According to the Federal Trade Commission (FTC), one in five American workers (approximately 30 million people) are contractually bound by a non-compete agreement. In January 2023, the FTC announced that it was proposing a rule that would largely prohibit the use of non-competition agreements. The announcement sparked opposition to the rule, including from the insurance industry which is specifically concerned how such a rule change may impact merger & acquisition (M&A) transactions.
Broader opposition to the rule from the U.S. Chamber of Commerce and other organizations may have temporarily stalled the proposed rule, with the FTC recently announcing a delay, to give the agency time to consider all concerns about the rule. They have targeted April 2024 for continued consideration.
State of New York moves to ban non-competes
Despite the concerns that stalled the FTC’s effort to ban non-competes, the New York State legislature has moved forward with its own version of the proposal, passing a Bill on June 20, 2023, and waits for Governor Kathy Hochul’s signature. The Bill proposes to prohibit New York employers from entering a non-compete agreement with any individual in a position of “economic dependence on, and under obligation to perform duties” for an employer.
The Bill has rather broad coverage in how non-compete agreements and employees are defined. It is also not retroactive and will only apply to agreements entered on or after its effective date. The Bill does provide exceptions for certain types of restrictive covenants including non-disclosure agreements to protect confidential and proprietary information, as well as agreements that prohibit the solicitation of clients if the employee leaves the company.
While Governor Hochul has previously expressed support for eliminating non-compete agreements, there are concerns that the New York legislature version of this proposal lacks specific details, and certain exclusions, that the Governor may require amendments for – in order to sign. Amendments may include language to address things like minimum salary thresholds, industry-specific exceptions, how to make a non-competes enforceable, and buyer protection considerations in M&A transactions.
Potential impact on the insurance industry
Whether a ban on non-compete agreements becomes an individual state-level law or Federal law, there are considerations insurance brokers should make when looking to protect their client base and prohibit producers from taking clients with them should they decide to work for another broker or start their own agency.
A more common way for agencies and brokerages to protect their business without resorting to a non-compete is through the use of non-solicits, non-piracy and non-acceptance provisions. As long as these types of provisions are not written to have the effect of precluding a worker from working in the same field as their former employer, they would not be impacted by any state or federal ban on non-competes.
Additionally, non-competes are routinely used in, and are a critical component of, M&A transactions that take place in the insurance sector. They protect the buyer from the worst-case scenario: the selling principal either starts a new agency or goes to work for a competitor and recaptures the business that he or she previously sold to the buyer.
The proposed (and now delayed) FTC rule recognizes a legitimate use of a non-compete in this context. However, it severely restricts such use to those that own 25% or more of the selling entity. Therefore, a non-compete between a buyer and an individual who owned 24% or less of the selling agency would be invalid and unenforceable, thereby creating significantly more risk to the buyer in such a transaction. Suffice it to say, if the FTC’s proposed rule became effective in its current form, it could have a significant effect on the insurance distribution sector.
As previously stated, the New York State Bill does not address non-complete agreements arising from the sale of a business – and thus is being defined as “not an exception.”
What are the chances for either of the proposed bills?
At this point the FTC’s rule is just a proposal and any vote on it has been delayed until April 2024. Once a final rule has been decided upon, there will be a 60-day period of public comment before it can become final and published in the Federal Register. From that point, 180 days must pass before it would formally go into effect.
Continued opposition to the proposed rule is expected to be substantial. Formidable questions exist, including, among others, as to whether the FTC even possesses the requisite authority to issue such rules. While the FTC is charged with protecting consumers and competition by preventing anticompetitive, deceptive, and unfair business practices, it has never historically regulated non-compete agreements in the employment context. If the proposal is elevated to the legislative branch, given the political makeup of the U.S. House of Representatives and U.S. Senate, Congressional action on the issue is highly unlikely.
For the New York State Bill, if eventually approved by Governor Hochul – New York would become the fifth state to implement such a ban, joining California, Minnesota, North Dakota, and Oklahoma. The effective date would be 30 days after approval. But depending on the final form of the Bill, legal challenges from various entities could delay the effective date.
So, while the FTC’s and New York State’s desired outcome – to effectively eliminate agreements that may unfairly limit worker mobility – may never fully come to fruition, both efforts should catch many employers’ attention. It should serve as a warning to employers who have relied on the use of non-compete agreements for illegitimate purposes and that regulatory and potentially statutory responses are being considered. But for now, the enforceability of restrictive covenants will remain status quo and continue to be determined based on individual state law.
If you have questions about Today’s ViewPoint or would like learn more about how MarshBerry can help your firm determine its path forward, please email or call Brian Ambrosia, Director, at 440.220.5430.
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