FTC Proposes Ban on Non-Competes

South Dakota law is rather non-compete friendly. While most contracts in restraint of trade are unenforceable under South Dakota, a covenant not-to-compete between an employer and employee (with certain time and geographic scope requirements) is valid. A recent federal development may change this legal landscape.

On January 5, 2023, the Federal Trade Commission (“FTC”) proposed a rule banning employers from imposing non-compete clauses on employees. (More technically, the rule does not say that non-competes are invalid but instead states that entering into a non-compete with an employee or maintaining a non-compete with an employee is an unfair method of competition under the FTC Act.) This proposed rule is not only prospective (meaning that it would apply to any new non-competes), but it is also retroactive (meaning that it would apply to any existing non-competes). Thus, this proposed rule would require all existing non-competes to be rescinded. The rule is currently in its 60-day public comment period. If the FTC finalizes the rule, it appears that it would set a compliance date of 180 days after publication of the final rule.

The FTC defines a non-compete as a contractual term between an employer and employee that prevents the employee from seeking or accepting employment with a person, or operating a business, after the conclusion of employment with the employer. While non-disclosure and non-solicitation agreements would be allowed, several agreements that have the practical effect of preventing competition would be invalid, including:

  • A non-disclosure agreement that is so broad that it prevents the worker from working in the same field after the conclusion of employment;
  • A term that requires the worker to pay the employer or a third-party entity for training costs if the worker terminates employment within a specified time period, if the required payment is not reasonably related to the costs that the employer incurred for training the employee.

Importantly, the proposed rule does provide an exception for business owners. A non-compete clause would be allowed for a seller of a business that owned 25% or more of the business. Currently, many purchase and sale agreements for small businesses include non-compete agreements, so this exception is well-founded. Of course, with the 25% threshold, any business owners who own less than 25% could operate a competing business after the sale, causing a significant concern for buyers.

Again, it is worth reiterating that this is currently a proposed rule. Stay tuned for further updates on the comment and possible adoption or rejection of this proposed rule.

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