Adapting to the FTC’s Non-Compete Rule

June 4, 2024

The Federal Trade Commission’s (“FTC”) Non-compete Rule deals a death blow to traditional employment non-compete covenants.  Assuming challenges are unsuccessful, the Rule will go into effect in August and will negate all existing non-compete clauses with a few exceptions. For many employers, the Rule will remove a significant hedge against competition.  However, non-disclosure provisions, which are not banned under the Rule, if worded carefully, can still provide valuable protection against unfair competition.

Key Elements of the Rule

A non-compete clause is broadly defined as:

  1. A term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from:
    1. seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or
    2. operating a business in the United States after the conclusion of the employment that includes the term or condition.

The FTC intends that by application of this definition, clauses restricting post-termination employment with specifically named competitors or with entities offering the same or similar services within a geographic area are banned.  Similarly, clauses that prohibit providing services to a list of customers of the former employer 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 non-compete clauses regardless of when the employer and employee signed an agreement.  The Rule also requires employers to provide clear and conspicuous notice to employees by the effective date of the Rule that their non-compete clause will not be, and cannot legally be, enforced.

Exceptions to the Rule

Employment agreements with “Senior Executives,” defined as employees in a policy-making 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 between an employer and a senior executive after the effective date of the Rule are prohibited.  The Rule does not ban non-disclosure clauses that prohibit an employee from divulging proprietary information such as customer contacts, pricing, and methods.  The Rule also exempts non-compete clauses between a seller and purchaser of an equity interest in a business that is part of a “bona fide” sale.

Application of the Rule – Death of the Geographic or Industry/Customer Specific Covenant

An employer has traditionally implemented non-compete clauses with geographic restrictions where it offers a service competitive with other employers within a geographic area and its employees develop relationships with the customers of the employer.  These restrictions are designed to prevent a departing employee 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 where employees, by virtue of their job, develop relationships with customers for the provision of a service within a specific geographic area.

Industry or competitor-based restrictions are used where an employee, by virtue of their job, learns a particular niche skill or process with a limited application except with other competitors in the same industry.  These types of non-compete covenants seek to prohibit a departing employee from working for a list of specific companies and/or industries.   Both the above types of non-compete clause are often accompanied by a list of key customers whom the employee cannot solicit 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 does not ban non-disclosure clauses.  A non-disclosure clause defines a class of information referred to as either confidential or proprietary information, which, if wrongfully divulged, would provide a competitor with an unfair competitive advantage.  Non-disclosure clauses prohibit an employee from divulging or utilizing that information to compete.  Non-disclosure clauses are often included in employment agreements alongside non-compete clauses.  Accordingly, employers will want to take a close look at their existing agreements.  While the non-compete clauses will be banned, the non-disclosure clauses will survive, provided that they are not so broadly worded as to, in effect, function no differently than a non-compete clause.  As the FTC acknowledged in its Final Rule, whether a given non-disclosure clause is functionally the same as a non-compete will turn on the facts and circumstances of particular covenants and the surrounding market context.

In Wisconsin, non-disclosure provisions are construed under Wis. Stats. § 103.465, the same as non-compete clauses, meaning that they are enforced “only if the restrictions imposed are reasonably necessary for the protection of the employer or principal.”  Wisconsin courts have required that non-disclosure clauses like non-compete clauses, be reasonably limited to scope and duration.  However, many employers have implemented non-disclosure 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 making them likely unenforceable under the Rule.

Bottom Line

Employers with existing employment agreements containing non-compete clauses need to review their current agreements considering the Rule.  Because non-disclosure provisions are not banned, particular attention should be given to the scope of such clauses.  If carefully drafted, they may still provide an employer with some protection against competition while not running afoul of the Rule.  When drafting non-disclosure clauses, care must be taken not only to ensure compliance with the Rule, but also state law.

This article, slightly modified to note recent updates, was featured online in the Wisconsin Employment Law Letter and published by BLR®—Business & Legal Resources. Reproduced here with the permission of BLR®—Business & Legal Resources.