No noncompetes… no problem

On April 23, 2024, the Federal Trade Commission (FTC) announced the issuance of its final rule prohibiting many employers throughout the United States from entering into noncompete agreements with their employees. The rule is effective retroactively, and employers covered by the new FTC rule are required to invalidate existing noncompete agreements previously signed by employees, unless an exception applies. The new rule is scheduled to become effective on September 4, 2024.

Employers and business owners should keep in mind that the FTC’s new rule does not prohibit enforcement of noncompete agreements in all situations. There are several types of employers that are exempt from the new FTC rule, such as banks and certain nonprofit entities. An existing noncompete agreement signed by a person who meets the definition of a senior executive remains enforceable under the new FTC rule. Also, a noncompete agreement between a buyer and a seller of a business or business assets remains enforceable under the new rule, so long as the agreement is entered into as part of a bona fide sale of a business entity, the person’s ownership interest in the business entity, or substantially all of a business entity’s operating assets.

There is ongoing litigation relating to whether the FTC has the authority to enact its new rule, and it’s possible that a court might take steps to preserve the status quo and halt enforcement of the new rule. Even so, there are other recent developments under state and federal law which have further challenged the enforceability of noncompete agreements. It’s no surprise that under the current legal environment, many employers are reluctant to sign new noncompete agreements with their employees. However, even in this uncertain legal environment, there are steps employers can take to reduce the risk of unfair competition.

Employers rely on restrictions in employment agreements for reasons that go beyond preventing employees from leaving to work for a competitor. Employees often have access to sensitive business information and intellectual property such as trade secrets, pricing information, client lists, and marketing and financial information. Employers need not simply rely on using noncompete agreements to protect against competitors gaining an unfair advantage by poaching employees and using them to access confidential information. Employers may continue to protect valuable information with non-disclosure agreements (NDA) and nonsolicitation agreements, among other things.

A well-crafted NDA used in an employment context will clearly define the categories of proprietary information that are considered confidential, set forth restrictions and practices relating to the disclosure of confidential information while on the job, and describe remedies in the event of a breach. NDAs must be carefully tailored to protect the legitimate needs of the employer, since an NDA that is drafted too broadly could be deemed to be a “de facto non-compete clause” and thus unenforceable under the new FTC rule. NDAs must also avoid violating employment laws that protect the rights of employees to report illegal activities and to engage in protected labor practices. Businesses should remain proactive and work with legal counsel to ensure that NDAs are drafted properly and signed at the outset of employment of new personnel.

Employers often require employees to sign nonsolicitation agreements which restrict ex-employees from soliciting customers of the employer. A well-crafted nonsolicitation agreement can effectively protect an employer against unfair competition while avoiding many of the legal challenges and enforceability issues relating to noncompete agreements. Under South Dakota law, nonsolicitation agreements signed by employees are enforceable so long as the restrictions are applicable within a specified area and during a period not exceeding two years from the date of termination of the agreement, and provided that the employer continues to carry on a like business within the specified area.

Although the impact of the new FTC rule remains uncertain at this time, employers should remain proactive and focused on steps that can be taken to protect their businesses. Employers which have previously used noncompete agreements to safeguard valuable information and protect against unfair competition may consider whether NDAs and nonsolicitation agreements could fulfill a similar role. Like all employment agreements, however, NDAs and nonsolicitation agreements must be narrowly tailored to the legitimate interests of the employer and carefully drafted by legal counsel to ensure that the agreements comply with state and federal law.