What the FTC Noncompete Proposal Could Mean for Franchising

On Thursday, the FTC proposed a ban on both new and existing non-competes nationwide. A non-compete clause is a contract based around a specific time period and geographic boundary that prevents someone from working for or starting a competing business after they leave their current job. In franchising, in-term non-compete clauses prohibit franchisees from having any ownership or business interest in a competing business while operating a franchise. Post-term non-competes prohibit a franchisee leaving a system from operating a competing business within a stated geographic territory for a defined period of time.

The FTC argues that non-competes “trap workers and decrease competition, resulting in lower wages marketwide and a lack of new business, entrepreneurship and innovation.” The FTC says non-competes affect around 20% of U.S. workers, and banning them could increase U.S. workers’ earnings by $250 billion to $296 billion annually. 

Although the term “worker” would be defined as “a natural person who works, whether paid or unpaid, for an employer” and would not include a franchisee in a franchisee/franchisor relationship, the new rule could still have a significant impact on the franchising industry overall, especially when it comes to employee management.  

1851 Franchise spoke with some of the top franchise lawyers in the industry to hear what they have to say about the potential ban on non-competes.

Tom Spadea, founder of Spadea Lignana Law Firm:

“Non-competes have always been looked at with skepticism and scrutiny by courts and regulators. As a nation, we are trending toward more rules and guidelines that overwrite contract provisions. This will give ammunition to franchisees complaining and litigating over their own non-compete provisions. Franchisors need to be prepared to defend their provisions based on the harm and potential harm not enforcing them could do to their business. It's not enough to just sit back and say that's what they agreed to. A franchisor has to have a legitimate defendable business reason related to the scope of the non-compete. And the reason can't just be we don't want more competitors. 

I think you will see non-competes shrink in terms of years and geographic scope in an effort to head off the trend of them becoming less and less enforceable over time. Franchisors should consider shifting their desired protection toward trade secrets, intellectual property and non-solicitation provisions that are viewed more favorably and are more enforceable.”

Andrew P. Bleiman, managing attorney at Marks & Klein, LLP: 

“If this change is extended beyond the employment context to franchising, the impact would be significant to franchising. For example, it may lead to the creation of competitive concepts from individuals who have received training, expertise and experience in systems and operations from franchisors that would be able to leave without competitive restrictions and compete on day one. However, franchisors would still have the protections of trademark and trade secret laws as well as contract law, giving franchisors the ability to enforce provisions of agreements with franchisees or their former employees concerning the protection and non-use of confidential information, among other things.”

Keith Kanouse, partner at Kanouse & Walker: 

“For low to mid-level employees, this will afford them the opportunity to advance to another franchise unit within the same franchise system and possibly make more money. The prohibition will hurt franchisors as to higher level employees that the franchisor has trained to be managers and assistant managers. Franchisors are also concerned that employees moving to a competitor will take confidential information with them. The in-term covenant not to compete prohibits franchisors from owning units of competitive systems. That prohibition may not apply to non-owners of the franchise.” 

Amy Cheng, founding partner at Cheng Cohen: 

“While the FTC’s proposed rulemaking to ban noncompete clauses carves out non-compete obligations imposed by franchisors and franchisees, it may still impact the franchise industry.  For many franchisees, training and retaining employees is already a challenge in this labor market, particularly franchisees that require management-level employees. The most troubling aspect of the proposed rulemaking is the broadened definition of a “de facto” non-compete clause. It proposes to include non-disclosure agreements that “effectively precludes the worker from working in the same field.” This vague prohibition is subject to interpretation and could leave franchisors at risk of losing the ability to protect confidential information of the franchise system.”

Beata Krakus, attorney at Greenfelder Law Firm: 

“You could say that this is not the first time franchisors see government action to curtail restrictive covenants. A few years ago, the state of Washington took action against franchisors that had non-solicitation provisions in their franchise agreements. Those provisions restricted franchisees from soliciting employees of the franchisor and sometimes also of other franchisees. In that case, most franchisors voluntarily revised their franchise agreements, largely because they were not actively enforcing their rights under those provisions.

Employee non-competes are a bit different, though. For lower-level employees, a ban may be OK for most businesses, including franchisors and franchisees. If the ban would apply to higher-level employees, it’s a very different story though. It should be noted that there are many middle-ground options between no regulation of non-competes and a ban. For example, in many countries, employee non-competes require some type of compensation to be paid to the employee. Some U.S. states are following this trend, requiring additional compensation for the non-compete, or they are banning non-competes for low-income earners.”

Charles N. Internicola, managing partner at The Internicola Law* Firm:

“The FTC's currently proposed rule prohibiting employer-employee non-competition agreements and certain non-solicitation agreements, appears, at this preliminary stage, to not have any unique impact on franchising other than the general effect this rule will have on all businesses. The intention of the rule appears to be to restrict non-competition agreements in the employer-employee relationship, and as long as the rule clearly and narrowly defines what we all traditionally understand an employee to be, this rule should not impact the integrity of non-competition and non-solicitation provisions in franchise agreements. However, the rule will impact the types of agreements and restrictions that franchisees can impose on key employees with access to confidential information. As to key employees, franchisors will need to make adjustments.” 

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