Legal Updates

Non-Compete Agreements Are Facing Increased Scrutiny

September 2023 by Anthony L. DeProspo, Jr.

This past summer, the New York State Legislature passed a bill that would ban virtually all new employee non-compete agreements. If the bill is signed into law by Governor Kathy Hochul, New York would join a growing number of states that severely limit or outright ban non-compete agreements.

The pending New York legislation is part of a notable trend, at both the state and the federal level, of increasing restrictions upon employers’ ability to use non-competes to prevent employees from leaving and joining a competitor. As a result, employers are facing increasing challenges in protecting their customer relationships and maintaining their proprietary business information and other trade secrets.

Background

Non-compete agreements (also known as covenants not to compete) are widely used to prohibit workers from taking jobs with competitors for a defined period of time after their employment ends. A non-compete agreement is generally part of a more expansive legal contract between the employee and the employer. Many non-compete agreements restrict employees from working in the same industry as their former companies. Such agreements also commonly contain prohibitions on the disclosure of confidential customer information or solicitation of employees.

Courts have historically enforced non-compete agreements to the extent that they are narrowly tailored and protect legitimate business interests. In recent years, however, numerous states have passed legislation significantly restricting, or even banning outright, non-compete agreements. At the same time, federal agencies have taken steps aimed at curtailing non-competes on a nationwide basis.

State Laws

A growing number of states have banned or sharply limited the enforceability of non-compete agreements, viewing them as severe restrictions on employee mobility.

For instance, the bill recently passed by the New York legislature would render unlawful any non-compete agreement entered into after the effective date of the law. Existing non-compete agreements would remain enforceable, as would non-solicitation agreements and agreements that prohibit the disclosure of trade secrets or other confidential and proprietary information.

Although it remains unclear whether the measure will become law, its approval by both houses of the legislature suggests that, at a minimum, significant restrictions upon non-competes in New York are in the offing.

If the bill is approved, New York would join a number of other jurisdictions that have virtually banned non-compete agreements. These jurisdictions include California, North Dakota, Oklahoma, the District of Columbia, and Minnesota.

Other states have enacted less sweeping, but significant, restrictions on non-competes. For instance, Colorado, Illinois, Maine, Maryland, New Hampshire, Oregon, Rhode Island, Virginia and Washington prohibit non-compete agreements unless the employee earns above a certain salary threshold. Other states – including Massachusetts – limit the time period over which a non-compete can extend and/or require that an employee be given some type of special compensation in exchange for a non-compete.

Proposed FTC Rule

At the federal level, on January 5, 2023, the Federal Trade Commission (“FTC”) announced a proposed rule that, if formally adopted, would amount to a near-total nationwide ban on non-compete agreements. The proposed rule would apply to employees, independent contractors, and anyone else who works for an employer, whether paid or unpaid, such as interns and volunteers.

Based on the FTC’s finding that non-compete agreements “constitute an unfair method of competition and therefore violate Section 5 of the Federal Trade Commission Act,” the proposed rule would make it illegal for a business to:

Enter into or attempt to enter into a non-compete agreement with a worker;

Maintain a non-compete agreement with a worker; or

Represent to a worker, under certain circumstances, that the worker is subject to a non-compete agreement.

The FTC’s proposed rule also takes the position that other forms of restrictive covenants, such as non-disclosure or non-solicitation agreements, could be construed to be so onerous as to be considered de facto non-competes.

The proposed rule’s public comment period expired on April 19, 2023. The FTC received thousands of comments, which it will review before publishing any final rule.

Assuming a final rule is eventually issued, it is likely to be extensively litigated. Given that non-competes, historically, have been a matter of state law, employer groups are likely to argue that the FTC lacks statutory or even constitutional authority to impose such a sweeping ban.

NLRB Memo

On May 30, 2023, the National Labor Relations Board’s (“NLRB”) General Counsel issued a guidance memorandum asserting that non-compete agreements can unlawfully chill employee rights protected by Section 7 of the National Labor Relations Act – i.e., the right to unionize or engage in other concerted (i.e., mutual) activities.

The NLRB’s General Counsel identified a number of examples of protected concerted activity that may be threatened by non-compete agreements:

Concertedly threatening to resign to demand better working conditions;

Carrying out threats to resign to secure improved working conditions;

Concertedly seeking or accepting employment from a local competitor to obtain better working conditions;

Soliciting fellow employees to work for a competitor; and

Seeking employment in order to engage in protected activity with other workers at an employer’s workplace.

According to the General Counsel, non-compete agreements improperly deter workers from engaging in Section 7 activity, unless a non-compete provision is narrowly tailored to “special circumstances” justifying the infringement on employee rights. In this regard, the NLRB stated that “a desire to avoid competition from a former employee is not a legitimate business interest that could support a special circumstances defense.”

If the General Counsel’s position on this issue is adopted by the NLRB in future rulings, it may be vulnerable to court challenges on similar grounds as with the proposed FTC rule. Nonetheless, employers should be prepared for future unfair labor practice charges by employees and unions based on non-compete agreements.

Next Steps For Employers

With these recent developments in mind, there are a number of steps we suggest employers take:

In conjunction with experienced employment counsel, review any non-compete agreements that you currently use, to ensure that non-competes are narrowly tailored, compliant with current legal standards, and presented only to employees as to whom an employer has a legitimate interest in protecting itself against future competition.

Consider potential alternatives to non-competes, such as retention bonuses, customer and employee non-solicitation covenants, and non-disclosure agreements.

Limit those employees who have access to confidential business information to avoid the need for non-competes in the first place. This may mean reassigning job responsibilities or making changes to reporting structures.

Keep a close eye on the latest developments affecting non-compete agreements in the state(s) where you do business.

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If you have questions about these recent developments or any other aspects of non-competition agreements, please feel free to reach out to one of our experienced employment attorneys.