United States: How The FTC's Proposed Ban Of Non-Compete Agreements Could Impact IP Litigation

On January 5, 2023, the Federal Trade Commission (FTC) proposed a new rule banning the vast majority of non-complete agreements as an unfair method of competition.² The rule also specifies that, if passed, all existing non-compete agreements must be rescinded within six months.³ The rule would preempt state laws governing non-competes.⁴ The announcement came as a follow-up to the Commission's statement last November "restor[ing] the agency's policy of rigorously enforcing the federal ban on unfair methods of competition."⁵ Despite the Commission signaling its intent to increase enforcement, the proposed rule came as a surprise to many, not only because it purports to preempt long-established state contract law but also because the last time the Commission issued a rule defining an unfair method of competition was the "Men and Boy's Tailored Clothing Rule," issued in 1968.⁶ This article provides a short explanation of the proposed rule and its potential impact on intellectual property litigation.

I. Non-Compete Agreements

A. What Are They?

A non-compete is a contract that prohibits an employee from working for an employer's competitors or setting up a competing business during or after their employment.⁷ Most non-compete clauses include a geographic limitation (e.g., specifying the state(s) in which the agreement applies) as well as an effective period (e.g., 1 year from the termination of employment).⁸ The use of non-competes is widespread. The FTC estimates that one-in-five Americans (20%) is affected by a non-compete agreement,⁹ while the Economic Policy Institute in 2019 estimated the proportion of private sector workers subject to non-competes as "somewhere between 27.8% and 46.5%."¹⁰ Furthermore, because non-competes are often used as a method to protect an employer's intellectual property (e.g., trade secrets), it is common to include a non-compete clause in the employment agreements of scientists and researchers. Employers justify the use of non-competes as a way to increase an employer's incentive to invest in its employees, for example through training or access to trade secrets.¹¹

B. Why Does the FTC Want to Ban Them?

The FTC has pointed to several justifications for the proposed rule. First, the FTC points out that the function of a non-compete agreement is to limit labor mobility, which Chair Lina M. Khan calls a "core to economic liberty and to a competitive, thriving economy."¹² The Commission also points to research showing that non-compete agreements depress wage growth. Directly, those bound by non-competes are unable to accept a higher-paying job with a competitor.¹³ This limited ability of businesses to compete for labor also slows down industry-wide wage increases even for those not bound by non-competes.¹⁴ In total, the Commission estimates that non-competes are responsible for nearly three-hundred billion dollars in lost wages nationally each year.¹⁵ Further still, the FTC suggests that non-competes hamper new and growing businesses by limiting their ability to hire skilled and experienced workers.¹⁶

While these economic effects may provide motivation to prohibit or limit the use of non-competes, the Commission is limited to acts within the power granted to it by Congress. In this case, the Commission points out that Section 5 of the FTC Act "directs the Commission 'to prevent persons, partnerships, or corporations ... from using unfair methods of competition in or affecting commerce,'"¹⁷ and that Section 6(g) of the Act authorizes the Commission to "make rules and regulations for [that] purpose."¹⁸

Many states already have some kind of limitation on the use of non-compete agreements. Three states— California, Oklahoma, and North Dakota—prohibit the enforcement of non-compete agreements entirely.¹⁹ Eleven other states and the District of Columbia prohibit the enforcement of non-compete agreements against employees earning less than a specified amount per year.²⁰ And in states where non-competes are not barred by statute, courts typically scrutinize non-competes for "reasonableness," refusing to enforce agreements, for example, that go beyond protection of an employer's legitimate business interest, or that are not properly tailored to that interest in terms of subject matter, geographic scope, or temporal applicability.²¹

C. What Concerns Would a Ban Raise?

According to the Commission,

the most commonly cited justifications for non-compete clauses are that they increase an employer's incentive to make productive investments—such as investing in trade secrets or other confidential information, sharing this information with its workers, or training its workers—because employers may be more likely to make such investments if they know workers are not going to depart for or establish a competing firm.²²

Therefore, one of the chief concerns raised in response to the Commission's proposed rule appears to be that, without the use of non-compete agreements, many businesses' trade secrets would (perhaps unintentionally) be exposed to hiring employers.²³ And while the FTC points to other types of agreements, such as non-disclosure agreements or non-solicitation agreements, to fill the gap left by a prohibiting non-compete agreements, ²⁴ employers will have to carefully review such agreements to ensure that they do not fall within the scope of the non-compete ban. The FTC has already warned that the scope of the ban is governed, not by the title of an agreement or clause in a contract, but by whether it effectively prevents a worker from seeking employment from a competitor.²⁵ In some cases, a broadly worded non-disclosure or non-solicitation agreement will fall within the Commission's prohibition and become unenforceable.²⁶

Another tool that employers might turn to in order to fill the hole left by prohibited non-compete agreements is trade secret litigation. Every state but New York has a trade secret statute patterned, to some extent, on the Uniform Trade Secrets Act. And New York recognizes trade secret misappropriation under common law. Furthermore, in 2016, Congress passed the Defend Trade Secrets Act, establishing a civil cause of action for trade secret misappropriation under federal law.²⁷ Enforcement of these laws requires often-costly litigation. Nevertheless, when necessary, trade secret owners can and do actively litigate their cases in state and federal courts in order to protect their intellectual property. And if trade secret owners can no longer rely on tailored, limited-duration non-competes as a first line of protection from immediate (and potentially undetectable) trade secret misappropriation, those owners might become more vigilant about implementation of internal trade secret policies and more aggressive about trade secret enforcement through litigation moving forward.

II. What to Expect Moving Forward?

The FTC has invited public comment on the rule through March 20, 2023.²⁸ If the Commission votes to pass the rule as proposed, it may be open to several legal challenges, as laid out by Commissioner Christine Wilson, the only Commissioner who voted against the proposed rule. For example, Commissioner Wilson points out that there may be questions as to whether Congress has given sufficiently clear authorization for the Commission to engage in this type of rulemaking, and even assuming that Congress's authorization is sufficient, whether it is an impermissible delegation of legislative authority under the non-delegation doctrine.²⁹

Since the proposed rule was introduced, the FTC has made several statements about it and held a virtual public forum to examine the proposed rule on Thursday, February 16.³⁰

III. Conclusion

Many businesses rely on tailored, limited-duration non-compete agreements to help protect their valuable confidential information. The proposed ban, if established, could necessitate a shift to heavier reliance on other methods of protection like active litigation over breaches of non-disclosure agreements and misappropriation of trade secrets. Forward-looking businesses may want to carefully examine their existing policies and agreements with the aid of counsel to determine which agreements they could expect to rely on if non-compete agreements are banned under the proposed rule and identify any further steps that can be taken to reinforce the protections around any trade secrets that would be weakened by the rule's passage.

Footnotes

1. The authors are attorneys at the intellectual property firm of Finnegan, Henderson, Farabow, Garrett & Dunner LLP. This article is for informational purposes, is not intended to constitute legal advice, and may be considered advertising under applicable state laws. This article is only the opinion of the authors and is not attributable to Finnegan, Henderson, Farabow, Garrett & Dunner LLP, or the firm's clients.

2. FTC, Non-Compete Clause Rulemaking (Jan. 5, 2023), https://www.ftc.gov/ legal-library/browse/federal-register-notices/non-compete-clause-rulemaking [hereinafter Proposed Rule]. The only proposed exception is for non-compete agreements entered into by substantial owners, members, or partners of a business who then sell their business. Proposed Rule 910.3 Exception.

3. Proposed Rule 910.5 Compliance date.

4. Proposed Rule 910.4 Relation to State laws.

5. FTC, FTC Restores Rigorous Enforcement of Law Banning Unfair Methods of Competition (Nov. 10, 2022), https://www.ftc.gov/news-events/news/ press-releases/2022/11/ftc-restores-rigorous-enforcement-law-banning-unfair- methods-competition.

6. Leah Nylen, What's a Noncompete Clause and Why Does the FTC Want to Ban Them?, The Washington Post (Jan. 24, 2023), https://www.washington- com/business/whats-a-noncompete-clause-and-why-does-the-ftc-want-to- ban-them/2023/01/24/ed4ef510-9c00-11ed-93e0-38551e88239c_story.html.

7. FTC, Notice of Proposed Rulemaking, at 2 (Jan. 5, 2023), https://www.ftc. gov/system/files/ftc_gov/pdf/p201000noncompetenprm.pdf https://www.ftc.gov/ system/files/ftc_gov/pdf/noncompete_nprm_fact_sheet.pdf [hereinafter FTC Notice].

8. Id.

9. FTC, FACT SHEET: FTC Proposes Rule to Ban Noncompete Clauses, Which Hurt Workers and Harm Competition, 1 (Jan. 5, 2023), https://www.ftc.gov/ system/files/ftc_gov/pdf/noncompete_nprm_fact_sheet.pdf [hereinafter FTC Fact Sheet].

10. Economic Policy Institute, Noncompete agreements (Dec. 10, 2019), https:// epi.org/publication/noncompete-agreements/.

11. FTC Notice,

12. FTC, FTC Proposes Rule to Ban Noncompete Clauses, Which Hurt Workers and Harm Competition (Jan. 5, 2023), https://www.ftc.gov/news-events/news/ press-releases/2023/01/ftc-proposes-rule-ban-noncompete-clauses-which-hurt- workers-harm-competition.

13. FTC Fact Sheet, I.

14. Id.

15. FTC Notice, 76

16. FTC Fact Sheet, 1.

17. FTC Notice, 67 (quoting 15 S.C. 45(a)(2)).

18. Id. at 67–68 (quoting 15 U.S.C. 46(g)).

19. FTC Fact Sheet, 1.

20. FTC Notice, 49–50, 149 (cataloging relevant state statutes).

21. See FTC Notice, 51–52.

22. FTC Notice, 93.

23. Leah Nylen, What's a Noncompete Clause and Why Does the FTC Want to Ban Them?, Bloomberg (last updated January 24, 2023).

24. FTC Notice, 93-101 (discussing trade secret law, non-disclosure agreements, and other means of protecting valuable investments).

25. FTC Notice, 108 ("[W]hether a contractual term is a non-compete clause would depend not on what the term is called, but how the term functions.")

26. The Commission is concerned, however, that some employers may seek to evade the requirements of the Rule by implementing restrictive employment covenants other than non-compete clauses that restrain such an unusually large scope of activity that they are de facto non-compete clauses. Under proposed § 910.1(b)(2), such functional equivalents would be non-compete clauses for purposes of the Rule, whether drafted for purposes of evasion or not.

27. Id., 95.

28. Non-Compete Clause Rule, 88 Reg. 3482 (Jan. 19, 2023) (to be codified at 16 C.F.R. § 910) https://www.federalregister.gov/ documents/2023/01/19/2023-00414/non-compete-clause-rule. FTC, Dissenting Statement of Commissioner Christine Wilson Concerning the Notice of Proposed Rulemaking for the Non-Compete Clause Rule, 9-13 (Jan. 5, 2023), https://www.ftc.gov/system/files/ftc_gov/pdf/p201000noncom- petewilsondissent.pdf.

29. FTC, FTC to Host Public Forum Examining Proposed Rule to Ban Noncompete Clauses (Feb. 2, 2023), https://www.ftc.gov/news-events/ news/press-releases/2023/02/ftc-host-public-forum-examining-proposed- rule-ban-noncompete-clauses.

Originally printed in IP Litigator  on May 9, 2023.

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