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Noncompete Agreements Under Siege at the State and Federal Level

July 21, 2023
Carlos Pastrana

Recent developments suggest that state legislatures and federal agencies are targeting noncompete agreements as an overbroad restriction on free-market competition. The State of Minnesota recently joined California, Oklahoma, and North Dakota in the list of states that have banned noncompete agreements outright, and New York seems poised to join this list. Noncompete agreements have also previously been severely restricted in Washington, D.C., and well as Oregon, Illinois, Massachusetts, Maine, Maryland, New Hampshire, Rhode Island, Virginia, Washington, Nevada, and Colorado. Both the Federal Trade Commission (FTC) and National Labor Relations Board (NLRB) also have recently taken steps to ban employers from using noncompete agreements.

Noncompete agreements restrain or prohibit employees from working for corporate competitors or opening their own competing businesses within a geographic area for a certain period of time after they leave an employer. Employers generally use noncompete agreements to keep their employees from taking trade secrets and proprietary information to a competitor in the event they leave, which is why they have a particularly high rate of usage in the healthcare, financial services and IT industries. According to a report from the United States Government Accountability Office (GAO), about 55% of employers said they use noncompete agreements, while roughly 18% of U.S. workers are currently subject to noncompete agreements and approximately 38% have been subject to noncompete agreements at some point in their careers.

On May 24, 2023, Minnesota Governor Tim Walz signed a bill into law prohibiting noncompete agreements across the state. The new law applies to agreements that employees or independent contractors entered into on or after July 1, 2023. The law does contain several carve-outs permitting noncompete restrictions under certain circumstances, including restrictions that are agreed upon “during the sale of a business” or “in anticipation of the dissolution of a business.”

Previously, California, Oklahoma, and North Dakota had banned noncompete agreements entirely.

Specifically, Section 16600 of the California Business and Professions Code makes post-employment noncompete clauses void in California. Courts in California, including the State Supreme Court, have consistently reaffirmed the strong public policy there against noncompete provisions. California’s ban on noncompete agreements, however, does not include the sale of a business and protection of trade secrets.

Meanwhile, Oklahoma law only allows an employee who has executed a noncompete with an employer to engage in the same business as that conducted by the former employer if the former employee does not directly solicit the sale of goods or services from established customers of the former employer.

For its part, North Dakota allows businesses — regardless of whether they are headquartered in or outside North Dakota — to protect trade secrets, but does not allow noncompete agreements, although there has been some confusion about the distinction between a trade secret and a similar line of work or business.

The New York State Assembly recently passed a bill that, if signed by Governor Kathy Hochul, would ban nearly all noncompete agreements. The governor had previously expressed support for eliminating noncompete agreements for New York workers making below the median wage, but the bill that is currently on her desk would apply to all employees in New York, regardless of compensation. If this bill becomes law, it would not retroactively nullify agreements into which parties had entered before the effective date of the law, but it would prohibit new noncompete agreements or the modification of existing agreements prospectively. The bill expressly would not cover agreements prohibiting disclosure of trade secrets, disclosure of confidential and proprietary client information, or solicitation of clients of the employer that the covered individual learned about during employment.

These state efforts to ban noncompete agreements are not outliers. This past January, the FTC proposed a new rule that would ban employers from imposing noncompete agreements on their workers. The agency bases its proposed rule on a preliminary finding that noncompete restrictions constitute an unfair method of competition and therefore violate Section 5 of the Federal Trade Commission Act. The FTC estimates that banning these restrictions would affect about 30 million Americans and boost wages by nearly $300 billion per year. After seeking public comment on the proposed rule, the agency received nearly 27,000 comments on the draft rule and is expected to vote on the final version of the rule in April of 2024.

In addition, NLRB General Counsel Jennifer Abruzzo published the agency’s opinion in a memo released on May 30, 2023, that some noncompete agreements violate the National Labor Relations Act (NLRA). The announcement, which expressly applies to both nonunionized and unionized employers, would seem to suggest that the NLRB will pursue unfair labor practice charges against employers that use noncompete agreements.

Employers would be well-advised to monitor these state and federal efforts, which would include two of the three states with the largest economies and two federal agencies that regulate business and employment relationships. Employers who do business in more than one state might end up having to grapple with a patchwork of different state and federal restrictions. It might be a good idea to be proactive and begin to explore alternatives to noncompete agreements that are not expressly banned by statute or regulation, including nonsolicitation and nondisclosure agreements.

If you have questions regarding noncompete agreements or are interested in learning more about our Labor and Employment Law practice, please contact your relationship attorney.