Companies Delay Voiding Noncompetes With Fate of Ban Uncertain

Companies are struggling with whether to inform current and former employees that their noncompete agreements are void as the validity of the Federal Trade Commission’s ban on such contracts remains in legal limbo.

The FTC regulation set to take effect Sept. 4 will trigger this notification requirement, erasing restrictive employment contracts for potentially 30 million workers by the FTC’s estimate and barring new noncompetes going forward.

But legal challenges to the rule so far have yielded two conflicting decisions—one saying the FTC likely has the authority to issue the ban and the other saying it likely doesn’t—raising uncertainty as to whether or when it will go into force and what businesses should do in the meantime.

Noncompete agreements, which restrict employees from taking a job with their employer’s competitors, have faced increasing scrutiny from state and federal policy makers.

While businesses use the contracts to protect their trade secrets and investment in employee training, critics say they inhibit career mobility and entrepreneurship and are sometimes misused on low- and middle-income employees with little access to company secrets.

Employment attorneys say companies would do well to take inventory of their existing noncompete agreements and make sure they have contact information for notifying those workers ahead of Sept. 4.

At the same time, they predicted many businesses will delay actually sending any revocation notices as long as possible, knowing that once they do, they can’t get those noncompetes back even if a court definitively blocks the FTC rule.

“I can’t imagine employers want to do that prematurely and then discover actually they are effective,” said Susan Sperber, a partner at Lewis Roca Rothgerber Christie LLP.

Even if its challengers succeed at blocking it, the FTC rule adds to mounting pressure for businesses to limit their use of noncompetes and potentially replace them with other kinds of contracts such as nondisclosure and nonsolicitation agreements.

“The writing is on the wall that noncompetes may be a thing of the past or at least severely restricted within the next decade to half-decade in the US,” said Mark Goldstein, a partner at Reed Smith LLP. “Businesses at least need to think about what their other options are going to be if that comes to fruition.”

Not Final Word

Judge Ada Brown of the US District Court for the Northern District of Texas earlier this month ruled the agency lacks the needed rulemaking power to ban noncompetes but stopped short of blocking its enforcement nationwide. She said she plans to issue a final decision by Aug. 30, days before the rule’s scheduled effective date.

Trade groups from the hospital, insurance, and financial services industries have filed briefs urging Brown to grant a nationwide injunction.

Meanwhile Judge Kelley Brisbon Hodge of the US District Court for the Eastern District of Pennsylvania sided with the FTC and upheld the regulation July 23.

If Brown issues a nationwide injunction within the next month, it could at least buy employers more time. But it likely won’t be the final word on the FTC rule’s validity, said Michael Elkon, a partner with Fisher & Phillips LLP.

“You could end up with conflicting decisions and then employers are going have to decide which one to follow,” he said. “Ultimately an appellate court is going to have to weigh in.”

While the cases play out in Pennsylvania and Texas, at least one other federal lawsuit is pending in federal district court in Florida, where a real estate firm also seeks to block the FTC rule.

The US Supreme Court’s June decision in Loper Bright Enterprises v. Raimondo—which eliminated the Chevron doctrine under which courts deferred to federal agencies’ reasonable interpretations of ambiguous statutes—likely hurts the chances that the Pennsylvania ruling upholding the FTC ban will survive on appeal, said Kevin M. Passerini, a partner with Blank Rome LLP.

“It is a very deferential ruling as it pertains to federal agencies,” he said. “That sort of deference is unlikely to be viewed favorably in the federal appellate courts, and particularly by this current Supreme Court. I would think its days are numbered.”

In the meantime, many businesses might opt not to follow the notice requirement, using the Texas ruling as a defense and knowing that the FTC has limited enforcement powers, Passerini said.

“The FTC doesn’t have a ton of teeth in this rule,” he said. “You might get a slap on the wrist in terms of an injunction.”

Growing Scrutiny

Even if it never takes effect, the FTC rule remains part of a growing pressure for employers to scale back noncompetes, which some businesses have included as a perfunctory part of new-hire paperwork, attorneys said.

The combination of increasing state-law restrictions, tougher judicial scrutiny of whether disputed contracts can be enforced, and the federal regulation has pushed businesses to use noncompetes more sparingly.

Companies are now being more judicious about which employees need to sign them, as well as how the restrictions are drafted, said Thomas A. Muccifori, a partner with Archer & Greiner PC.

“We’re definitely seeing courts now scrutinize” the details of “each noncompete agreement more closely,” he said.

There’s also growing public awareness of the issue, with FTC Chair Lina Khan and other Biden administration officials speaking on cable news networks about how noncompetes hurt workers and the economy, Muccifori said.

“It’s worked its way into the parlance of common culture,” he said.

David Woolf, a partner at Faegre Drinker Biddle & Reath LLP, agreed that employers are taking “a change in approach” on drafting restrictive contracts.

Companies that have long used them “without doing a full legal analysis are now doing that,” he said. “Once it becomes the focus of regulatory and government action, they start to look at it more closely.”

“It’s clearly a trend,” Woolf said.

For years states have taken the lead on restricting companies’ use of noncompetes and could continue to do so if the FTC rule is invalidated. California, Minnesota, North Dakota, and Oklahoma ban virtually all employee noncompetes, and at least 11 other states plus Washington, D.C., restrict their use to higher-income or salaried employees.

State lawmakers also have targeted noncompetes specifically for doctors and other health-care professionals, partly aimed at addressing health-care work force shortages in rural areas. Pennsylvania Gov. Josh Shapiro (D) signed the latest such measure (HB 1633) into law July 17.

Despite the movement toward limiting them, some lawmakers have shown reluctance to ban them outright—in the last year three Democratic governors, including New York Gov. Kathy Hochul, have vetoed bills to ban the contracts.

Bipartisan proposals also have been floated in Congress to ban or limit noncompetes, and National Labor Relations Board General Counsel Jennifer Abruzzo has taken the position that noncompetes can violate federal labor law in some instances.

“The FTC wanted the chaos that’s going on right now,” Passerini said, “so that companies decide they don’t want the fight and they’ll stop using them.”