Listen to this article

Noncompete clauses in employment contracts are valuable tools used by employers with their high-level workforce. Many companies use noncompetes and other restrictive covenants to protect their sensitive information, trade secrets and customer/investor relationships and goodwill, and they also rely on them when they share knowledge and corporate secrets/strategy with key employees and invest in training.

But that could soon change, or at least be put to a legislative and legal test, if efforts to ban noncompetes here in New Jersey and at the federal level are successful.

Recently, the general counsel of the National Labor Relations Board issued a memo commenting that the promulgation and enforcement of noncompete agreements interferes with the ability of non-supervisory employees to exercise their rights under the National Labor Relations Act. The GC asked her NLRB colleagues to challenge unlawful, overbroad noncompetes that interfere with employees’ employment opportunities. The GC explained her belief that noncompetes “chill” employees from engaging in protected concerted activity, such as taking steps to improve their working conditions or soliciting others to leave employment for better working conditions.

This action by the NLRB is consistent with aggressive action against noncompetes by the Federal Trade Commission, which pursued enforcement actions and proposed a rule banning the practice, and action on bills in New Jersey and other states. These moves should concern many employers and employees alike.

This year, the FTC proposed a sweeping ban affecting existing and contemplated noncompetes. This proposed new rule seeks to largely bar companies and individuals from entering into new noncompetes, and seeks to void the covenants already in existence.

This is the broadest proposed ban we have seen to date, and it has many employers thinking this could be a step too far, with serious concerns over long-term business ramifications. The FTC received more than 26,000 comments in response to the proposed rule and is still reviewing its original proposal.

In New Jersey, the movement to do away with noncompetes has culminated in Assembly Bill 3715, which was drafted last year. While it hasn’t been passed by the lower house, it is very much still alive.

Many in the state have deemed the proposal problematic for a variety of reasons. New Jersey courts for decades have set out the standard for evaluating whether a noncompete is enforceable. This proposed bill would upset settled precedent and would leave the state’s businesses without important protections they have enjoyed for years.

In many cases, there is a legitimate concern that a senior executive, possibly one who has access to the trading strategy or a company’s latest innovation, could inevitably disclose such information in a directly competitive job immediately after departure. Companies could rethink their desire to locate key executives in New Jersey if the business environment becomes so unfavorable to noncompetes. That would be an unintended consequence of this legislation.

The New Jersey bill has been met with wide-scale pushback from the business community, and the FTC’s efforts have also been met with extensive opposition. Shortly after the FTC proposed this rule, the U.S. Chamber of Commerce announced it would challenge it in court if adopted. Many other groups have now announced disagreement with it and have challenged the FTC’s authority.

Additionally, while state and federal governments have scrutinized and criticized the misuse of noncompetes and proposed scaling back their usage over the years, an outright ban with the breadth of the proposed FTC rule has not gained traction in Congress. In the majority of states, the proposed federal rule contravenes existing state laws, and there remains a big question as to whether an agency can take such sweeping action without express authority of Congress.

State and federal lawmakers also need to consider that in some cases, the benefits employees receive in connection with noncompete agreements are significant. Many in the workforce benefit from the equity arrangements, incentive compensation and bonuses that often accompany their signing. Without the protections businesses receive when employees commit to refraining from certain conduct through noncompetes, they may not be as inclined to provide employees with what are often very lucrative benefits. Companies also offer severance in exchange for noncompetes, to help employees bridge periods between jobs, and employees enjoy unfettered access to information and strategy and being part of growing, sophisticated businesses. It would seem that adversely affecting an employee’s compensation or career track would be the opposite of the intent of a noncompete ban, but they are real possibilities.

As these initiatives work their way through the New Jersey Legislature and the federal government, companies need to be mindful that not only are noncompetes being targeted, but courts also scrutinize them to ensure they are necessary to protect an underlying legitimate employer interest, such as protecting confidential information and customer goodwill. To safeguard against possible restrictions – if not an outright ban – employers should consider other types of contractual restrictions, like a prohibition on soliciting customers/investors or a robust non-disclosure agreement, to protect company assets.

While what happens in New Jersey with A3715 and at the federal level, with the FTC proposed rule and implementation of the NLRB directive, remains to be determined, lawmakers and regulators need to consider those unintended consequences that could place undue and unforeseen burdens on a company’s ability to protect what is in many cases their most important assets. Curbing noncompete abuse is a good and necessary thing, but careful consideration needs to be made to ensure the solution to this problem is a workable one.

Heather Weine Brochin is a partner with Day Pitney LLP in New Jersey and chair of the firm’s Employment and Labor practice.