out in the coming months or even years, and the future of non-competes will hang in the balance.
Where do we go from here?
As the country waits for the FTC to publish the final rule, Virginia businesses will continue to hire, and workers will continue to work. So, how does a Virginia attorney help a client navigate all this uncertainty?
Virginia attorneys need to remember that the proposed rule follows a Virginia statute enacted in 2020 that prohibits non-competes for certain low wage workers in the Commonwealth.26 This prohibition significantly limits the use of non-competes as a matter of state law. Of course, other states treat non-competes differently, including complete bans in several states. Regardless of the future of the FTC's proposed rule, businesses and attorneys must ensure any restrictive covenant complies with the applicable state law.
Employers also need to assess whether using non-competes makes sense with the prospect of a nationwide ban. For now, Virginia lawyers must think carefully about the scope of restrictive provisions in employment contracts with the proposed rule in mind. The strategy of drafting non-competes, non-solicits, and non-disclosure agreements as broadly as possible to "cover the waterfront" is increasingly problematic considering the FTC's focus on restrictive covenants.
This is a good time for businesses to think outside the box. Businesses should explore alternative measures to protect confidential information, business expectancy, and customer goodwill outside the four corners of a contract. While often lost in the legal shuffle, the best way to keep customers is to demonstrate the value of the business so customers have no reason to leave for a competitor. Recognizing the limitations of restrictive covenants, especially in a digital world with tools that directly connect employees and customers outside the workplace (e.g., Facebook or LinkedIn), some employers are getting back to practical measures to protect business interests—such as requiring the exclusive use of company-owned phones or email for business, creating relationships between customers and several different employees, creating a policy for customer outreach upon an employee departure, or rethinking public messaging upon an employee departure. Instead of focusing on preventing an employee from leaving, it is a good time to get back to basics and establish policies and procedures that protect business interests when that employee leaves, as opposed to relying on a legal document as the sole protection.
For employees, it might be time to dust off the resume.
Footnotes
1. Notice of Proposed Rulemaking for Non- Compete Clause Rule Part I (Jan. 5, 2023)
2. "FTC Extends Public Comment Period on Its Proposed Rule to Ban Noncompete Clauses Until April 19," Federal Trade Commission, March 6, 2023, https://perma.cc/F5SY-ZNUL.
3. Omniplex World Servs. Corp. v. U.S. Investigations Servs., 270 Va. 246, 249 (2005)
4. Assurance Data, Inc. v. Malyevac, 286 Va. 137, 145 (2013)
5. Omniplex World Servs. Corp. 270 Va. at 252 (2005)
6. See e.g., Lasership, Inc. v. Watson, 79 Va. Cir. 205 (2009) (listing Virginia courts declining to "blue-pencil")
7. Proposed § 910.5
8. Proposed § 910.2(a)
9. Id.
10. Proposed § 910.1(f)
11. Proposed § 910.1(c) citing 15 U.S.C. § 57b-1(a)(6)
12. Proposed § 910.1(b)(1)
13. Proposed § 910.2(b)(1)
14. Proposed § 910.2(b)(2)
15. Proposed § 910.2(b)(2)(A)-(C)
16. Proposed § 910.3
17. Proposed § 910.1(b)(2)
18. Proposed § 910.1(b)(2)
19. Proposed § 910.1(b)(2)(i) and (ii)
20. See e.g., "A Brief Overview of the Federal Trade Commission's Investigative, Law Enforcement, and Rulemaking Authority," Federal Trade Commission, revised May 2021, https://perma.cc/M3GZ-3HPG.
21. 15 U.S.C. 45(a)(1)
22. Notice of Proposed Rulemaking at p. 12-48.
23. Id. at 89-98
24. "FTC Proposes Rule to Ban Noncompete Clauses, Which Hurt Workers and Harm Competition," Federal Trade Commission, January 5, 2023, https://perma.cc/3SYZDJ6Z.
25. "Dissenting Statement of Commissioner Christine S. Wilson Regarding the Notice of Proposed Rulemaking for the Non- Compete Clause Rule," Federal Trade Commission, January 5, 2023, https://perma.cc/V87S-N2KJ.
26. Va. Code § 40.1-28.7:8
Originally published by Virginia Lawyer Magazine
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