Episode 26 | Following the Rule: A Guide to Recent FTC Developments - With the Federal Trade Commission recently issuing their “Final Rule,” this leaves employers facing a lot of unknowns along with impending questions about the state of their companies. Labor and Employment Practice Group Chair
Brian Kelly and
Andrew Cleves join host
Mike Smith to delve into what kinds of non-compete clauses will be barred by this rule and what this means for employers moving forward.
Podcast First Aired: August 7, 2024
Transcript
Mike Smith:
Welcome to another edition of Frantz Ward's podcast, Shoveling Smoke, where we discuss current legal issues affecting the business community and our daily lives.
I'm Mike Smith, your host for today's edition. It's been a while since I've had a chance to host, so I'm happy to have been called from the bullpen to handle today's show.
We've been hearing from months now that the federal government has decided to outlaw non-compete agreements. Many people are celebrating this, but others are concerned about how it'll impact their business' ability to protect trade secrets and their investment in employees.
Experience has taught us that developments like this are often very different in reality than they've been portrayed in the media and on social media. So, given the importance of this issue to individuals and businesses of all types, we're going to talk today about what's really happening. As usual, we’ve brought in the Frantz Ward experts who are going to give us that insight.
Today, we welcome Brian Kelly, my partner who is practice group leader of Frantz Ward's Labor and Employment Group; and Andrew Cleves, another one of my partners at Frantz Ward, whose practice involves dealing with the non-compete issues on a daily basis.
Welcome, gents.
Andrew Cleves:
Thank you very much.
Brian Kelly:
Thanks for having us, Mike.
Mike Smith:
So, I think a good place to start about this discussion and this issue seems to be looking at how it all came up in the first place and what the Federal Trade Commission was up to. Andrew, can you tell us a bit about that?
Andrew Cleves:
Sure. Well, it all started with the FTC’s leadership under the Biden administration, exploring what it described as the harmful impact of non-compete agreements on American workers, employers, and the country as a whole.
So, they started the rulemaking process, ultimately and finally issuing the final rule on April 23rd of this year. So, in that rule, it declares that it is an unfair method of competition for a person to do any one of the following: one, enter into or attempt to enter into a non-compete clause; two, enforce or attempt to enforce a non-complete clause. Or three, represent that a worker is subject to a non-compete clause.
Mike Smith:
Now, I know you folks in the Labor and Employment Group have heard from all kinds of employers and employees who have a lot of questions about this new FTC rule, and what it means and how it's going to impact them. So, I thought maybe we could spend some time tackling some of the most common questions.
So, Andrew, we'll stick with you for a minute – when does this rule become effective?
Andrew Cleves:
Sure. That will be September 4th of this year. So, just about four weeks from today.
Mike Smith:
And specifically, what kinds of non-compete clauses are going to be barred by the rule?
Andrew Cleves:
That's a good question, and one thing I want to, I guess, clarify or say from the start, is that the phrase “non-compete” is often used in a general sense to describe what more accurately would be called restrictive covenants.
So, this rule from the FTC bars what I'll call traditional non-compete clauses (I'll explain what that means in a minute). But what the rule generally does not bar is companies from entering into or enforcing two other types of restrictive covenants, which are fairly common.
Those are one, non-solicitation provisions, which frequently prohibit the solicitation of customers, prospective customers, and or employees. And two, non-disclosure provisions.
I should know with that though, that non-solicitation and non-disclosure provisions may fall within the ambit of the ban non-competes if those provisions are impermissibly overbroad.
So, turning to the specific or traditional non-competes, the rule bars any clauses or provisions that are a term or condition of employment and that prohibit or prevent a worker from or penalize a worker for, one, seeking to accept work in the U.S. with a different person where that work would begin after the conclusion of their employment. So, in other words, going to work for a competitor.
Two, operating a business in the U.S. after the conclusion of employment. In other words, going and starting your own competing business.
Now, importantly (and you may have picked up on this from what I just described), the rule only bans restrictions on activities that occur after the employment relationship ends. So, in other words, an employer can still restrict an employee's ability to compete during his or her employment, and those are often found in the context of duty of loyalty provisions in agreements.
Mike Smith:
So, specifically, what are employers restricted from doing?
Andrew Cleves:
Well, beginning on the effective date, and right now that's September 4th, employers are prohibited from entering into any non-competes that are barred by the rule with any workers. In addition, they're prohibited from enforcing or attempting to enforce any existing non-competes with workers other than anyone that's defined as a senior executive.
Mike Smith:
So, Brian, let's have you jump in here and give us some thoughts on some of these questions. First one that jumps to mind is, can an employer enforce an existing non-compete against anybody?
Brian Kelly:
It’s a pretty common question, Mike. Like Andrew mentioned, there's this very small carve out for the term “senior executives” under this new rule, which of course, begs the question, who the heck is a senior executive.
But the rule provides that if someone is a senior executive, and if that senior executive entered in a non-compete before the rule’s effective date, so assume it's September 4th, an employer can still enforce that non-compete against that person, but only until that non-compete expires.
Mike Smith:
Does the rule tell us who a senior executive is?
Brian Kelly:
It does, and it does so with somewhat ambiguous terms in a way. There are two parts of the test to tell whether someone's a senior executive.
One is just about how much they earn. That's pretty objective, easy to apply. Under the current test as they have it laid out in the rule, somebody has to make over $151,164 each year to be a senior executive. So, that's the easy part. Just objectively to be a senior executive, they have to make more than that.
The harder part is the job duties test for someone to be a senior executive. And what the FTC has said is that you can't try to carve out just anyone as a senior executive. It's got to be someone who's in an actual policy-making position. So, someone who's high enough up in the organization that they actually can make policy decisions and have final authority to make those policy decisions on things that really are significant to the business.
And so, who is that? That'll certainly vary by organization. The FTC said that most of your traditional c-suite employees, the CEO, CFO, COO, those will be senior executives. What's going to be left for the courts to bear out is who else beyond those traditional c-suite executives?
Mike Smith:
Brian, can you give us an idea – is this rule going to cover all types of employers, or are there certain ones carved out? How does that work?
Brian Kelly:
That is one area that's also relatively clear from the rules. Because the rule was generated by the Federal Trade Commission, the Federal Trade Commission, the FTC can only regulate certain types of employers, and there are a lot of employers that are exempted from FTC’s jurisdiction.
So, savings and loan institutions, certain types of banks, non-profits, common carriers that do trucking over the road, some of those organizations are exempt from the FTC jurisdiction, so they're outside of its reach.
Now, that doesn't mean that Congress might try to make a broader law at some point in the future, and Andrew and I deal all the time with individual states that go ahead to ban non-competes. But for purposes of just this FTC rule, it'll apply broadly to essentially all employers except those that are outside the FTC’s reach.
Mike Smith:
So, I'm definitely going to have to keep an eye on this as we go in the future in that regard.
Brian Kelly:
Absolutely. It's going to have very broad impact if it goes forward.
Mike Smith:
Andrew, let me jump back to you. We all know that a lot of our employers that we represent have handbooks or written policies. How does the rule apply to that or affect those?
Andrew Cleves:
Yeah, no, that's a good question. So, when looking at whether employee handbooks or policies would apply, I mean in a typical lawyer fashion, the answer is they potentially may apply. The rule is not specifically limited to non-compete clauses and contractual agreements.
So, it could extend to any non-compete restrictions in handbooks or policies if such clauses are defined to be a term and condition of employment. So, certainly, worth companies taking a look at their handbooks and policies.
I mean, in my experience, a company may have a confidentiality non-disclosure provision in the handbook, but if they do have an have a non-compete, it certainly could be subject to this rule.
Mike Smith:
Does the employer have any kind of notice obligations under the rule?
Andrew Cleves:
It does. So, by or before the effective date, employers must provide what the FTC called clear and conspicuous notice to workers subject to non-competes that the rule bars, and then that notice must explain that such non-competes cannot and will not be enforced by the employer beginning on the effective date.
Then that notice (in case you're wondering what it might include) must identify the employer and worker and be sent to the worker's last address on file. An employer may deliver that notice through hand delivery, regular mail, email, or text message.
And in case any employers have put this off or sweating what the actual notice should look like, the FTC does have a sample that they can use. May want to run it by council to see if council has any changes, but FTC has at least provided a baseline.
Mike Smith:
Does this notice requirement apply to former workers or employees as well?
Andrew Cleves:
Yes. If the former employees with a non-compete clause is still in effect, employers must provide notice to them using their last known address on file. There is an exemption that employers do not have to provide the notice if they do not have any record of a mailing address, email or phone number on file.
However, I would expect that would be the exception because most non-compete provisions are limited to being in effect for one or two years.
Mike Smith:
So, does the rule require employers to rescind actual agreements with their workers?
Andrew Cleves:
No, the rule does not go that far. And the FTC did consider requiring that they be rescinded, but the final rule only requires employers to provide notice to workers that their non-compete clauses will not be enforced.
Mike Smith:
But we see there's litigation all the time on enforcing non-competes. Is there any comment or indication on how existing current litigation would be affected by the rule?
Andrew Cleves:
Yeah, the rule does not affect currently existing litigation. And in fact, also will not affect any litigation filed prior to the effective date. So, if anyone has a former employee and they're contemplating whether or not they want to file a cause of action, you got about four weeks to make that decision as it currently stands.
Mike Smith:
Brian, let me jump back to you, I still have a few final questions to tackle here. Does the rule contain any other exceptions?
Brian Kelly:
There are some. So, we talked a little bit about the senior executives, and the only other real broad category of individuals that employers should still be able to enforce non-competes against, come up in the context of the sale of a business.
So, if I am an employer and I buy a business from someone, certainly very typical, I'm going to say, “Hey, Mike Smith, I'm buying your business. I want to lock you into a non-compete so you can't take all your customer relationships and then compete against me.”
So, the FTC did leave in there that there's an exception if somebody enters into a non-compete in connection with the sale of a business, then that non-competes can still be enforced against that person, which certainly is fair since protection from the non-compete would be a significant portion of what you would be buying presumably.
Mike Smith:
So, one of the compensation strategies we often see that our clients use is bonus repayment provisions. And a lot of people argue that that kind of provision essentially constitutes a non-compete. Is that permitted under the rule still?
Brian Kelly:
It is, it just can't be something that someone tries to get too cute with. So, a retention bonus agreement is usually saying, “Hey, we're going through a period of transition, or I just want to make sure you stick around.” So, if you stay with this company for a big amount of time, the next year, you're going to get a retention bonus for sticking around that long.
And so, if that's all it is, that it just says if you stay for a set period, you get some money, that's a retention agreement, not a non-compete, and that's okay. If it goes beyond that, and so if it says, “Hey, if you leave before that time, you have to pay back more than the retention bonus,” it's not okay because that's certainly intended as a penalty to try to deter you from leaving.
Similarly, if the retention agreement isn't just tied to you sticking around, so stay for a year, you get the payment, it also says stay for a year and if you leave, you can't do X, Y, and Z after you leave. Well, that's not okay. And that would be unenforceable because that's not just a retention bonus agreement. That's where someone's trying to hide a non-compete in something like that.
So, yes, you can, but you can't get cute and try to turn a retention bonus agreement into something else.
Mike Smith:
Well, how about severance agreements? A lot of times, we see our clients try to sort of tie a non-compete to a severance agreement. Would that be permissible under the rule?
Brian Kelly:
It wouldn't. The idea is if the severance agreement pays out only if the person honors the non-compete. So, say, I'm going to pay you the severance, but I get to take the money back if you compete with me afterwards, then it's not just a severance agreement, it's a non-compete. So, the FTC says that is not permitted as well.
Mike Smith:
How about going outside the United States? Will the rule apply to restrictions on competition outside the U.S?
Brian Kelly:
No is the short answer. It gets back to the idea of where this rule came from. Since the FTC is part of the executive branch of the U.S. government, its reach is limited. And so, the FTC does not have authority or power to regulate any type of behavior or competition outside the U.S.
So, if you had a non-compete that just said, “Hey, you can't go work in Canada,” arguably that's a restriction on competition outside of the U.S., and that would be something the FTC could not stop from happening.
Mike Smith:
And finally, there's always the $75 million question, and that's what's the penalty if we violate this new rule?
Brian Kelly:
That's something also we're going to have to see. The FTC has said that if there's a violation, so for example, if an employer continues to pump out non-competes, or if an employer tries to intimidate an employee or former employee by threatening to enforce a non-compete, what's most likely is the FTC would try to get an injunction against the employer to shut the person down.
There are provisions where the Federal Trade Commission, the FTC could try to seek penalties in light of what we've seen in some of the recent Supreme Court decisions. It's certainly up for debate whether the FTC would be able to enforce civil penalties against employers or whether they would have to go to court and try to get a court order in that regard.
So, for right now, the primary risk and the primary penalty violating the rule would be an injunction, not so much about monetary relief. But if the FTC decides to get more aggressive, we may see that change.
Mike Smith:
Well, it sounds like employers and employees have a lot to consider under this new rule. Andrew, you've mentioned a couple times that it's supposed to go into effect September 4, is that really going to happen?
Andrew Cleves:
We'll see. I know everyone would probably rather hear a more definitive answer, but the reality is there are multiple court challenges to the rule currently in effect (two of those of note). There’s one in Pennsylvania where the judge initially issued a ruling that was favorable to the rule.
And then on the other side, is a case in Northern District of Texas where that judge in a preliminary injunction ruling, said that the FTC had exceeded its authority, the plaintiffs were likely to succeed on the merits of challenging the rule; however, the judge limited that decision and only enjoined or prevented it from being enforced against the named plaintiffs.
However, there's another deadline coming up in that case by August. The court has indicated that it'll rule on the merits of the case on or before August 30th. So, August 30th is the Friday before Labor Day, and the rule is set to go into effect that following Wednesday. So, we hopefully will know before the 4th, although it may not be more than a couple days beforehand.
Mike Smith:
So, given this uncertainty we've got here, Brian, what do you suggest employers do right now to address the new rule?
Brian Kelly:
As with all these crazy things and with the unpredictability of the courts, the first thing that we always from our labor group suggest, everybody just take a deep breath. There are very few situations where you need to operate in panic mode, and this isn't one of them.
Now, like Andrew said, we're supposed to hear certain things by August 30th. So, there's still some time to hold back before employers do dramatic things like throw out all the non-competes and start contacting employees.
But what employers ought to do is take a look at what they have in place. If the idea, like you said at the outset, Mike, is to make sure that intellectual property and things of that nature, confidential information being protected, there are other ways to do it. Andrew mentioned non-solicitation agreement, non-disclosure agreements, those are still okay to use even under this rule from the FTC.
And so, from a strategy standpoint, what employers ought to start thinking about is, you know what, maybe there ought to be an alternative to the traditional non-compete. If I'm really worried about intellectual property, let's get a good non-disclosure agreement in place. If I'm worried about my specific customers, maybe I have something in place, and non-solicitation agreements is people can't solicit my customers.
They can still compete, they can still go into business, and they can enter into this industry, but they can't use the information I've given them to go after my customers. So, really those contingency plans ought to be underway now. I wouldn't roll them out, but you plan for life under the rule just in case it goes into effect.
Similarly, Andrew mentioned the idea of having to get notices out to employees and former employees who are still under non-competes if the rule stays in effect. It makes sense right now, while we're waiting for these core rulings to at least have a strategy for those notices. Get a list together, get the addresses, prepare the draft notices in case they have to go out.
But in the meantime, employers should continue to enforce their non-competes. If they are valuable to the business, if they're written in a way that they're otherwise enforceable under the court rules, they ought to do that. They’re presumably in effect for a valid reason, and they ought to be enforced.
And of course, keeping in touch with whomever your trusted source is for this type of information to know about the developments and what's changing. Those are the steps that I would take now Mike as an employer.
Mike Smith:
Okay, well, Brian and Andrew, thanks very much for your insights today. I think it's very helpful and gives our listeners some guidance as to what's going on out there. It certainly sounds like we haven't heard the last of this story, and it will be interesting to see how it all shakes out.
And I would suggest to keep an eye on the Frantz Ward website for any reports of new developments, which our labor and employment folks are certainly going to report on in the future.
And that wraps up another episode of Shoveling Smoke. Thanks for checking in with us. Look out for another podcast soon.
Shoveling Smoke is a production of Evergreen Podcasts. Our producer and audio engineer is Sean Rule-Hoffman. Thanks for listening.