Non-Compete Agreements in California

Non-compete agreements can be an important key to protecting your trade secrets. They must be limited in scope and duration, and with the new FTC ruling, your company has certain obligations that it must comply with. If not, you may find your so-called contract void and unenforceable. We can help draft and review agreements, and serve as your outside legal counsel for trade secret matters. For a free consultation, call us at (877) 276-5084.

Issue: The Federal Trade Commission banned non-compete agreements in California. What does this mean for your business in California?  

Introduction 

Non-Compete Agreements (NCA) for years have served as a tool businesses could utilize to protect sensitive business information, including trade secrets, client lists, and proprietary processes. By preventing former employees from joining competitors or starting their own competing ventures, businesses sought to safeguard their competitive edge. For example, imagine a tech company that develops cutting-edge software solutions for the healthcare industry and invests heavily in research and development to create algorithms and software platforms that significantly enhance care and streamline operations. These unique functionalities and relationships are crucial for sales and business growth. To protect these valuable assets, a company may have wanted to implement a Non-Compete Agreement to prevent key employees from leaving the company and joining competitors. For instance, a software engineer with extensive knowledge of the algorithms could potentially share this information with a rival company, eroding the original company’s competitive edge. 

However, under the Federal Trade Commission’s (FTC) new rule, Non-Compete Agreements have been banned nationwide. The FTC is a federal agency with rule-making authority given by Congress. The FTC’s authority to ban NCAs stems from Section 5 of the Federal Trade Commission Act, which deals with unfair competition. This new federal rule categorically bans non-compete agreements with all workers from the effective date onward. This decision is rooted in the belief that NCAs constitute an unfair method of competition, as they restrict workers’ ability to pursue new job opportunities and negotiate higher wages. The new rule is set to go into effect 120 days after its publication in the Federal Register, bringing significant changes to employment law and impacting businesses and workers nationwide. 

Key Provisions on the New Rule

Under Section 910.2 in the FTC, which surrounds unfair methods of competition, the federal rule states it is improper to:   

1. To enter into or attempt to enter into a Non-Compete Agreement 

2. To enforce or attempt to enforce the Non-Compete Agreement  

3. To represent that the worker is subject to a Non-Compete Agreement 

Prohibition on NCAs  

The final rule prohibits entering into, attempting to enter into, enforcing, or attempting to enforce a non-compete clause. It also bans representing that a worker is subject to an NCA. An example of entering or attempting to enter into a Non-Compete Clause could be if a software development company hired a new software engineer, and as part of the employment contract, the company includes a clause that prevents the engineer from working for any competitor within a 50-mile radius for two years after leaving the company. However, under the new FTC rule, this clause would be prohibited. Additionally, suppose the company tries to negotiate such a clause even if the engineer does not sign the contract. In that case, this attempt is also against the FTC rules. An example surrounding the enforcement or attempt to enforce an NCA could be if a marketing firm has a former employee who has joined a competitor. Suppose the firm decides to send a cease-and-desist letter to the former employee, threatening legal action if they do not quit their new job based on an existing non-compete agreement. Under the new FTC rule, this action is prohibited. A final example, surrounding the representation of a worker being subject to an NCA, could look like a human resources manager telling an employee who is resigning that a non-compete agreement binds them and cannot work for a competitor. Even if the company does not take any further action to enforce the NCA, simply representing that the worker is subject to it is prohibited under the new FTC rule. 

Exceptions 

There are a few exceptions, such as agreements related to the sale of a business. For instance, if you sell your RV dealership, you cannot open a new dealership down the road. Additionally, certain franchisor/franchisee agreements may be exempt. For instance, if a woman owns a franchise of a popular fast-food chain, and the franchisor includes a clause in the franchise agreement that prevents her from opening a competing restaurant within a certain radius during the term of the franchise agreement, this type of non-compete clause is potentially exempt under the FTC rule. 

Treatment of Existing NCAs  

For senior executives earning over $151,164 annually and holding policymaking positions, existing NCAs can remain enforceable but cannot occur again in the future. This is like the idea of being grandfathered into the clause. However, for all other workers, existing NCAs are not enforceable, and employers must notify these workers in writing that they are no longer bound by these agreements, whether it is delivered in-person, email, or last known address. For example, a senior executive at a company earns over $151,164 annually and holds a key policymaking position. His employment contract includes a non-compete agreement that is still in effect. Under the FTC’s new rule, this existing non-compete agreement can remain enforceable, and Mark is still bound by its terms but cannot have one again in the future. 

FTC Predictions based on the NCA ban 

The FTC provides a fact sheet on its website that predicts banning non-competes will result in reduced healthcare costs of 74 to 194 BILLION and will reduce spending on physician services over the next decade. It is also predicted that new businesses will be formed with a 2.7% increase in new firm formation, resulting in about 8,500 additional new companies each year.  

According to the FTC, we should also see a rise in innovation, with an average rise of 17,000 to 29,000 more patents yearly. This causes a predicted increase of about 3,000 to 5,000 new patents in the first year the non-competes are banned, rising to about 30,000 to 53,000 in the time of ten years. The FTC also estimates higher worker earnings, estimating 400 to 488 BILLION in increased wages for workers in the next decade, which will average out to an extra 524 dollars per year…  This may not sound like a massive sum of money compared to the 400 to 488 billion stated. Still, it is always better to make more than less money when you are free to do so and can peddle your services to the highest payer. So, there are many financial and economic reasons for the rule.  

Conclusion:  

The FTC’s new rule banning non-compete agreements introduces significant changes for employers and employees alike. By prohibiting the use of non-competes, except in specific circumstances related to the sale of a business and certain franchisor/franchisee agreements, the rule aims to enhance worker mobility and foster a more competitive labor market. Companies must adapt their employment practices to comply with these new regulations, ensuring they do not unlawfully restrict their employees’ future employment opportunities. 

For more information, or if you are dealing with a legal matter involving California trade secrets, non-solicitation agreements, or unfair business practice claims, call us at (877) 276-5084.