Non-compete agreements have been on the minds of franchisors, franchisees, federal regulators and New York franchise lawyers. The Federal Trade Commission (FTC) issued a final rule banning non-competes that will likely impact franchising and the private sector.
Let’s review the FTC rule and how it may impact NY franchisors and franchisees.
What are Non-Compete Agreements?
Non-compete agreements are contracts between an employer and an employee (or sometimes between a company and a contractor), whereby the employee agrees not to work for – or start – a similar business in competition against the employer after the employment relationship ends. These agreements typically have a specific duration and geographic scope within which the former employee cannot compete.
The primary purpose of non-compete agreements is to protect the employer’s business interests by preventing former employees from using the knowledge, skills, and contacts gained during their employment to compete against the employer, either by starting a competing business or by joining a competitor.
Employees have felt constricted by their terms, while employers feel they are a necessary measure to protect their data, processes and trade secrets.
Non-Competes and Franchising
The franchise business model relies on non-competes. That is because enforcement of non-compete agreements helps ensure that once franchisors train franchisees on the franchisor’s proprietary business methods, franchisees cannot simply exit the system, change the name of their businesses and operate competing businesses at the former franchised locations.
The FTC’s Final Rule
After considering 26,000 public comments submitted in 2023, the FTC issued a final rule banning most noncompete agreements. The FTC’s final rule determined that non-competes are unfair methods of competition, and employers forcing employees to enter into non-competes are in violation of Section 5 of the Federal Trade Commission Act which declares “unfair methods of competition in or affecting commerce” to be unlawful. (15 USC 45(a)(1).)
The FTC found that non-competes negatively affect competitive conditions in labor markets by:
- Inhibiting efficient matching between workers and employers.
- Affecting competitive conditions in product and service markets.
- Inhibiting new business formation and innovation.
The FTC also noted evidence that non-competes lead to increased market concentration and higher prices for consumers.
The Commission estimates that the non-compete ban will lead to more innovation and the creation of more than 8,500 new businesses per year. This is welcome news just in time for National Small Business Month in May.
The Commission also specifically addressed the uniqueness of franchises.
How Is Franchising Impacted By The FTC Rule?
As previously discussed, the FTC made it clear that it would not apply the rule to the franchisor-franchisee relationship and that franchisees are expressly excluded from the definition of “worker.” The FTC stayed true to its word.
However, the FTC’s Compliance Guide noted that the non-compete ban does apply to those agreements between employers and workers at franchises.
Ultimately, the franchisee is not an employee of the franchisor. But the worker at a franchisee’s location is the franchisee’s employee, and, barring application of an exception noted in the Rule, can generally leave the franchise for a competitor without violating law.
A Note About NY Non-Competes and Franchising
Currently, under New York common law, non-compete agreements are enforceable with respect to the franchisor/franchisee relationship. In those instances, non-compete agreements are presumptively valid as they help to ensure that the franchisor can protect its proprietary business methods. This is not the case in every state. Franchisors and franchisees should speak with a NY franchise lawyer regarding the proposed rules and non-compete agreements at state and federal levels.
Looking Ahead
The effective date of the FTC’s Final Rule is 120 days after it has been published in the Federal Register, and not after the public announcement.
Furthermore, lawsuits will be filed to test this new rule, and as always, Lusthaus Law will follow those developments and keep you informed on non-competes in New York.
Contact Lusthaus Law
In addition to the updates listed above, remember that Lusthaus Law’s website is a resource for New York franchisors and franchisees. We have published two downloadable and complimentary e-books and our Insights blog is regularly updated to reflect industry trends and recent achievements in client representation.
Contact us today to learn more about how Lusthaus Law P.C. can help you navigate a clear path for your franchise’s successful future.
