How Will President's New Executive Order on Non-Compete Agreements Affect Employers?

President Joe Biden on July 9, 2021, issued a wide-ranging Executive Order intended to promote competition in the American economy. Among other things, it encourages the Federal Trade Commission (FTC) to ban or limit non-compete agreements. What is the likely outcome, and what should businesses do to prepare for it?

Historically, non-compete agreements have been regulated by the states, not the federal government. Some 47 states permit non-compete agreements to be used to a greater or lesser extent. Three states – California, North Dakota and Oklahoma – and the District of Columbia largely ban non-compete agreements. Almost a dozen states prohibit or significantly limit the use of non-competition agreements with low-wage workers. Illinois, Oregon, Nevada and Virginia recently joined this group.

Non-compete agreements protect an employer's trade secrets and customer goodwill developed by the company. They prevent an employee from taking a job with a competitor that would put the former employer's trade secrets and other confidential business information at risk of being used or disclosed, whether intentionally or by inevitable or unavoidable disclosure. Employers also rely on trade secret law and nondisclosure agreements to protect this valuable information, but neither provides the level of protection that a non-compete agreement does.

Under most state laws, non-compete agreements for employees must be reasonable in time, geographic area (the territory in which the employee is restricted) and scope (the nature of the work that the employee is prohibited from engaging in during the restricted period). States take one of three general approaches to overly broad non-compete agreements: 1) judicial modification in which the court revises the agreement to a permissible scope; 2) "blue pencil" in which the court simply crosses out the offending language, leaving the remaining language enforceable or not; and 3) "red pencil" in which the court voids any restriction that is overly broad, leaving such provision unenforceable. The first approach encourages employers to draft overly broad restrictions, while the latter two encourage narrow restrictions in order to avoid the risk that the agreement will be invalidated.

The idea of having the FTC curb non-compete agreements is not new. It was floated during the Obama Administration and explored during the Trump Administration. In January 2020, the FTC held a public workshop to examine whether there is a sufficient legal basis and empirical economic support to promulgate a rule that would restrict the use of non-compete agreements. It then sought public comment from interested parties on a series of questions relating to this issue.

In response, the Antitrust Law Section of the American Bar Association expressed doubt about the Commission's legal authority and ability to limit such agreements and urged that "the question of non-compete clauses is likely to be ill-suited" to rulemaking.

Another detailed and thoughtful submission was provided by a group of lawyers and paralegals from around the country with extensive experience in restrictive covenants and trade secrets. This group offered no opinion on whether the FTC has legal authority to promulgate a rule on non-compete agreements, but instead focused on policy and practical issues. It recommended that the FTC should not step in and regulate non-compete agreements, and instead let the states continue to regulate their own economies as they see fit. If, however, the FTC decides that non-compete agreements are an appropriate subject of federal regulation, the group recommended that the regulations be limited and address the following issues:

• a ban on non-compete agreements for low-wage or hourly workers (defined as employees who are not exempt under the Fair Labor Standards Act).
• a mandate that employers provide advance notice to the employee that a non-compete agreement will be required.
• a mandate that courts strike an overly broad non-compete agreement in its entirety unless the language reflects a clear (good faith) intent to draft a narrow restriction, in which case the court may revise it to a permissible scope.

Notably, these reforms are the same ones on which the Obama Administration's initiative on non-compete agreements had focused.

In light of the new Executive Order, it seems unlikely that the FTC will decide to do nothing. On the other hand, it would be a radical and hotly contested step for the Commission to supplant state law and ban non-compete agreements outright. What seems most likely is a set of reforms like the ones outlined above which would have an impact while leaving most of existing state law in place. Employers should prepare accordingly.