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IRA Financial Blog

Will Non-Competes Become Illegal? – Episode 373

Adam Talks

In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses a new FTC-proposed rule which would ban the use of non-compete clauses for employees.

Breaking News: Will Non-Compete Agreements Become Illegal?

Hey everyone, Adam Bergman here, tax attorney and founder of IRA Financial. On today’s show, we’re going to be discussing a January 5, 2023, Federal Trade Commission proposed rule about banning employers from using non-compete clauses on employees.

This is kind of breaking news. The FTC is sticking their neck out into an area that many didn’t think they would travel in, but where we are now is they are seeking comments over the next 60 or so days for public comments on their proposed rule, which I will discuss in a couple of minutes. But banning non-competes, which is pretty significant for small businesses all the way up to Fortune 500 companies that want to make sure that they are doing what they can to keep their key employees from going out and taking all the institutional knowledge, trade secrets, secret sauce of the companies they’re working for, and sharing it with competitors.

So, non-competes are very, very common, and again, all widespread types of businesses, different industries across the board. So, having the FTC essentially ban them is a massive rule. Just the outset, I don’t think it’s ever going to go anywhere. But they are kind of serious about it. They’re looking for comments. It’s not a congressional rule; they do have the authority to make rules.

So, what is the FTC? Well, the FTC is the Federal Rule-making Authority, and they have the ability to issue industry-wide regulations, rules, and guides to deal with common unfair or deceptive practices and unfair methods of competition, right? So you go to the FTC and follow complaint if a company is doing unfair advertising or unfair actions that are disrupting an industry, a sector of an industry, or just even your business, or even to the mass consumer. So, it’s a very important government agency, but for them to dip their toes in this is pretty bold.

So, let’s talk about the rule for a second. I’m sure everyone listening or watching has heard of what a non-compete is, right? You may have signed one yourself. Some companies don’t even give you an option. If you want to work for them, whether you’re in sales or engineering, marketing, you may be forced to sign a non-compete as part of your employment package, where you are essentially saying that maybe it’s for twelve months, maybe it’s for six months, 18 months, 36 months, whatever the case may be, you will not compete with a, hopefully, narrow scope of companies or industry-type players. And in some cases, the non-competes are even restricted by geography. Let’s say you live in Texas. You can’t compete with companies that are offices in Texas or in the Southwest or Southeast. So, courts have struck down non-competes that are overly broad. You know, i.e. seven years, you can’t work in this industry anywhere in the world, right? That’s probably not going to survive court challenge. But twelve months, you can’t compete in the coffee business because you are a coffee, if you sell coffee in the state of New York and this company wants to restrict you from working with competitors in the coffee industry, maybe in the Northeast or in New York, it’s probably going to hold up a court.

So, what’s this rule all about again? It just came out January 5, so it’s quite new. There’s a 60-day comment period, which is happening now, and after the rule is published in the Federal Register, there’s going to probably be many comments on this, okay? This is going to be a hot topic for business owners, lawyers and the like that are going to want to have some comments because right now this proposed rule is super broad. We’ll see it applies to 25% or greater; there’s exceptions, I should say, for 25% or greater owners. So, you can do non-competes if you buy someone business more than 25%, but there is no exception for key employees, right? Or executives. So, that’s probably going to be a common area that many will talk to and say, hey, okay, you want to maybe prohibit non-competes for rank and file employees, but you have to have some type of exceptions for executives, key employees, things like that.

So, let’s talk with the facts. This proposal defines a non-compete clause as a contractual term, between an employer and a worker that prevents the worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer, okay? So, that’s a non-compete. Nondisclosures and non-solicitations will not be impacted, it seems. It’s only a non-compete. So, nondisclosure basically means if you work at Company X and you go to Company Y, you can’t spill all Company X’s secrets to Company Y. And non-solicitation essentially says if you go from Company X to Company Y, you can’t solicit employees at Company X to go to Company Y. Those provisions will remain intact. They are not subject to attack by this FTC non-compete rule, okay?

So what about trying to bury a non-compete provision in a non-solicitation or nondisclosure agreement? That’s very common these days, and this rule would prevent that because it would basically say you cannot force or even have employees sign non-competes, even if you stick it in a non-solicitation or nondisclosure agreement, okay?

So what about existing non-competes? What do we do? I have a non-compete with Jane or Sally. What do we do? So, this is pretty controversial. The rule states that an employer that enter into a non-compete with a worker prior to the compliance date, must rescind; you got to stop the non-compete clause no later than the compliance date. You got to give notice to the workers that the non-compete is no longer in effect within 45 days of rescinding the non compete; of the rule actually being rescinded, okay? So, that means if you signed a non-compete with an employee a year ago, two years ago, once this rule, if it’s ever finalized and becomes law, within 45 days, you got to tell the worker, guess what? You’re free. You can do whatever you want. I can’t restrict you to compete.

I mentioned there’s an exception for 25% owners or businesses. So, a non-compete clause would be allowed for a seller of a business that owned 25% or more of a business, okay? So, obviously it’s quite common in sale agreements that include non-competes for the executives, the seller, so they don’t just sell their business and go the next morning and open a new business and compete directly against you. That would be crazy, and that would stop a lot of M & A, right? If I was buying a furniture business and suddenly the guy I’m buying it from could open the store next to me tomorrow and just compete with me, that’s not going to entice people to enter into M & A transactions. So, that’s going to be allowed, but if you buy 10%, there would be no non-compete. And again, I mentioned key employees, executives, things like that, someone, maybe a CTO or a chief marketing officer, growth revenue officer, can’t be a non-compete. So, they’ll be able to go to your competitor the next day. Now, yes, you could still get disclosures, non-solicitation, nondisclosures, which will add some protection, but you’re not going to be able to stop them from competing.

So basically, the CDC is not saying that non-competes on its face are invalid. They’re basically saying that they’re an unfair method of competition. We don’t like it, right? It’s unfair because you’re restricting people’s freedom. You’re restricting people’s ability to go out and earn a living, and we’re going to stop them. And I’ll push back on that because, again, I think the courts and, I don’t have enough time to kind of go through various case law on non-competes, but it’s out there. If you Google non-competes case law, you’ll see courts are pretty consistent that they will respect non-competes that are fair and narrow. As I mentioned, like twelve months, you can’t compete in the coffee industry, in maybe a certain state or a region, but they’re not going to allow non-competes for seven years, five years, in a lot of cases; where you can’t, if you’re, let’s say, a software engineer, you can’t go get a software engineering job for five years. That will never hold up. But they may say you can’t work for a competitor in the AI fields in this particular space, this particular area, for a year, three or four or five years, I agree, will not hold up in court, so I’m not sure the FTC actually has to do anything because the courts will protect it.

So, as I mentioned, they’re focused on unfair methods of competition, right? And they believe this unfair method of competition, the FTC does, is affecting commerce and is deceptive. And I’m not sure I agree. I think it’s a broad push by the FTC to get more relevant. I don’t think there’s a huge need for it. I think comments period, you’re going to see a lot of businesses, small, medium, and large, push back and say, hey, we need this. We got to protect ourselves. We can’t have our key employees going out competing with us and doing that right away. FTC will push back and say, well, you got nondisclosures. You got non solicitation. So they can’t really give up your secret sauce. All they can do is get a job with a competitor. What’s wrong with that?

Non-competes have been around for a long time, right? So, for the FTC to come in right now and try to ban them for anyone that owns less than 25% of a business and essentially everyone, other than anyone that owns more than 25% of a business, I’m not sure that’s going to fly. I don’t think the Supreme Court will go along with it. It will certainly get challenged.

So, what’s going to happen? So there’ll be a comment period, right? And then, there’s another 180 days or so where the FTC can gather information and come up with further guidance, and then essentially they could promulgate a rule, a law. But, what will happen then is it’s going to get challenged, right? You’re going to get someone, a business or someone, that’s going to challenge the law, and then it’s going to be up to the courts, right? We see kind of how the Supreme Court’s been ruling, whether it’s abortion or different areas, they basically want Congress to make laws, not necessarily federal agencies, and they want Congress to make these laws. So, they’re probably going to push back and say, hey, FTC, yeah, you may have jurisdiction on this, but we’d rather Congress make these types of laws because it’s going to impact interstate commerce. We feel that that’s something that Congress should have some input on, and then the FTC will push back and say, no, that is our jurisdiction. We’re allowed to make these rules. We’ve done it in the past. We made rules that, for example, dealt with the Internet or certain practices involving child online privacy or different rules that impact federal commerce. This is just another byproduct of that. So, there’s no reason we can’t do it. We’re able to do it, right? Our charter allows us to have federal rule-making authority, issue industry-wide regulations, rules and guides, rules is the keyword, to deal with common, unfair and deceptive practices.

The question is, is it common, unfair, or deceptive? I’m not sure a non-compete is an unfair deceptive practice. Now, the employee may say, it is unfair. I’m receiving no value in return. I have to sign this thing, right? There’s nothing I’m receiving in return for signing this non-compete, right? Usually when you enter into a contract, there’s generally some quid pro quo, right? I’m providing something and I’m receiving something. Here, you could say, well, you’re getting employment; and you may say, well, I’m forced to sign this thing. It’s not fair. It’s deceptive. And that’s what the FTC’s saying, is saying, sign nondisclosure, sign non-solicitation, that I understand why a business would want you to do that. Non-compete seems overly broad and deceptive, and you are potentially impacting interstate commerce, and then a company will say, no, that’s not true. We’re protecting ourselves, protecting M & A, protecting interstate commerce, because without having these non-competes, it’s going to be a wild, wild west and it’s going to be impossible to retain employees.

Now, if I was the FTC and I was going to fight back on that, I’d say, well, there’s other ways to retain employees, like deferred comp, equity options, right? There’s other ways to keep employees happy; saying, okay, if you stay with us X amount of times and you don’t go compete with these types of companies, you can draft these bonus pools or deferred comp in a way where you can basically say, even if you leave us, so long as you’re not employed for competitors, you can still get a percentage of this deferred comp or equity pool or something like that. So, employment attorneys, ERISA attorneys will get creative and if this rule ever does pass and finding ways that’s not in the “non-compete world” for retaining employees.

So, it’s breaking because this is pretty big stuff. I don’t think it’s gotten the publicity it deserves; I haven’t seen it in a lot of, the Wall Street Journal hasn’t done much on it. It’s surprising because this is a rule that will impact, as I mentioned, small, mid-size, large, and super large businesses in all different fashions. And there’s going to be a wide variety of opinions on it from both sides. So, it’s going to be interesting how this comment period persists, and then obviously, the 180 days after that, they have 180 days to basically set a compliance, to set the rule up and finalize the rule. So we’ll see what happens. Even if the rule does get finalized and becomes law, I definitely think this will go to the Supreme Court for sure, and we’ll see where the Supreme Court goes. But, it’s going to cause a big mess because let’s say you have to, the rule becomes law, so you have 45 days to rescind the non-compete. So, now you go to John and Jane, say, hey guys, sorry, non-competes, it’s not enforceable anymore. And then eight months later, or a year later, the Supreme Court says, well actually, it is enforceable. This rule isn’t enforceable, so go back to your non-compete. Do you think John and Jane is going to sign the non-compete? They’re going to be like, no, I’m not signing this now. Forget it, I’m already employed; you need me. Forget about it. I ain’t signing this thing. So, there’s going to be more aggravation, and even if the rule doesn’t get finalized, it may kill non-competes because maybe some employees will push back and say, look, the FTC doesn’t like it, this thing will become law. Why are you forcing me to sign it? It’s unfair. The FTC says they believe it’s deceptive, it’s unfair method of competition. I’m not signing it and we’ll see where it goes. But, I definitely thought this was an important topic to discuss on today’s show, and I’ll definitely keep you in the loop in the next couple of months. Not sure we’ll hear back initially after the comment period ends, but maybe they will provide an updated rule based off comments, like key employees, executives are included, things like that. I’m not sure, personally, as I mentioned, I don’t think there’s a need for this rule. I think the courts do a good enough job policing it. But, I do think the FTC probably does have jurisdiction. We’ll see how the Supreme Court, if it ever does get to the Supreme Court, because the rule becomes law, we’ll see how they adjudicate it. But, based on what they’ve done over the last year or so, as the Court has taken more of a federalist approach, I think they’ll probably say, hey, we think this is a law that Congress should promulgate, not you guys, kick it back and validate it.

So, to be continued. Super interesting. And again, thanks for listening. If you’re watching on YouTube, thank you as well. Appreciate you guys spend some time with me. Super, super important topic, especially if you’re a business owner, entrepreneur, small, mid-size, large, like this will impact all of us. So, either way, again, even if it doesn’t pass, employees may push back on non-competes being part of nondisclosure or non-solicitation agreement. So, it’s interesting. It’s not really tax law, which is kind of the area I like to talk about on the podcast, tax law, alternative assets, retirement stuff. But I thought this was just too important to ignore.

So, hope you guys enjoyed it. Have a great day. This is a weekly podcast, as you probably know, it drops every Wednesday, so check it out. If you haven’t subscribed to the YouTube channel, you definitely should. Great content. If you’re interested in alternative assets, self-directed, Solo Ks, and leave a comment. I promise I go through the comments and I will do my best to get through all them as quick as possible. So, thanks again for spending your time with me today. I appreciate it. Have an amazing day.

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