Navigating Non-Competes in a Changing Labor Market
A proposed rule would prohibit employers from using non-compete agreements with workers. What does this mean for the accounting and finance profession?
The use of employee non-compete agreements in hiring practices has faced criticism in recent years, with opponents expressing concern that they prevent job mobility and stifle wages for workers. Employers, however, are often proponents of non-competes and see them as necessary for protecting their intellectual property (IP), trade secrets, client lists, and other business interests. Now, the federal government is stepping in on the issue.
On Jan. 5, 2023, the United States Federal Trade Commission (FTC) proposed a rule that would ban almost all employee non-compete restrictions, superseding varying state laws and retroactively invalidating existing agreements. Currently, most states—including Illinois—allow non-compete agreements with reasonable duration and geographic scope. A few states—California, North Dakota, and Oklahoma—ban them, and others restrict them with salary thresholds.
The potential for a national ban is already making employers in all states scramble. Some are now amending existing restrictive covenant agreements and making changes to future employment and separation agreements.
While there’s no need for accounting and finance firms, or those working for them, to panic yet, there are a few things to consider to get ahead of a potential federal ban.
UNDERSTAND NON-COMPETE AGREEMENTS AND OTHER RESTRICTIONS
There are a few common types of restrictions employers can currently impose on employees:
- Post-employment non-compete: This agreement prohibits a former employee from working for competitors or in a competitive business for a certain duration. This is the strictest restriction type. Of course, during employment, employers have more leeway to restrict competition and other activities, and employees have common law fiduciary duties.
- Post-employment non-solicitation: This agreement prohibits a former employee from contacting clients, prospects, employees, contractors, and/or vendors of their prior employer to lure them away or to a competitor. Sometimes agreements include a non-solicit that may be considered a “de facto” non-compete. It prohibits accepting the client’s business, even if it wasn’t solicited by the former employee.
- Confidentiality/non-disclosure, trade secrets, IP, and non-disparagement: These types of agreements and clauses come under less scrutiny and have fewer limitations than non-compete/non-solicit agreements but are still widely used.
Importantly, it’s best for employers to establish restrictions at hire, whether in an employment or restrictive covenant agreement or incentive/stock option agreement/plan. Otherwise, it can be challenging to convince an employee well into their employment to agree to restrictions, especially if their employment is ending. Additionally, employee handbooks with confidentiality or non-compete policies aren’t generally enforceable contracts.
KNOW IF YOUR NON-COMPETE IS ENFORCEABLE
It’s risky for current or prospective employees to assume any agreement they’re subject to isn’t enforceable. Generally speaking, there are three key requirements for a non-compete or non-solicit to be considered valid.
1. Legitimate Interest to Protect: The employer must have a legitimate business interest to protect. Such interests may include long-term client relationships, company goodwill, trade secrets, or confidential information acquired by the employee.
2. Reasonable and Narrow Scope: Employer restrictions must have a reasonable and narrow scope that doesn’t create hardship on the employee. One example is geographic scope (i.e., the geographic area(s) where the employer is currently doing business or imminently intends to do so). Some geographic scopes are limited to a radius of five miles, but can range from a state, region, continent, or even internationally, depending on the scope of the employer’s operation and market.
Restrictions must also have a limited duration (up to a few years is generally acceptable). The more important the employee’s role, the longer period a non-compete may be upheld.
Agreements must also narrowly focus on activities that actually compete with the employer. For example, courts look for narrow definitions of “competitive business,” the employer’s “clients,” and restrictions tied to the employee’s actual duties and contact with confidential information and clients.
Additionally, restrictive agreements can’t violate public policy. Agreements that are illegal, give employers virtual monopolies on the workforce in that field or location, or unduly deprive an employee from work options aren’t valid.
3. Consideration: Finally, like all contracts, restrictive agreements must be supported by valid consideration (i.e., something of value given to the individual). State laws differ on what’s deemed adequate consideration. For some, it’s sufficient to offer new or continued at-will employment where either party can terminate anytime without cause or notice. Other states, like Illinois, require more. Courts generally enforce the parties’ “choice of law” (as designated in the contract). However, if an employee worked in a different state, particularly one with more employee-friendly restrictive covenant laws, a court might apply that law.
MIND ILLINOIS’ 2022 AMENDED RULES
On Jan. 1, 2022, Illinois amended its Freedom to Work Act, which both codified court decisions and added new restrictions for employee post-employment non-compete and non-solicit agreements. The law doesn’t apply to independent contractors or to non-competes in the context of a business sale, nor to employees covered by collective bargaining agreements or most employees in the construction industry. Here are some key points from the statute:
- Unless an employer provides an at-will employee with a specific “benefit” for signing, the employer can’t enforce a non-compete until the employee works at least two years after signing. According to the statute, an acceptable benefit is “a period of employment plus additional professional or financial benefits or merely professional or financial benefits adequate by themselves.” While the law doesn’t define “additional professional or financial benefits,” the legislation may be suggesting signing bonuses, equity grants, and other types of traditional consideration. For example, an employer can provide protection beyond at-will employment by promising severance pay if the employee is terminated without cause.
- Courts can modify a non-compete/non-solicit clause to render it enforceable.
- Non-competes are only valid for employees earning at least $75,000 annually. The threshold amount will increase by $5,000 every five years until it reaches $90,000.
- Non-solicits can only be imposed on employees earning $45,000 or more. This minimum will increase by $2,500 every five years to a $52,500 base.
- Minimum earnings include any W-2 compensation, including salary, bonuses, commissions, and tips, as well as elected deferrals like contributions to a 401(k) plan, a flexible spending account or a health savings account, and commuter benefit deductions.
- The circumstances of employment separation (e.g., voluntary resignation vs. termination for cause) are generally irrelevant for enforcement. But employers who furlough, fire, or lay off employees due to COVID-19 or similar circumstances can’t enforce the restrictions unless they provide “garden leave” (employee’s base salary) for the entire restrictive period.
- Employers must give employees at least 14 days’ notice and an opportunity to review agreements with an attorney. Importantly, it’s best to notify new employees 14 days before their start date.
- The attorney general can enforce, investigate, and sue employers who engage in a “pattern and practice” of violations. Monetary penalties are up to $5,000 for each violation or $10,000 for each repeat violation within five years.
- If an employer sues unsuccessfully, the employer must pay the individual’s attorney’s fees.
WATCH FOR THE PROPOSED FEDERAL BAN
State laws on non-competes, including the above-mentioned Illinois law, would be superseded by the FTC’s proposed federal ban. Understand that the FTC’s proposed rule is limited to employee non-competes and wouldn’t affect non-solicits or other restrictions. However, it would ban “de facto” non-competes (barring individuals from accepting or doing unsolicited business). Notably, it would apply retroactively to existing agreements and would require employers to notify current and former employees that the provision is invalid.
The business community’s reaction to the FTC’s proposed ban hasn’t been surprising. Most employers strongly reject a broad ban and are pushing to narrow the scope. The U.S. Chamber of Commerce has vowed to fight the ban and questioned the FTC’s legal authority to implement a wholesale ban without authorization from Congress.
As it stands now, the FTC is reviewing public comments and will vote on the rule in April 2024. Here are some steps those using or subject to non-competes can consider to prepare for a possible ban.
- Make sure all agreements comply with current state laws.
- Narrowly tailor restrictions to meet actual business needs.
- Consider alternatives to non-competes, like strengthening covenants on confidentiality, IP, and non-solicitation.
- Think about what to offer as adequate consideration to current and prospective employees subject to restrictive agreements.
- Provide required notice (e.g., 14 days in Illinois).
- Do due diligence when hiring to make sure there aren’t any conflicts with a candidate’s agreements with current or former employers. Otherwise, the former employer could sue for intentional interference with that agreement.
- If a current or former employee is violating or threatening to violate a restrictive covenant, investigate and take necessary action.
While much uncertainty looms over the FTC’s vote, one thing is certain—those that act proactively now and stay informed will be in the best position to handle any changes that come.
Lori Goldstein, JD, is the attorney and owner of the Law Office of Lori A. Goldstein LLC, in Northfield, Ill.
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