Regardless of the Federal Trade Commission ban on non-compete agreements, nearly every state will refuse to enforce non-compete agreements that do not satisfy a reasonableness standard. Some states, in fact, refuse to enforce non-compete agreements even if they are considered “reasonable.”
Recently, the U.S. Court of Appeals for the Seventh Circuit issued a ruling that highlights the distinction between a non-compete agreement and a forfeiture-for-competition provision. The court noted that the forfeiture-for-competition may not be subject to the reasonableness test.
While such provisions are subject to much less restrictive standards than non-compete agreements, employers should note the court’s emphasis on the “extraordinary hardship” issue. Some types of extreme burdens, then, could prevent the employee from working — and thus make the agreement subject to the typical reasonableness standard.
Non-Compete vs. Forfeiture-for-Competition
Generally, a non-compete agreement prevents employees from working for their employer’s competitors for a certain period of time within a specific geographic area. States that limit the use of non-compete agreements generally require the agreement to be reasonable both with respect to time and location. Most states also require the non-compete to serve a legitimate business purpose and generally be equitable and fair.
The Seventh Circuit recently found that a forfeiture-for competition provision was not subject to the same reasonableness review. In this case, a plant manager resigned and went to work for a competitor. As a part of his overall compensation package, he had been awarded restricted stock units over the years. The units, which were governed by Delaware law, stated that he would forfeit (or be forced to return) them if he went to work for a competitor within nine months of leaving employment. Each restricted stock unit was subject to its own nine-month forfeiture period, making the nine-month periods overlap.
When the employer sought to enforce the forfeiture-for competition provision, the former employee sued. An Illinois court initially found for the employee because the provision failed the typical reasonableness test. On appeal, the Seventh Circuit found that the Delaware Supreme Court had distinguished the forfeiture-for competitions provision from typical non-compete agreements.
However, the Delaware court case was based on a forfeiture-for competition provision contained in a limited partnership agreement that had been negotiated between sophisticated parties. In the current case, the contract had been the subject of little or no negotiation.
The Seventh Circuit found that the Delaware rule was not restricted to the limited partnership context. Further, the forfeiture could take on a variety of forms, including restricted stock units and a range of agreements.
According to the court, forfeiture-for-competition provisions may require an employee to forgo certain benefits if the employee decides to work for a competitor, but they do not prevent the employee from working for the competitor. The court was careful to note, however, that some forfeiture-for-competition provisions may be so extreme as to have the effect of preventing an individual from working.
In the current case, the employee’s annual salary was $109,000. He voluntarily accepted the restricted stock units, which were available to less than 2% of the employer’s workforce. The units themselves were valued at between $130,000 and $340,000. While the value of the restricted stock units was substantial, the court found, forfeiting them did not rise to the level of an “extraordinary hardship” that would require the reasonableness review.
FTC Ban on Non-Competes: Background
In 2024, the FTC banned the use of nearly all non-compete agreements nationwide. The ban, which was applied to both prospective and existing non-compete agreements, classified such agreements between employers and workers as unfair methods of competition. It was expected to have a wide-ranging impact on business owners who rely on these agreements to protect their business interests, value and trade secrets.
On Aug. 20, a U.S. District Court judge of the Northern District of Texas officially set aside the FTC's non-compete ban as unlawful and exceeding the agency’s authority. The judge, Ada Brown, found the rule to be unconstitutional, arbitrary and capricious in violation of the Administrative Procedures Act. Absent the nationwide ban, the FTC rule would have gone into effect Sept. 4.
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