Here’s what employers should know when adapting to FTC’s noncompete rule
The Federal Trade Commission’s (FTC) noncompete rule deals a death blow to traditional noncompete agreements. Assuming challenges are unsuccessful, the rule will go into effect in August and will negate all existing noncompete clauses, with a few exceptions. For many employers, the rule will remove a significant hedge against competition. However, nondisclosure provisions, which aren’t banned under the rule, can still provide valuable protection against unfair competition if worded carefully.
Key elements of the rule
A noncompete clause is broadly defined as:
- A term or condition of employment that prohibits a worker from, penalizes a worker for, or prevents a worker from:
- Seeking or accepting work with a different employer when the work would begin after the conclusion of the employment that includes the term or condition; or
- Operating a business after the conclusion of the employment that includes the term or condition.
Under this definition, clauses restricting employment with specifically named competitors or with entities offering the same or similar services within a geographic area are banned. Similarly, clauses that prohibit employees from providing services to their former employer’s customers or prohibit competitive work within specifically named territories are also banned.
The rule is retroactive in application; except for senior executives, the rule will ban all noncompete clauses regardless of when the employer and employee signed the agreement. The rule also requires employers to provide clear notice to employees by the rule’s effective date that their noncompete clause won’t be, and can’t legally be, enforced.
Exceptions to the rule
Employment agreements with “senior executives,” defined as employees in a policymaking position and receiving compensation of at least $151,164 in the preceding year, can remain in place after the effective date of the rule. However, any new employment agreements entered into between an employer and a senior executive after the effective date of the rule are prohibited.
The rule doesn’t ban nondisclosure clauses that prohibit an employee from divulging proprietary information such as customer contacts, pricing, and methods. The rule also exempts noncompete clauses between a seller and a purchaser of an equity interest in a business that’s part of a “bona fide” sale.
Death of the geographic, industry/customer-specific covenant
Employers have traditionally implemented noncompete clauses with geographic restrictions when they provide a service that competes with other employers within a geographic area and their employees develop relationships with their customers.
These restrictions are designed to prevent departing employees from taking customers with them to a competitor. Service providers of all types and descriptions, including medical practices, construction firms, consultants, spas, and salons, are examples of businesses that have employees who develop relationships with customers for the provision of a service within a specific geographic area.
Industry- or competitor-based restrictions are used when employees learn a particular niche skill or process with a limited application except with other competitors in the same industry. These types of noncompete covenants prohibit departing employees from working for a list of specific companies and/or industries. Both the above types of noncompete clauses are often accompanied by a list of key customers employees can’t contact post-departure for a discrete period of time—usually two years.
Under the rule, attempts to prevent competition through geographic, industry-specific, or customer list-based restrictions will be unavailable to employers.
The future of employment clauses
The rule doesn’t ban nondisclosure clauses. A nondisclosure clause defines either confidential or proprietary information that, if wrongfully divulged, would provide a competitor with an unfair advantage. Nondisclosure clauses prohibit an employee from divulging or using that information to compete.
Nondisclosure clauses are often included in employment agreements alongside noncompete clauses, so employers should take a close look at their existing agreements. While noncompete clauses will be banned, nondisclosure clauses will survive, provided they aren’t so broadly worded that they function no differently than a noncompete clause.
As the FTC acknowledged in its final rule, whether a given nondisclosure clause is functionally the same as a noncompete will depend on the facts and circumstances of particular covenants and the surrounding market context.
In Wisconsin, nondisclosure provisions are construed under Wis. Stats. § 103.465 the same as noncompete clauses, meaning they’re enforced “only if the restrictions imposed are reasonably necessary for the protection of the employer or principal.” Wisconsin courts have required nondisclosure clauses like noncompete clauses to be reasonably limited to scope and duration.
However, many employers have implemented nondisclosure provisions with overly broad definitions of what constitutes confidential information and without any time limitation on disclosure, not only rendering them unenforceable under state law but also making them likely unenforceable under the rule.
Bottom line
If you have existing employment agreements containing noncompete clauses, you’ll need to review your current agreements considering the rule. Because nondisclosure provisions aren’t banned, particular attention should be given to the scope of such clauses. If carefully drafted, they may still provide you with some protection against competition while complying with the rule.
When drafting nondisclosure clauses, take care to ensure compliance with not only the rule but also state law.
