Non-Compete Retreat
By: Lane Fisher and Max Staplin, Fisher Zucker
While the Federal Trade Commission (FTC) is best known by the franchising community as the primary federal agency that regulates the industry, the FTC caught the attention of franchisors, franchisees, and most of the rest of the country last week when it issued a new rule banning the use of non-competition covenants for “workers” on a nationwide basis. Notably, the final rule explicitly states that it does not impact non-competes between franchisors and franchisees, though it does apply to a person who works for a franchisee or franchisor.
We expect this rule to be challenged, but in the event that the challenge is unsuccessful, it will take effect 120 days after it is published in the Public Register. After the effective date, it will be an unfair method of competition for a person to (1) enter into or attempt to enter into a non-compete clause, (2) enforce or attempt to enforce a non-compete clause, or (3) represent that a worker is subject to a non-compete clause. These restrictions will also retroactively apply to prior agreements, with a carveout for senior executives, where the restrictions will only apply to non-compete clauses entered into after the effective date of the new rule. Additionally, employers are responsible for providing “clear and conspicuous” notice to workers prior to the effective date of the rule that their non-compete clause will not be and legally cannot be enforced.
KEY DEFINED TERMS
1. Worker means a natural person who works or who previously worked, whether paid or unpaid, without regard to the worker’s title or the worker’s status under any other State or Federal laws, including, but not limited to, whether the worker is an employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor who provides a service to a person. The term worker includes a natural person who works for a franchisee or franchisor but does not include a franchisee in the context of a franchisee-franchisor relationship.
2. Non-compete clause means:
- A term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from: (i) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.
- For the purposes of this part 910, term or condition of employment includes, but is not limited to, a contractual term or workplace policy, whether written or oral.
3. Senior executive means a worker who:
- Was in a policy-making position; and
- Received from a person for the employment: (i) Total annual compensation of at least $151,164 in the preceding year; or (ii) Total compensation of at least $151,164 when annualized if the worker was employed during only part of the preceding year; or (iii) Total compensation of at least $151,164 when annualized in the preceding year prior to the worker’s departure if the worker departed from employment prior to the preceding year and the worker is subject to a non-compete clause.
Impact on Franchising
Even though it does not apply to franchisor-franchisee non-compete clauses, this rule figures to have a substantial impact on the franchising community. First, franchisors and franchisees will need to evaluate existing non-compete clauses to determine if they will remain effective. This analysis primarily hinges upon whether the worker in question qualifies as a “senior executive” under the definition of above. If it looks like this rule is going to take effect, we would not be surprised to see a number of companies provide some sort of consideration to their senior executives to enter into new non-compete agreements to ensure that they have as much protection as possible.
Second, most franchisors require certain of their franchisees’ employees to enter into the franchisor’s prescribed form of confidentiality and non-competition agreement, a copy of which is generally attached to the franchise agreement. This requirement is very common for the franchisee’s general manager (or similar role) and somewhat common for other management/key personnel.
Prior to the effective date of this rule, franchisors will need to remove the non-compete clauses from these agreements, but they should still maintain the requirement that anyone with access to the franchisor’s proprietary information sign the modified agreement with the confidentiality provisions intact. Additionally, franchisors should work with their franchisees to provide the required notice that existing non-compete clauses are no longer enforceable. While the workers at-issue are technically the franchisee’s and franchisors must be wary of joint employer rules, the franchisor is often explicitly listed as a third-party beneficiary on these agreements. Therefore, it would be prudent to inform franchisees of the notice requirement.
Whether any of the existing non-compete clauses will remain effective will turn on whether any of the individuals qualify as a senior executive, as defined above. In addition to meeting the salary threshold, someone must hold a “policy-making position” in order to qualify as a senior executive, which generally means a business’s CEO/president or someone with the final authority to make decisions that control significant aspects of the business. In the franchisee context, this will generally be a tough hurdle to overcome unless the franchisee is an absent owner that delegates full day-to-day authority to the employee in question.
Finally, it is noteworthy that while the rule explicitly carved franchisor-franchisee non-competes, the FTC ominously clarified that this does not mean that it believes franchisor-franchisee non-competes are beneficial to competition. In fact, this decision received a significant amount of analysis beginning on page 385 of the rule. Many commenters requested that the rule be expanded to cover franchisor-franchisee non-competes, maintaining that franchisees don’t have significant bargaining power and will be similarly situated to workers that are unable to find a new job. The FTC ultimately disagreed with these commenters, determining that franchisor-franchisee non-competes are more analogous to restrictive covenants between businesses, which are permitted. However, the fact that this was seemingly a hotly-debated topic indicates that this could be revisited in the future.
The next few months will provide more clarity on this potentially significant change to contractual relationships, both within franchising and in the broader context of the American economy.
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