BY PARKER E. THOENI AND PAUL D. BURGIN

In a nationwide trend, covenants not to compete are under increasing scrutiny at the federal and state level. Indeed, state legislatures are enacting legislation with increasing regularity that limits the enforceability of covenants not to compete, with some states such as Maryland further expanding their restrictions on covenants not to compete. The crackdown on covenants not to compete is not limited to the state level, as federal agencies are following suit.

• FTC

In 2021, the Biden Administration directed the Fair Trade Commission (“FTC”) to take action to limit non-competes. Following that directive, on January 5, 2023, the FTC issued a Notice of Proposed Rulemaking (“NPRM”). The NPRM fundamentally prohibits non-compete clauses except in context of sale of business and business to business contracts such as franchise agreements. 

1. The FTC’s legal basis for the NPRM

The FTC is the agency that enforces antitrust laws such as the Sherman Act. The FTC explained that the legal basis for banning non-competes is that they constitute restraints of trade that are subject to Section 1 of the Sherman Act. Whether the FTC has a legal basis, or the legal authority, to ban non-competes is contested and beyond the scope of this article. 

1. The FTC’s rationale for the NPRM

The FTC offered numerous reasons it felt non-competes constitute an unlawful restraint of trade. First, the FTC asserts that non-compete agreements create friction in the job market. The FTC also asserted that non-compete clauses suppress wages and increase gender and racial gaps. The FTC also felt that non-competes inhibit new business formation and result in decreased innovation. On the other hand, the FTC conceded that the existence of non-compete clauses leads to increased training and investment in employees. 

1. The Proposed Rule

The NPRM, should it become a Rule in its current form, would prohibit employers from (1) entering into non-competes with workers, (2) maintaining non-competes with workers, or (3) representing to workers that they are subject to a non-compete. The Rule would require employers to rescind existing non-competes, which could be achieved by providing workers with a model notice to be developed by FTC. It should be noted that, unlike the confusion surrounding the first iteration of the DC ban on non-competes (discussed below), the FTC Rule would apply to post-employment agreements only. 

The Rule applies to all workers, not merely employees. The FTC expressly identifies the following categories of workers that would be covered under the Rule: employees, independent contractors, interns, externs, volunteers, apprentices, and sole proprietors serving a client. 

As to the sale of business exception to the Rule, the exception would only apply if the seller of the business owns more than twenty-five percent of the business or division of the business being sold. 

The Rule does not apply to certain types of agreements. Those types of agreements are NDAs, restrictions on solicitation of clients, restrictions on conducting business with clients, restrictions on recruitment of employees, liquidated damages agreements, and agreements to repay training costs. However, the FTC goes on to explain that the Rule would apply to other types of agreements if they are so broad they constitute non-competes based on a functional test. For example, the Rule would prohibit extremely broad NDAs or agreements to repay training costs that bear no relation to the employer’s actual cost to train. 

1. Alternatives Considered by FTC

In coming to its proposed Rule, the FTC considered several alternatives and invited comments regarding the alternatives. The alternatives considered were (1) a categorical ban for low wage workers and a rebuttable presumption that non-competes for high wage workers were not enforceable, (2) a categorical ban for low wage workers and no ban for high wage workers, (3) a rebuttable presumption that non-competes are not enforceable for all workers, a test the FTC said would be more restrictive than most state laws, (4) a rebuttable presumption for low wage workers but no requirements for high wage workers, and (5) a potential carveout for senior executives such that a rebuttable presumption would apply only to them. 

1. Timing of Final Rule

Bloomberg Law has reported that the FTC will vote on the NPRM in April 2024. The NPRM followed several consent orders issued by the FTC, as well as a flurry of activity by the Department of Justice, so the federal government is not at a standstill while the NPRM is pending. It is noteworthy that the NPRM contained a sharp dissent, which questioned the assertions in the NPRM as well as the FTC’s authority to issue such a rule. 

• National Labor Relations Board (NLRB) General Counsel Jennifer Abruzzo Argues That Non-Compete Agreements Violate the National Labor Relations Act (NLRA).

Continuing the trend of government challenges to non-compete agreements, on May 30, 2023, National Labor Relations Board (NLRB) General Counsel Jennifer Abruzzo issued a memorandum stating her position that non-compete agreements violate the National Labor Relations Act (NLRA) except in limited circumstances. The memorandum explains that non-compete agreements are overbroad in violation of Section 8(a)(1) of the NLRA to the extent they chill employees’ exercise of rights guaranteed by Section 7 of the NLRA unless the non-compete agreement is “narrowly tailored to address special circumstances justifying the infringement of employee rights.”

The memorandum cites five specific types of activity protected by Section 7 of the NLRA that are chilled by non-compete agreements:

1. Employees’ right to threaten resignation to demand better working conditions.
2. Employees’ right to carry out concerted threats to resign or otherwise concertedly resigning to secure improved working conditions elsewhere.
3. Employees’ right to concertedly seek or accept employment with a local competitor to obtain better working conditions.
4. Employees’ right to solicit coworkers to work for a local competitor as part of a broader course of protected concerted activity.
5. Employees’ right to seek employment to specifically engage in protected activities with other workers at an employer’s workplace.

Although General Counsel Abruzzo does not provide any examples of such special circumstances justifying a non-compete agreement, the memorandum states that an employer’s desire to avoid competition is not a legitimate business interest. This aspect of the memorandum is unsurprising and consistent with Maryland law, as non-compete agreements designed solely to restrict competition are lacking in any protectable interest. The General Counsel’s memorandum further states that “retaining employees or protecting special investments in training employees” will likely never justify an overbroad non-compete provision, and training investments can be protected by less restrictive means such as a longevity bonus. 

With regard to protection of proprietary and trade secret information, these legitimate business interests “can be addressed by narrowly tailored workplace agreements that protect those interests.” Conversely, according to the memorandum, non-compete agreements between employers and low-to-middle wage workers who do not have access to trade secrets or other protected interests are unlawful.

Further, GC Abruzzo wrote that non-compete agreements limiting only an individual’s managerial or ownership interests in a competing business would not violate the NLRA because they would not be construed as prohibiting the individual from accepting other employment. Lastly, this memo does not impact non-compete agreements entered into with managers and supervisors, or properly classified independent contractors. Of course, employers must ensure proper classification of independent contractors before taking any solace in this exception to the memorandum. The proper classification of independent contractors has recently been a point of emphasis among federal agencies and state legislatures. 

General Counsel Abruzzo’s memorandum does not expressly bar non-solicitation agreements, commonly used to protect customer relationships, however, they may be susceptible to future attack by the Board given this Board’s pattern of action. 

General Counsel Abruzzo’s memorandum is only guidance at this time, however, the memorandum directs Regional Directors to submit cases involving non-compete provisions that are arguably unlawful under this analysis to the Board’s Division of Advice. At some point, her theory of the law will likely be tested in front of the NLRB and a federal court.

Despite the memorandum not being law, employers may choose to review their non-compete agreements to ensure they are utilized for supervisory employees or independent contractors, and are supported by a legitimate business justification in order to avoid future unfair labor practice charges.

• Maryland Expands its Non-Compete Ban for Low Wage Workers

In 2019, the General Assembly passed the Non-Compete and Conflict of Interest Clause Act, which prohibited employers from including a non-compete or conflict of interest provision in an employment contract with an employee earning $15 or less per hour or $31,200 or less annually. According to the bill, such provisions, which restrict the ability of the employee to work for a new employer or become self-employed in the same or similar business or trade, are void as against public policy. The bill specifically provides that employers may still prohibit such employees from taking client lists or other proprietary client-related information.

In the 2023 Legislative Session, the General Assembly expanded the law’s earnings threshold to 150% of the State minimum wage rate. The increased threshold takes effect on October 1, 2023. At the current minimum wage rate of $13.25 for employers of 15 or more employees, this means employees making $19.88 per hour or less will be covered under the law. For smaller employers at the $12.80 rate, the applicable cutoff will be $19.20 per hour. Upon an increase in the minimum wage rate to $15.00 effective January 1, 2024, the threshold will be $22.50 per hour. While Maryland’s non-compete law is not as draconian as its counterpart in Washington D.C., it is demonstrative of the growing trend of curbing non-compete agreements. 

• Washington D.C. Non-Compete Ban

Maryland employers with workers who perform a substantial amount of work in the District of Columbia should be familiar with the Non-Compete Conflict of Interest Clarification Amendment Act, which narrowed the scope of the very broad ban on non-competition agreements pursuant to the Ban on Non-Compete Agreements Amendment Act of 2020. In an apparent recognition of the overbreadth of the law, the D.C. Council meaningfully narrowed the ban on non-competes in the following ways:

1. Definition of Covered Employee Narrowed

The definition of Employee has been narrowed in several respects. First, the definition now applies only to employees who perform 50% or more of their work in D.C. or who have D.C. as a base, perform substantial work in D.C., and do not perform 50% or more of their duties in another jurisdiction.

Second, the new law creates a definition for “highly compensated employees” who are excluded from coverage unless they fall into the category of “broadcast employees.” Non-competition agreements are generally permitted for highly compensated employees, employees earning $150,000 or more ($250,000 for medical professionals), an amount that will be adjusted annually based on the Consumer Pricing Index. For highly compensated employees, a non-competition agreement must be provided at least 14 days prior to the commencement of employment and must set forth the scope of activity restricted, the geographic scope, and the temporal scope must be limited to 365 days (except that a 730-day restriction is permitted for medical professionals).

1. Scope of Prohibition Narrowed

The definition of non-compete agreement, which was particularly problematic under the original law, and seemed to abrogate the common law duty of loyalty, has been appropriately narrowed. Under the Clarification Amendment Act, the definition no longer includes agreements that prohibit employees from accepting work that would reasonably require the employee to (i) disclose or use an employer’s confidential information; (ii) create a conflict of interest; (iii) interfere with the duties of an employee of a higher education institution; or (iv) impair the employer’s ability to comply with D.C. or federal law, a contract, or a grant agreement.

Also carved out are agreements that contain long term incentives, a term that is broadly defined.

• Practice Pointer

When drafting non-compete agreements, practitioners should be mindful of the increased scrutiny such agreements are drawing and frequent developments in legislation and guidance regarding their enforceability. Practitioners should ensure that the non-compete agreements they draft are compliant with relevant law, narrowly tailored and no broader than necessary.

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Parker Thoeni is a partner and Paul Burgin is an associate at Shawe Rosenthal LLC.