On January 5, 2023, the Federal Trade Commission (“FTC”) issued a Notice of Proposed Rulemaking (“NPRM”) to prohibit employers from entering into post-employment non-compete agreements with workers. The proposed rule, if adopted, would essentially ban non-compete agreements nationwide, with very limited exceptions. The FTC will soon publish the NPRM in the Federal Register, triggering a 60-day public comment period. Here are answers to some of the key questions employers may have about the proposed rule.
1. What is the proposed rule?
The proposed rule would provide that it is an “unfair method of competition,” and therefore a violation of the FTC Act, “for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non-compete clause; or, under certain circumstances, represent to a worker that the worker is subject to a non-compete clause.”
In sum, pursuant to the proposed rule, employers would be: (i) prevented from entering into non-compete agreements with workers; (ii) required to issue a rescission of existing non-compete agreements with current and former employees; and (iii) required to provide current and former workers with notice that any worker’s non-compete clause is no longer in effect and may not be enforced against the worker.
2. How does the Proposed Rule Define a “Non-Compete” Clause?
The proposed rule defines a “non-compete clause” as “a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.” Under the proposed rule, a “non-compete” clause includes not only traditional clauses that prohibit post-employment competition, but also clauses that effectively “function” like non-compete clauses. The FTC provides two specific examples of “de-facto” non-compete agreements. First, a nondisclosure agreement might “function” like a non-compete agreement if it “is written so broadly that it effectively precludes the worker from working in the same field after the conclusion of the worker’s employment with the employer.” Second, a contractual term between an employer and a worker might “function” as a non-compete agreement if it requires the worker to pay the employer or a third-party entity for training costs upon the worker’s termination from employment within a specified time period, and the required payment is not reasonably related to the costs the employer incurred for training the worker.
3. What Employers are Covered?
The proposed rule defines “employer” as “any natural person, partnership, corporation, association, or other legal entity that hires or contracts with a worker to work for the person.” In effect, this broad definition effectively applies to all employers, unless the employer is subject to an exception from FTC jurisdiction (e.g., certain banks, federal credit unions, common carriers, etc.).
4. What Employees/Workers are Covered?
If enacted, the proposed rule would impact almost all workers, including employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors. Notably, the proposed rule contains no exception for senior executives, highly paid workers or highly skilled workers, although the proposed rule seeks comments on whether non-compete clauses between employers and those categories of employees should be subject to a different standard than non-compete agreements between employers and other categories of workers.
5. How does this Proposed Federal Rule Interact with State Laws on Non-competes?
As drafted, the proposed rule would supersede and preempt any inconsistent state statute, regulation, order or interpretation, except that, if any state law provides greater protection to workers than afforded under the proposed rule, then the state law would continue to apply.
(The proposed rule offers a detailed overview of the current status of state law on non-compete agreements at pages 49–56).
6. Are there any Exceptions to the Proposed Rule?
The proposed rule would include a limited exception for non-compete clauses between the seller and buyer of a business so long as the party restricted is an owner, member or partner holding at least 25% ownership interest in the business.
7. Would the Proposed Rule Apply to Non-Compete Clauses Executed Before the Rule Becomes Effective?
Yes. While the proposed rule prohibits future use of non-compete clauses, it also prohibits employers from maintaining existing non-compete clauses. It further requires employers to rescind all current non-compete agreements that fall within the scope of the proposed rule.
8. When will the Proposed Rule Become Effective and How Likely is it that the Proposed Rule will be Challenged in Court?
The proposed rule is subject to a 60-day public comment period once it is published in the Federal Register (which, as of the date of this article, has not yet occurred). Following that, the FTC will consider the comments and decide whether to amend the proposed rule in light of the comments. There is likely to be a tremendous number of comments. The US Chamber of Commerce has already voiced its opposition to the proposed rule. Thereafter, and assuming the FTC eventually publishes a final rule, it will be effective 60 days later, and employers would be required to come into compliance with the rule within 180 days after the publication of the final rule. No doubt, the final rule would be subject to legal challenges in court.
9. Where Does the FTC Claim Its Authority to Issue this Rule?
The FTC cites to Section 5 of the FTC Act which declares “unfair methods of competition” to be unlawful and further directs the FTC to “prevent persons, partnerships, or corporations . . . from using unfair methods of competition in or affecting commerce.” Within the FTC Act, it also directs the FTC to make rules and regulations to fulfill the purposes of the Act.
10. What should Employers do Now?
For now, employers and businesses with employees, contractors, and others who are subject to non-compete agreements or clauses need to be mindful that the legal landscape may be changing soon with respect to these legal documents. As the FTC noted in its proposed rule, many states have enacted substantial restrictions on businesses with respect to non-compete agreements in the past 10 years alone, and courts continue to look with disfavor on these agreements as an impermissible restraint of trade on competition. Now is a good time to take a close look both at existing non-compete clauses and other contractual provisions that may be deemed to be a non-compete provision under a final FTC rule, including non-disclosure, non-solicitation, and provisions requiring employees to reimburse employers for certain training expenses, and assess if modifications are in order, and/or how the business will implement the rule. At the very least, employers may wish to review the restrictive covenants they have in place with employees, and mark sure they are narrowly tailored as to: (i) duration and geography, (ii) the activities the business seeks to prohibit post-employment; and (iv) the employees it requests to sign the covenants.