As the federal government moves to do away with noncompete agreements, business clients are seeking counsel on their best options to keep trade secrets and customers from walking out the door with employees who leave in a tight labor market.
Labor and employment law is among several categories experiencing surges at Kentucky legal firms. Mainstay categories remain busy, but firms report their work is increasing for real estate deals, mergers and acquisitions, and cannabis, which becomes medically legal in the commonwealth in 2025.
This year it is the potential regulatory change in how employers may use noncompete covenants that is generating the most inquiries at law firms across Kentucky.
Sentiment has grown in recent years toward limiting or deleting the noncompete covenant, a key element of work contracts.
“The perception is that the labor market has stagnated in the United States,” said Doug McSwain, whose practice as a partner and attorney at the Lexington office of Wyatt Tarrant and Combs includes labor and employment law.
Case law preventing employees who whose jobs give them insider skill or knowledge from becoming competitors dates to medieval times, when master practitioners didn’t want apprentices they’d trained to set up shop next door as competitors. However, employers far and wide still use noncompete clauses even including hourly workers such as Jimmy John’s sandwich makers. In the past, restrictive covenants primarily applied to a local area, but now they often cover a wider range to protect an employer’s national market.
Last January, the Federal Trade Commission stated it wants to limit or eliminate the noncompete covenant and asked for public comments regarding the targeted revisions to be submitted by the end of 2023. The U.S. Department of Justice has made it known it is the FTC’s ally in ending the noncompete clause.
“They basically came out with a proposed ban,” McSwain said.
The reaction has been vigorous. More than 30,000 comments had been submitted by August and the flow is continuing, McSwain said, which means formal action is unlikely until at least sometime in 2024. Chelsea Granville Reed in the Louisville office of Dentons said the vote is set for April 2024.
“We’re seeing large and small (clients) really questioning: Are our existing agreements overly broad? Are we going to have to completely pull these from our existing agreements because they’re going to be banned?” Reed said.
The national marketplace that exists today for more industries and work categories is helping drive the FTC to push for change in the law. A growing number of states have limited or banned noncompete employment covenants already, complicating HR compliance for companies with operations and employees across many states.
The FTC’s proposal is both a reaction to organic change taking place in labor markets and the HR profession and an effort to further its goal without deploying regulatory power, McSwain said. Formal action will trigger court challenges, which could bring judicial injunctions.
“The U.S. Chamber of Commerce made very clear that if the FTC comes out with a rule dealing with noncompetes—either banning them or something just short of banning—as they have proposed, they will challenge it in the court system,” McSwain said. “And they will no doubt ask some judge to give them a nationwide injunction to enjoin the enforceability of that rule even before it ever goes into effect.”
Voluntary private-sector action is preferable.
In May of this year, Reed said, the National Labor Relations Board essentially agreed with the FTC and had its general counsel issue a memo saying overly broad noncompete agreements are unlawful under the National Labor Relations act “because they tend to chill participation in the workforce, impairing the ability to resign and impairing the ability to move to another job.”
Legal challenges to noncompete covenants do arise, she said.
“There’s a lot of proprietary information that employers have the right to protect,” Reed said.
So, what should a business do now in light of the undefined change that is coming?
“The best advice for employers and businesses with respect to a noncompete is one, avoid using a noncompete for any low-skilled low-wage worker. Don’t go there,” McSwain said. “Two, be very careful that you understand the reason you want to have a noncompete for other higher skilled or higher wage employees. Consider whether or not you could accomplish the same purpose that you want through a different kind of agreement, such as a nonsolicitation of customers or nonsolicitation of any of your fellow employees should you ever depart.”
Employers can structure nonsolicitation and nondisclosure agreements that clearly articulate the trade secret they want to protect and safeguard their competitiveness, he said. Add in proper protection of business intellectual property and there likely is no legal need for noncompete covenants.
“If you have those intellectual property protections in place, a departing employee isn’t going to be able to violate your intellectual property” rights, said McSwain, who was a speaker at the Kentucky Society of Human Resource Managers conference in late August in Lexington and addressed the FTC and DOJ’s crackdown on restrictive employment agreements.
“Employment law is so closely tied to the state of our economy,” Reed said, “and in the post-pandemic world, we’re all more attuned to the way employment ties into our daily lives. Restrictive covenants are just one aspect of that.
Medical cannabis is highly regulated
Kentucky residents with medical prescriptions will be able to legally use cannabis in 2025, joining residents in the majority of other states, including neighboring Ohio and Indiana. The business steps in handling medical cannabis are well established elsewhere, but it remains new to Kentucky and state regulators have not created and released precise legal guidance to enact a 2023 General Assembly law.
“There is a growing level of interest, despite the perception that the market for legal medical cannabis is still many months away,” said Michael Holtz, a partner in the Louisville office Dentons and a member of its corporate practice. “Gov. Beshear only recently appointed a director of the program, Sam Flynn, and the Cabinet for Health and Family Services has not yet initiated rulemaking. I expect that once draft rules are published, likely sometime later this fall, there will be an uptick in interest.”
Kentucky’s boards of medical licensure and nursing have until July 2024 to create standards for medical professionals who want to issue medical cannabis certifications and prescriptions. Once the rules have been issued, Holtz said it would be wise for medical professionals to get legal advice as to whether they want the option of issuing medical cannabis certification or do not.
“It goes without saying that participating in this industry will require careful planning. However, the one thing that prospective operators should be focused on is making sure that the municipality where they plan to operate will actually allow cannabis businesses. Cities can ban cannabis businesses. However, if they do there is a petition process to get on the ballot to seek to overturn the appeal. This process has tight deadlines and missing a deadline could set a business back years.”
Cannabis is highly regulated at the state level where it is legal, but it continues to be illegal under federal law.
“This unique legal status impacts every aspect of a cannabis business’s operations, from tax treatment, financing and corporate structure to the issues that you would expect for highly regulated businesses, such as complying with packaging, labeling and testing standards,” Holtz said. “It is critical that these businesses work with legal counsel with cannabis law experience who understand issues specific to the cannabis industry, whether they arise in the context of a supply contract, a lease or a subscription agreement. “
Growth and consolidation = M&A deals
Legal firms are also seeing their merger and acquisition practices become busier. Growth in sectors such as bourbon, banking and healthcare inevitably leads to consolidation as competition drives efficiency, and the ongoing shift of ownership from retiring baby boomers continues to generate transactions.
All but the smallest deals require legal structures and due diligence and activity in Kentucky is up according to Branden Gross, an M&A specialist with the Dentons office in Lexington.
A key legal service in such deals is the due diligence, especially for larger transactions with more complex financial elements. The findings do sometimes bring changes in a purchase price, which usually is a multiplier of net profits.
“During our due diligence we may find overly optimistic numbers from the front end,” Gross said. Or, potential legal responsibility liabilities such as an environmental cleanup can show up.
Gross says legal partners know the experts to bring to the table to assess a company’s 401k program obligations and whether they are funded and if tax obligations at all levels are being met. Sometimes a legal review finds that a company can make better elections in its tax status or business structure, he said.
“Often I kind of quarterback a lot of different areas of expertise,” Gross said. “We’ve got a full team.”
Beyond direct financial information, he said, legal experts will assess employment issues, intellectual property protection, and environmental situations that can create compliance obligation issues.
“Depending on the size of the transaction, we can have five to six people working on it or it could just be one or two,” Gross added.
