Legal Viewpoint: Next Steps for Noncompete Agreements

Since the Federal Trade Commission (FTC) issued its final rule banning noncompete agreements on April 23, it’s been a long summer for employers playing the frenzied “what if” game.

What if the FTC rule stands? What if it is enjoined? What if it is upheld in part and enjoined in part? What if different courts rule differently?

Then there’s the corollary questions: “What do we do while waiting? What stance do we take with existing employees under noncompetes? What about the employees we are recruiting? What about former employees still under restrictions?”

On August 20, those guessing games abruptly stopped when the U.S. District Court for the Northern District of Texas issued its eagerly awaited ruling in Ryan LLC v. FTC, enjoining the final rule from going into effect on September 4. Critically, the court enjoined the final rule nationwide. The court concluded that the FTC exceeded its authority and that the rule itself was arbitrary and capricious. In particular, the court chastised the FTC for not considering less disruptive alternatives or exceptions before issuing a blanket, one-size-fits-all ban. While the FTC may still appeal that decision, most employers heaved a sigh of relief that everything would be as it previously was, as though the final rule was never issued.

In practical terms, the injunction reverts the playing field to the status quo before April 23. Employers need not issue notices to current and former employees subject to noncompetes alerting them that their covenants will not be enforced, as the FTC final rule had required. Employers need not evaluate which employees meet the FTC definition of “senior executive.” Most importantly, employers remain free to require new hires starting on or after September 4, to enter into restrictive covenants incident to their employment, as long as they are consistent with governing state law. 

Critically, more states are limiting noncompetes than ever before. They are banned outright in California, Minnesota, North Dakota, and Oklahoma. Thirty-three other states plus the District of Columbia currently limit noncompete enforceability based on the income level of the subject employee, the industry in which the employee works, and/or the duration of the restriction. Even in states where noncompetes are permitted, they are disfavored. Courts never like to preclude individuals from pursuing a livelihood if viable, less restrictive alternatives are available.

Accordingly, with the FTC final rule now on pause, it is the perfect time for employers to take stock of their restrictive covenant agreements, ensuring they are narrowly tailored to support legitimate business interests and align with the current state of the law in effect in relevant jurisdictions. As part of that assessment, employers should consider their goals regarding protecting their business and the litigation risks. For example, courts will only enjoin employees from competing where the employer seeking enforcement can demonstrate that (a) there is a likelihood of success on the merits of proving a breach of a lawful contractual obligation, (b) enforcing the restriction is consistent with the public interest, (c) the balance of the equities favors enforcement, and (d) monetary damages are too speculative to be calculated. No injunction will be issued where the employer fails to carry its burden on any of those elements. The employer will then have to decide whether to pursue a claim for damages instead against an employee directly competing day in and day out. While that still offers the employer a remedial path, it may not be the path the employer desires or anticipates.

Employers should also consider whether the same protections can be achieved with less restrictive alternatives, such as covenants that do not limit employees’ ability to become employed elsewhere after the employment relationship ends. Consider nonsolicitation, noninterference and nondisclosure covenants, particularly ones tailored to the specific work performed and business interests implicated. A nonsolicitation covenant tied to key clients, vendors, or employees in a department is more powerful than a blanket noncompete. Critically, it is more readily enforceable, especially if narrowly tailored in scope and duration. 

This is also the time to assess who in your organization is subject to covenants and consider whether everyone subject to restrictions needs to be. This is particularly true for lower-level administrative employees, whose departure may not pose nearly the same competitive threat as their boss. Perhaps those employees only need to agree to protect confidential and proprietary business information from use or disclosure. Even the FTC recognized the importance of employers being able to protect confidential information and trade secrets, and courts in most states will enforce nondisclosure obligations far more frequently than noncompetition restrictions. Indeed, most states protect unauthorized use or disclosure of trade secrets by statute, offering yet another pathway to protect critical business information.

Ultimately, the tumult of the last few months highlights the importance of periodically taking stock of the viability of restrictive covenant agreements currently in use. Think of it like an annual physical but for workplace contracts. Document the date and scope of the review and calendar it again for next year. This schedule will create an ounce-of-prevention mentality to ensure the enforceability of contracts in the future and the protection of legitimate business interests critical to business operations.

Jennifer Snyder is a partner and co-chair of the labor and employment practice of Dilworth Paxson, based in the Philadelphia office.