Many companies rely on restrictive covenant agreements to protect important business interests, but federal and state governments have become interested in–and hostile to–these agreements. While various bipartisan U.S. congressional actions have failed to gain traction, federal agencies and state legislatures have been active in attempts to curtail the use of restrictive covenants.
The FTC Changes Its Position and Issues Notice of Proposed Rulemaking
In 2016, the Federal Trade Commission (FTC) and Department of Justice (DOJ) jointly published its Antitrust Guidance for Human Resource Professionals. In the guidance, the FTC and DOJ focused on no-poaching and wage-fixing agreements under antitrust law with regard to traditional restrictive covenants between an employer and its own employees. Under the guidance, the DOJ and FTC will apply the “rule of reason” test, permitting an employer to defend its restrictive covenants by pointing to the need to protect legitimate business interests. Then, on January 5, 2023, the FTC changed its position by issuing a far-reaching notice of proposed rulemaking (NPRM) that would prohibit the use of non-compete clauses in employee agreements and preempt all state laws providing lesser protection than the proposed rule. The proposed rule would apply to any contractual term that functions to prevent a worker from seeking or accepting employment or operating a business after leaving the employer. The proposed rule does not ban non-disclosure or customer non-solicitation agreements, but the ban could apply if those provisions were broad enough to prohibit a worker from working in the same field.
The NPRM received attention and concern from many companies. Over 21,000 comments were submitted. The final rule is expected this year but would not go into effect until 180 days after it is published. If not significantly changed from the proposed rule, the final rule is likely to face numerous legal challenges. First, the rulemaking likely exceeds the FTC’s legal rulemaking authority under the Federal Trade Commission Act and the delegation clause. Second, the rulemaking invades the state provenance of contract law. Third, the rulemaking may trigger the major questions doctrine—and, as such, any action purporting to ban non-compete provisions would need to be undertaken by the U.S. Congress.
The National Labor Relations Board General Counsel Weighs In
While the FTC rulemaking languished for over a year, on March 22, 2023, the National Labor Relations Board (NLRB) General Counsel issued GC Memo 23-05 on the McLaren Macomb decision noting additional problematic provisions potentially impacting National Labor Relations Act (NLRA) rights, including non-compete clauses, non-solicitation clauses and no-poaching clauses. Then, on May 30, 2023, the General Counsel issued GC Memo 23-07, declaring her opinion that the “proffer, maintenance and enforcement” of non-compete agreements in employment contracts and severance agreements violate the NLRA “except in limited circumstances.” The opinion does not impact company’s agreements with supervisory or managerial employees but gives little exception for non-supervisory and non-managerial employees, allowing such agreements only when narrowly tailored and necessary to protect trade secret information. Companies are already receiving Unfair Labor Practice charges in accordance with the memo.
State Attention on Restrictive Covenants Continues to Increase
While federal agencies have shown increased attention to restrictive covenant agreements, they have traditionally been a matter of state law. Perhaps recognizing the limits of its own authority, the FTC has sent letters to states urging them to ban non-competes. While California, North Dakota, Oklahoma and, as of July 1, 2023, Minnesota are the only states that completely ban non-competes between employers and employees, nearly half of all U.S. states and the District of Columbia have enacted legislation relating to restrictive covenants. Proposed legislation continues to increase. In 2021 alone, there were 66 bills filed in 25 states. In 2022, there were 99 bills filed in 33 states. By the beginning of March of 2024, there were already over 50 bills filed.
Many of the state laws enacted have focused on banning restrictive covenants for workers making under a certain level of compensation. These vary widely from $15 per hour or less in Maryland to over $100,000 in Washington, Oregon and Colorado. Other states, including Colorado, Illinois, Maine, Massachusetts, Minnesota, New Hampshire, Oregon, Virginia and Washington, as well as the District of Columbia, have enacted notice provisions, ensuring employees may not simply be presented with an agreement the first day of employment and expected to sign. Other state initiatives have focused on specific types of employees, such as healthcare employees (including temporary healthcare staff), veterinarians and broadcast employees.
In 2023, California, which has long banned non-competes, went further in passing two bills enforcing its stance. Under Section 16600.1 of the California Business and Professions Code, by February 14, 2024, employers were required to send individualized written notices to current and some former California employees that any non-compete provisions they may have entered are void. Under Section 16600.5 of the California Business and Professions Code, employers may not enter into or attempt to enforce non-compete agreements “regardless of whether the contract was signed and the employment was maintained outside of California.” The new law paves the way for employees to avoid otherwise valid obligations by moving to California after their employment ends.
While state legislatures have been increasingly strict, in recent years, state attorney generals have also been vigorous in challenging employer-employee non-competes. As just a few examples, attorney generals of Illinois, New York and Washington initiated widely publicized investigations and cases against employers that they believed had abused non-compete agreements by subjecting low-wage employees to them.
What Should Companies Do Now?
Restrictive covenant agreements remain important tools in protecting companies’ legitimate business interests. While there has been increased pressure on non-competition agreements, companies may consider using a multi-layered approach of non-disclosure provisions, non-solicitation provisions and trade secret law to protect important business interests. Rather than a one-size-fits-all approach to restrictive covenant agreements, companies may carefully consider the types of employees who receive these agreements. Employers may consider drafting agreements intentionally and narrowly, and tailored in accordance with the law of the state where the employee resides.
Christine Bestor Townsend is a shareholder in the Milwaukee and Chicago offices of Ogletree Deakins and co-chair of the firm’s Unfair Competition and Trade Secrets Practice Group. She is a trusted counselor and experienced litigator on a full range of labor and employment issues, including proactively assisting employers in complying with state and federal employment laws, navigating complex leave and accommodation situations, and handling personnel issues. Christine represents employers before federal and state courts and administrative agencies throughout the country, including in the areas of trade secret and noncompetition, wage and hour, employee benefits and employment discrimination.
