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How business owners can prepare for the FTC’s noncompete ruling to go into effect

By April 29, 2024No Comments

(This column originally appeared in The Inquirer)

The Federal Trade Commission issued a rule last week that will effectively eliminate the use of noncompete agreements. The change will have major impacts on most businesses, regardless of their size.

Noncompetes have basically been around forever. They’re usually a paragraph in an employment agreement although sometimes they can be a stand-alone contract.

A typical noncompete restricts an employee from working at a similar company or starting a similar business within a certain geographical range or within an industry if they leave their existing job. It’s designed to protect the employer from losing that employee — and any proprietary information they may have about the business — to a competitor.

However, the FTC sees things differently.

FTC Chair Lina M. Khan believes that noncompetes — which the agency claims impacts an estimated 30 million workers — limit the ability of employees to find work or start new businesses, and eliminating them will increase earnings, generate new patents, and lower health care costs.

“Noncompete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new start-ups that would be created a year once noncompetes are banned,” Khan said in a statement. “The FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.”

Immediately following the FTC’s announcement, the U.S. Chamber of Commerce said it would sue based on the agency’s “unlawful power grab.”

“Since its inception over 100 years ago, the FTC has never been granted the constitutional and statutory authority to write its own competition rules,” the U.S. Chamber said in a statement. “Noncompete agreements are either upheld or dismissed under well-established state laws governing their use. Yet, today, three unelected commissioners have unilaterally decided they have the authority to declare what’s a legitimate business decision and what’s not by moving to ban noncompete agreements in all sectors of the economy.”

The U.S. Chamber’s and other lawsuits against the rule could result in injunctions and appeals and may not be resolved until a decision is made by the U.S. Supreme Court, which could take years. Another factor: the November presidential elections. Most experts believe that it is likely that a change in presidential administration could also put a halt to the implementation of this rule.

So what should businesses do now?

Be patient.

“Wait until the rule becomes effective,” said David Schiller, an attorney in Norristown, “and that date has yet to be set.”

Once published in the Federal Register — which should be shortly — the rule would then become finalized in 120 days.

Tell your staff.

Employers are now required to give notice to all employees of this new rule. Example language can be found on the FTC’s website.

Be aware of exceptions.

Although all employees will be affected, it’s also important to evaluate exactly who may be excluded.

For example, although existing noncompete arrangements with highly paid executives (those making more than $151,164) will be allowed to continue, new noncompete clauses for those making more than this amount will be ineffective after the rule goes live.

There are other exceptions.

Nonprofit organizations are not impacted by the rule as the FTC does not have jurisdiction over these types of entities. So — for example — doctors who own their own practices but are affiliated with nonprofit health care organizations would be excluded. The same goes for banks.

“Banks aren’t regulated by the FTC, although bank holding companies may fall under the rule,” said Josh Ganz a partner at Duffy, North, Wilson, Thomas & Nicholson, LLP in Hatboro. “However, banks can still use noncompetes for their employees and executives.”

Noncompete agreements that are included as part of the sale of a business are also exempted from this rule. Deferred compensation and “garden leave” arrangements (where an employee is paid during a transitional period not to work) would also be excluded, according to Schiller.

Strengthen confidentiality agreements.

“Even though the FTC has proposed terminating noncompetes, businesses can still protect their proprietary information and trade secrets with nondisclosure and confidentiality agreements,” Schiller said. “We’re starting to talk to our clients about reviewing these contracts and making them as restrictive as possible.”

Ganz agrees.

“It’s important to strengthen your existing confidentiality agreements,” he said. “These contracts are going to become even more valuable than before to protect your business.”

Know your state’s rules.

State rules may also come into play, although the noncompete regulations in Pennsylvania, New Jersey, and Delaware are less restrictive than the FTC’s rule, so the federal rule takes precedence. Other states that may have more restrictive regulations would take precedence over the FTC. The rule is also going to create some interesting legal questions.

“For example, what if my company paid an employee last year a bonus to sign a noncompete agreement and now that agreement is invalid,” said Ganz. “Can the employer get their money back from that employee?”

In the meantime, businesses can proceed with their noncompete clauses but they should also be prepared that it could become nullified. Ganz believes that the FTC is going to have a hard time overcoming some of the legal challenges made to this rule. Schiller isn’t so sure.

“You have to go with the assumption that this is real and it’s going to happen,” says Schiller. “If the courts turn it over that’s one thing, but the advice we’re giving our clients is that this is a ruling from the FTC and you have to take it seriously. My expectation is that ultimately the FTC will be given the authority to act.”

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