By Jeremy Falcone and Derrick Foard, Ellis & Winters, LLP
This has been a bad year for the Instapot, Bed Bath & Beyond, and the North Carolina Tarheels. But the non-compete provision may be the owner of the worst 2023.
Non-compete provisions are used throughout the country to limit employees’ ability to take knowledge gained at one employer and deploy it with a competing company. By some estimates, almost 20% of the current United States’ workforce is subject to a non-compete agreement. More than a third of employees have been subject to a non-compete agreement at some point during their careers. The statistics show that these non-compete agreements have become a fairly standard occurrence within employment relationships.
While other states, like California and Illinois, have statutorily prohibited non-compete agreements, North Carolina allows employers to enforce non-compete agreements. To be enforceable, the agreement meets a five-factor test. The non-compete must be in in writing; reasonable as to time and territory; made a part of the employment contract; based on valuable consideration; and designed to protect a legitimate business interest of the employer. See Copypro, Inc. v. Musgrove, 754 S.E.2d 188, 191-92 (N.C. Ct. App. 2014). The agreements also cannot violate North Carolina public policy. See Phelps Staffing, LLC v. C.T. Phelps, Inc., 226 N.C. App. 506, 509, 740 S.E.2d 923, 927 (2013)
But 2023 has suggested that the non-compete levees may run dry, even in North Carolina.
It was not February that made us shiver. Instead, in January 2023, the FTC proposed a new rule that would largely ban non-competes. The FTC described non-competes as “a widespread and often exploitative practice that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses.” FTC Proposes Rule to Ban Noncompete Clauses, Which Hurt Workers and Harm Competition (Jan. 5, 2023). Non-competes, the FTC claims, violate section 5 of the Federal Trade Commission Act as an unfair method of competition.
The FTC quotes some staggering figures, estimating that a non-compete ban would increase American wages by $300 billion per year.
The FTC’s proposed rule would extend to independent contractors, employees, and even volunteers. It would prohibit (a) entering into or attempting to enter into a non-compete with a worker, (b) maintaining a noncompete with a worker, or (c) representing to a worker that the worker is subject to a noncompete (in certain circumstances). The FTC did leave a little wiggle room for employers, noting that the prohibition would not extend to “other types of employment restrictions,” presumably non-solicitation and confidentiality provisions. Id. However, the FTC cautioned that those other provisions would also be prohibited if they were “so broad in scope that they function as noncompetes.” Id.
Fortunately, the courtroom will remain adjourned and no verdict will be returned in the short term. The FTC will not be voting on the proposed rule until April 2024, and it received a substantial number of public comments that will need to be reviewed prior to any implementation.
As if that wasn’t bad enough, in May 2023, the General Counsel of the National Labor Relations Board (NLRB) offered up its whiskey to the FTC’s rye in a memorandum further criticizing non-compete agreements. (See Memorandum GC-23-08). While the NLRB general counsel does not make law, she does prosecute the National Labor Relations Act (NLRA) and the position can become law if and when the NLRB issues a decision or rule. So while the memorandum is not law, it provides a good idea of which direction the Chevy is heading.
In the memorandum, the NLRB outlines its position that non-compete agreements interfere with employee rights under the NLRA.
A 1935 law may seem like odd precedent to support the NLRB’s argument. The NLRA does not mention the word “non-compete,” as it was passed long before the heyday of non-competes.
But the NRLB believes that non-compete agreements violate Section 7 of the NLRA. That provision protects the right to “self-organization, to form, join, or assist labor organizations.” Under the NRLA, it is unfair labor practice to “interfere with, restrain, or coerce employees in the exercise of the rights guaranteed” in Section 7.
According to the NLRB, non-compete provisions affect these Section 7 rights by interfering with an employee’s ability to seek better working conditions by threatening to resign, actually resign, or seeking out employment with a competitor. Non-compete provisions also prevent employees from soliciting their co-workers to work for a local competitor.
The NLRB did give lip service to some exceptions, noting that there may be some situations in which a legitimate business interest could justify the use of a non-compete agreement. But at the same time, the NLRB made clear that the church bells all were broken with any such exception:
- A desire to avoid competition from a former employee? Not a legitimate business interest.
- Retaining employees or protecting special investments in training employees? Not a legitimate business interest.
- Protecting business interest in proprietary or trade secret information? Yes, a legitimate business interest—but not a legitimate business interest that justifies a non-compete provision.
If the FTC rule and NLRB position eventually are enforced, what is left? Will the music be able to play?
Perhaps as to the King and Queen, but not the jester. The NLRB does note that “provisions that clearly restrict only individuals’ managerial or ownership interests in a competing business” may be acceptable. This is because the NLRB does not apply to “supervisors” (those who have the authority to hire, fire, discipline, promote). Presumably, a non-compete agreement signed by a manager or front-line worker may be valid if the provision only prohibits the employee from work with a competing company as a manager or owner. Similarly, it may be the case that any non-compete for a supervisor would be acceptable (even if it limited front-line work at the new employer). But the memo is not clear on that point.
But before we start singing dirges in the dark for the non-compete provisions, all hope may not be lost. In our highly-politicized environment, there is frequently a great run-up to significant change, followed by a quick district court opinion from a favorable jurisdiction that bars the change from taking place. For instance, in 2016, employers all over the country scrambled to get their policies for handling exempt and non-exempt status adjusted to meet the proposed requirements from the Obama administration. But a Texas district court issued an injunction, and the changes never took place.
Even still, the levee may end up running dry here. The proposed FTC rule and NLRB memo suggest that employers should look away from non-compete agreements and rely more on narrowly-tailored non-solicitation and confidentiality provisions to attempt to prevent their trade secrets and know-how from being brought to a competitor. Certainly employers will now risk potential enforcement action by the NLRB for attempts to hold an employee to a non-compete. Equally as problematic, though, employers may also have difficulty getting courts to grant relief based on the general thrust of the law on these provisions. A state court reviewing a motion for a TRO or preliminary injunction may be disinclined to enter such an order in the face of such headwinds on non-compete provisions generally.
So what is an employer left to do?
First, employers should revisit their current restrictive covenant provisions. Non-compete provisions should be carefully reviewed and the risk of potential NLRB enforcement action should be considered.
Next, employers should consider how they can use other restrictive covenant provisions and agreements to protect confidential information. Confidentiality provisions continue to be generally upheld, so employers can rely on these provisions to protect the most critical company information. Additionally, non-disclosure agreements are generally enforceable so long as they are reasonable in duration. Furthermore, a narrowly-tailored non-solicitation provision—particularly for important clients with whom the employee has closely worked—should be fair game.
Finally, employers should look for ways to keep employees happy. Even before the FTC proposed rule and the NLRB memo, it was sometimes difficult to enforce a non-compete provision. The best defense against needing the provision is preventing the employee from leaving in the first place.
And last, of course, grab some whiskey and rye and start singing, “This’ll be the day that I die.”
Article feature of NCADA's Employment Law Practice Group.
