Franchising and the Noncompete Rule

How does this latest rule affect franchising?

by Seth Lederman

Legal rules abound in franchising. Navigating them can be a headache for franchisors and franchisees. While the goal is to ensure compliance and protect the interests of both parties, these legalities can still create challenges. Recently, the Federal Trade Commission (FTC) approved a Noncompete Rule that imposes significant restrictions on the use of noncompete clauses in employment contracts. What is the effect of this rule, and how will it impact franchising?

Understanding the Noncompete Rule

The Noncompete Rule applies to all employers subject to the FTC’s authority, with limited exceptions for certain types of organizations such as banks, nonprofits, and common carriers. It covers all paid and unpaid workers, including employees, independent contractors, interns, volunteers, and apprentices.

The rule exempts noncompete agreements with “Senior Executives” who meet specific criteria regarding compensation and policy-making positions. It also exempts noncompete clauses entered as part of a bona fide sale of a business entity or its operating assets.

The rule becomes effective 120 days after its publication in the Federal Register, which typically provides employers several months to prepare for compliance. However, they may face legal challenges from business organizations, potentially delaying its implementation.

Regarding franchise agreements, the rule does not prohibit noncompete clauses in franchise agreements between franchisors and franchisees. However, it does apply to noncompete contracts signed by employees of franchisees or franchisors. Employers violating the rule may face enforcement actions and penalties by the FTC.

Overall, the FTC’s Noncompete Rule aims to promote competition and mobility in the labor market by restricting noncompete clauses while also recognizing certain exceptions and limitations to balance the interests of employers and workers.

Implications for franchising

The FTC’s final Noncompete Rule could have significant implications for franchisors and franchisees. Noncompete agreements have been standard in the franchising industry, often restricting franchisees from operating competing businesses after leaving or selling franchises.

Typically, franchisors rely on noncompete clauses to protect their brand and business model. With the Rule banning most noncompete clauses, franchisors may need to reconsider their franchise agreements and revise their approach to post-employment restrictions.

Franchisors should review existing agreements to identify any noncompete clauses that may be impacted by the rule. They must provide clear and conspicuous notice to affected workers that these clauses will not be legally enforceable.

On the other hand, franchisees may benefit from increased freedom to pursue other business opportunities after leaving a franchise. The rule may give them more flexibility to enter new ventures or work in the same industry without facing legal repercussions from noncompete agreements.

While franchisees are not directly impacted by the rule as it does not apply to them in the franchisor-franchisee relationship, they may still be indirectly affected if franchisors revise their franchise agreements in response to it. Franchisees should stay informed about any changes made by the franchisor regarding post-employment restrictions.

Reaction to the Noncompete Rule

The rule represents a significant shift in the legal landscape surrounding noncompete clauses. The FTC’s final Noncompete Rule will likely change how franchisors and franchisees structure their agreements and conduct business. Franchisors may need alternative ways to protect their brand and ensure franchisee loyalty. In contrast, franchisees may gain greater autonomy in their career paths. Franchisors and franchisees must adapt to these changes and ensure compliance with the new regulations.

The FTC’s recent decision regarding noncompete clauses has sparked significant reactions, particularly within the franchise community.

The International Franchise Association (IFA) successfully advocated for the inclusion of noncompete clauses in franchise agreements, preserving franchisors’ ability to protect their proprietary information and business model. This decision acknowledges the importance of maintaining the franchisor-franchisee relationship and preventing unfair competition within the franchise system.

While noncompete clauses are allowed in franchise agreements, the FTC’s ban on such clauses in employment contracts has raised concerns within the business community. The IFA and others worry that prohibiting noncompete clauses in employment contracts could lead to increased breaches of contract and harm small business owners who rely on these clauses to protect their investments.

The FTC estimates that its ban on noncompete restrictions in employment contracts will significantly increase entrepreneurship, with the launch of more than 8,500 new businesses annually.

The FTC advocates for using alternative protections, such as trade secret laws and nondisclosure agreements, to safeguard proprietary information and intellectual property.

Additionally, the FTC suggests that companies can retain employees by offering competitive pay and improving working conditions rather than relying on noncompete restrictions.

Overall, while the FTC’s decision to limit noncompete clauses aims to promote competition and entrepreneurship, it also underscores the ongoing debate surrounding the balance between protecting business interests and fostering employee mobility and innovation.

The world of franchising is exciting, but navigating it requires knowledge and guidance. Seth Lederman is an expert in assisting potential franchisees in achieving their goal of being their own boss. Contact Frannexus for help on your franchise journey.

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Learn about the various franchise industry segments, from Home Services to Beauty, and more. With nearly 4000 available franchise opportunities, understanding the pros and cons of the industries is crucial for a successful franchise search.

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Having helped hundreds of people get into business ownership through franchising, we are in a unique position to educate prospective franchise investors.

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On our quest to share the best in franchise information, we've developed a series of How-To articles with practical advice to move you forward in your franchise search.

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View our collection of educational franchise videos for large investors and first-time entrepreneurs.

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The FranBlog is a trusted digital publication, providing news and information that entrepreneurs and franchise investors want.

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Basics

Are you sick of the 9-5 grind and actively looking for alternatives? Start with the basics of going into business for yourself.

Intermediate

Searching for the right franchise opportunity is like looking for a needle in a haystack. If you want to search smarter, not harder, check out the franchising insights and knowledge to get you there faster.

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