FTC’s blocked noncompete rule an opportunity to rethink practices

Published: August 29, 2024 | by Robert S. Teachout, Legal Editor at Brightmine

On August 20, a federal court in Texas issued a nationwide permanent injunction blocking the Federal Trade Commission (FTC) final rule just weeks before it would have taken effect. The rule would have required employers to rescind existing noncompete agreements and actively notify workers that they are no longer in effect, except in the case of existing noncompete agreements for senior executives, and banned new noncompetes.

The outcome, while expected, was not guaranteed; and employers anxiously waited for months for a final ruling before the rule’s effective date of September 4. Of the three court cases filed to block the FTC noncompete rule, two courts (Texas and Florida) issued preliminary rulings finding that the rule was likely unlawful, while a Pennsylvania federal district court had found in favor of the rule.

The rule may still be revived. The FTC is seriously considering an appeal to the 5th Circuit Court of Appeals. And the Florida and Pennsylvania courts may still issue rulings with different findings and outcomes. It is possible for one or all of the cases to make their way to the US Supreme Court.

So, what should employers do now?

State restrictions remain

With the FTC rule blocked, the legal landscape remains as it was. Noncompete agreements are regulated by a patchwork of state statutes and case law, with more laws restricting some or all noncompete agreements every year.

Four states — California, Minnesota, North Dakota and Oklahoma — already ban the use of noncompete agreements in employment. Thirty-four other states place restrictions on employers that protect several categories of employees from the use of noncompete agreements. These restrictions generally support state goals of protecting low-income employees and ensuring access to critical services and information.

Even where there are no restrictions on the use of noncompete agreements, state courts have issued rulings that limit the scope of noncompete agreements. The case law establishes limits on the length of time, geographic boundaries and what consideration is needed for such an agreement to be valid, and whether a court may modify an agreement to make it enforceable.

Employers that continue to use contracts including noncompete clauses need to keep all these factors in mind.

Reevaluate using noncompetes

Noncompete agreements, which prohibit employees from providing services to competitors for a period after their employment ends, have always been subject to judicial, legislative and agency scrutiny. However, in the wake of news stories over the past few years that have covered the abuse of such contracts (such as employers requiring them for fast food employees and other low-wage workers), states and courts have taken a harder look at whether more limits are needed.

In addition, public perception of noncompetes is decidedly negative. A study conducted shortly after the FTC announced its final rule found that 70% of employees, as well as 72% of business executives, supported the noncompete ban. An August 2024 Monster survey found 94% of employees support eliminating noncompetes.

Given the current negative sentiment, employers should reconsider whether the use of noncompetes should be continued as before. Assess if alternative methods for protecting legitimate business interests would be just as effective while having less risk of being voided and offering more benefits to the organization’s reputation. State legislatures have enacted fewer restrictions on the use of nonsolicitation and nondisclosure agreements. In addition, the federal Defend Trade Secrets Act and many state laws protect legitimate trade secrets and confidential information.

Employers are best advised to consider what protections they really need rather than what restrictions they can get away with imposing. An employer that determines there is still a need to use noncompete agreements at a minimum should carefully scrutinize:

• Which employees are required to sign a noncompete. State legislators and courts are less likely to restrict noncompetes for high-level employees, such as well-paid executives and department heads who are privy to confidential product development, organizational strategies and trade secrets.
• How long a noncompete stays in effect. The longer the agreement’s term, the more likely it is that it may be found unenforceable.
• The geographic limit on the where a former employee can accept similar work. As with the time limitation, the larger a geographic limit is, the greater the chance of the agreement being voided.

Ultimately, noncompetes are meant to serve a legitimate purpose: protecting the employer’s business, standing and goodwill. Carefully considering when to use a noncompete and when to use an alternative approach will help avoid abusive practices and make such decisions more defensible if challenged in court.