Reevaluating Non-Compete Agreements

The bottom line

Non-compete agreements, which restrict employees from working with competitors post-employment to protect proprietary information, face increasing scrutiny and legal challenges. Employers are increasingly reviewing and adjusting these agreements to ensure their reasonableness and legality. Alternative protections such as confidentiality clauses and adjusted compensation are being considered.

Companies often want to protect valuable leads and proprietary information through the use of non-compete agreements. The thinking is that if an employee leaves, the value of the information learned can be protected from access by market competitors. However, as these agreements are restraints on free trade, it seems that few other employment law concepts have generated such recent attention, scrutiny and confusion.

Non-compete agreements usually take the form of a clause or term in an employment contract that says the employee will not enter into competition with the employer, or go to work for a competitor, for a specified period of time after the employment ends. They are sometimes called “restrictive covenants” because they are promises not to engage in certain kinds of behavior.

Proponents vs. opponents

Proponents of non-competes point to the value in secrets and processes that need to be openly shared with employees to maximize their opportunities. That freedom, they argue, must be protected against corporate espionage and the whims of a “grass-is-greener” mentality.
Opponents stress that the rigidity these agreements impose on the workforce marketplace is negative for all sides. It ties up employees with knowledge and skills that should be in the market, while also preventing the best applicants from being used by companies.

Federal and state developments

Recent federal developments have tended toward the opponent’s view of non-compete agreements. In April 2024, the Federal Trade Commission issued rules that effectively bar future non-compete agreements and void any such existing agreements. The rules are broad, but their effect is to bar any policy that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from seeking work after employment terminates. Exceptions exist for current agreements with senior executives or those earning a certain amount, as well as business sale transactions.

Despite being called a “final rule,” the FTC announcement is neither final nor the current rule. The bar on non-competes is effective 120 days from publication of the requirements in the Federal Register and, even then, may be subject to Congressional review. Beyond that review, legal contests are a certainty, and there will be many challenges.

Regardless of the FTC’s position, challenges to non-compete agreements also exist at other levels. Anti-trust contests come from the Department of Justice, and the National Labor Relations Board recently took the position that non-compete agreements unlawfully interfere with worker’s rights. Lower than the federal level, a few states bar the agreements outright. A minority bar certain categories of non-competes, including wage thresholds and notice requirements. Other states have limited controls over enactment, but challenges to their fairness remain.

Preparing for legal challenges

Employers who use non-competes should take steps now to be ready for these mounting challenges. A review of current non-compete agreements should be made with an eye toward the reasonableness of the restrictions they impose. The scope of limitation should be narrowly tailored to protect a legitimate business interest. The scope of limitations should be reasonable in terms of time, geography and prohibited activities. In addition, consider what levels of employees are subject to non-compete agreements, as defaulting to all employees can create unreasonable use limitations.

In addition, where non-compete clauses are part of larger employment contracts, it is important to ensure that the clause can be severed from the agreement. Carve-out or severability terms in contracts can help preserve the other terms and limitations of an employment contract even where certain provisions cannot be enforced or are later found to be illegal.

If you cannot use non-competes or want to try alternative protections, there are options to consider. Exercise caution when looking at clauses that could operate as “functional bars” to other employment (e.g., reimbursement, non-solicitations, etc.). Besides those, however, contractual terms that protect the confidentiality of proprietary information and trade secrets can help achieve large parts of the current goals served by non-compete agreements. Likewise, adjusted compensation agreements or fixed-term employment can help motivate employees to maintain confidences, even when day-to-day work ends.