The U.S. Federal Trade Commission sent shockwaves through the corporate world in April when the agency imposed a ban on noncompete agreements – and like any good shockwave, this new rule will reverberate through the ethics and compliance function too.
Let’s begin with the rule itself. It bans essentially all noncompete agreements, which the FTC defines as any agreement that prohibits an employee from either taking a similar job at another employer or from starting their own business that might compete with the employee’s previous employer. When the rule goes into effect (most likely by September) an estimated 99% of all noncompete agreements in the United States will become void.
The FTC did include a temporary exclusion for a company’s senior executives, defined as executives who both (1) earn more than $151,165 annually; and (2) are in a “policy-making position” for the entire business. Existing noncompetes for senior executives will be allowed to run their natural term, but a company won’t be able to adopt any new noncompete agreements with senior executives after that.
One can see how a noncompete ban would appeal to workers: more ability to push for better wages (at least $400 billion in higher wages over the next decade, the FTC estimates), and an easier path to starting your own business (an additional 8,500 new businesses created every year).
On the other hand, employers don’t relish the idea of spending time and money to train employees on job-related skills, only to see those employees take that knowledge out the door to a rival. Plus, noncompete agreements are already addressed by numerous state laws; and the implications of noncompetes can spill into issues such as severance agreements, equity compensation and more.
In other words, this is an ethics, compliance and legal thicket – with corporate compliance officers right in the middle.
Start with the compliance issues
Yes, business groups such as the U.S. Chamber of Commerce have already vowed a lawsuit over the FTC rule, and federal courts might suspend the noncompete ban while litigation proceeds.
Compliance officers shouldn’t let that prospect of a delay lull you into a false sense of security. There’s plenty here to keep you busy regardless of what the courts do.
For starters, assess how your company would comply with the noncompete ban anyway. For example, the FTC says senior executives are excluded from the ban – so can your company easily identify who those senior executives might be? Can you work with the HR team to identify which executives make more than $151,165 per year and have policy-making duties as part of their job descriptions?
The details of the FTC rule make clear that the agency wants senior executives under this rule to be roughly analogous to executive officers as defined by the Securities and Exchange Commission: few in number, and true decision-makers for the entire enterprise. So, if you conclude that you have 97 senior executives across 14 operating divisions, expect somebody somewhere (regulator, union rep, plaintiff lawyer) to say you’re doing it wrong.
Second, consider all the other noncompete restrictions your company might face at local levels. For example, noncompetes are unenforceable in the state of California. In Massachusetts, noncompetes cannot last longer than 12 months and cannot be enforced against hourly wage workers. Other states don’t necessarily have laws against noncompetes, but do have court rulings that set precedent for how noncompete litigation is handled.
So much like the state-by-state approach businesses need to take to data privacy laws, large companies should perform a similar state-by-state analysis to understand the noncompete restrictions they face – and then craft corporate hiring policies that reflect all those strictures.
Quite simply, businesses have a significant policy management challenge here. You need to be sure the hiring policies you have comply with state and local law as appropriate and be sure hiring managers in your various locations follow those policies. Otherwise, a manager might try to compel new hires to sign noncompetes that aren’t enforceable, exposing your company to litigation risk it doesn’t need.
Ethical and legal issues may overlap
We’d be remiss if we didn’t also point out a pesky truth about noncompete agreements: employees hate them. Noncompetes remind everyone of the power imbalance between large company and lone employee, which is not conducive to the culture of ethics and compliance organizations want to achieve.
In that case, why bother with noncompete agreements at all?
A business might be able to craft similar protections for its commercial interests through other arrangements in employment contracts, such as non-solicitation, non-disclosure, or trade secrets clauses. For example, you could prevent one departing employee from recruiting other current employees through non-solicitation clauses, or prevent the departing employee from re-creating your specific product through trade secrets protections.
That’s not a given; the FTC did warn that companies can’t use such clauses if they are “so broad or onerous that it has the same functional effect” as a noncompete agreement. Your compliance and HR teams would need to consult closely with outside counsel to be sure that whatever you do still passes muster with the FTC rule – but it is possible.
Compliance officers might want to urge senior leaders to consider that course. It’s perfectly reasonable for a company to want to protect its commercial interests, but doing so through noncompetes seems like a path of diminishing returns. If your company can protect those interests through other means that don’t leave employees feeling alienated and frustrated, that’s a good thing.
You’ll still have challenges around policy management, training and documentation, but in today’s complicated employment law environment, you’re going to have those challenges no matter what happens with the FTC rule. If you can have them while still preserving a strong corporate culture with employees, that’s a path worth taking.
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