On January 5, 2023, the U.S. Federal Trade Commission (“FTC”) issued a Notice of Proposed Rulemaking (“NPRM”), seeking comments on a proposed rule that would effectively ban the use of non-compete agreements, nationwide. In a typical non-compete agreement, employees agree not to work for a competing employer, or start a competing business, within a certain geographic area and period of time after their employment ends. The FTC is taking the position that such agreements are, on their face, anti-competitive and hurt workers and, accordingly, want to prevent all employers from entering into non-compete agreements with any “workers,” paid or unpaid – including both employees and independent contractors, as well as to require employers to rescind any existing non-compete agreements with workers and “actively” inform them that the agreements are no longer in effect, with very limited exceptions. The FTC is seeking public comment on various issues related to the proposed rule over a 60-day period. The rule would require full compliance within 180 days after the publication of a final rule.
Although the proposed rule, if finalized, is destined to receive vigorous legal challenges from numerous stakeholders, all employers should consult with counsel and take immediate action to prepare for the possibility that this rule will go into effect later this year. In addition, as recent FTC enforcement actions announced this week have made clear, the FTC is taking the position that the use of non-compete agreements in various industries violates the federal antitrust laws – whether or not the new rule goes into effect – and has put employers on notice that it intends to vigorously enforce those laws. This latest push by the Agency grows out of the Biden Administration’s belief that lack of labor market competition harms workers, arguing that employers’ ability to restrict worker mobility can decrease wages, reduce benefits, and worsen working conditions. Promoting fair competition in labor markets is a “key priority” for the FTC. In addition, numerous states have recently enacted extensive limitations on using non-compete agreements, and three states, California, North Dakota, and Oklahoma, outright ban them.
What you need to know about the proposed rule:
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.” The FTC would apply a “functional test” as to whether a contract provision is a “de facto non-compete clause” because it has the effect of prohibiting such employment. Although this would be a particularly fact-specific analysis, the proposed rule provides examples of potentially “de facto” non-compete clauses, including:
- Overly broad non-disclosure (confidentiality) agreements that “effectively preclude the worker from working in the same field after the conclusion of the worker’s employment with the employer;” and
- Agreements that require an employee to repay the employer’s unreasonable training costs if the worker’s employment ends within a specified time period.
For purposes of the rule, the FTC defines a “worker” as a person who works, whether paid or unpaid, for an employer, including “without limitation, an employee, individual classified as an independent contractor, extern, intern, volunteer, apprentice, or sole proprietor who provides a service to a client or customer.” The term “worker” does not include a franchisee in the context of a franchisee-franchisor relationship; however, the term worker “includes a natural person who works for the franchisee or franchisor.”
The proposed rule would declare it to be an “unfair method of competition” 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 represent to a worker that the worker is subject to a non-compete clause “where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause.”
The rule would not simply “void” such agreements; to the contrary, the proposed rule requires employers to actively “rescind” any non-compete clause no later than 180 days after finalization of the rule, and provide notice to the worker that the worker’s non-compete clause is no longer in effect and may not be enforced against the worker. The employer must notify the worker in “individualized communication” within 45 days of rescinding the non-compete clause. The notice must be sent to current and former employees who may be covered by such an agreement. The proposed rule provides (non-mandatory) “model language” for the required notices, which can serve as a “safe harbor” against enforcement.
The requirements of the proposed rule would not apply to a non-compete clause that is entered into by a person who is selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or by a person who is selling all or substantially all of a business entity’s operating assets, “when the person restricted by the non-compete clause is a substantial owner of, or substantial member or substantial partner in, the business entity at the time the person enters into the non-compete clause.” Non-compete clauses covered by this exception would remain subject to Federal antitrust law and all other applicable laws.
The proposed federal rule would supersede any state statute, regulation, order, or interpretation to the extent that such statute, regulation, order, or interpretation is inconsistent, unless such statute, regulation, order, or interpretation affords any worker greater protections.
As for comments, the FTC is particularly interested in public comment on:
- Whether franchisees should be covered by the rule;
- Whether senior executives should be exempted from the rule, or subject to a rebuttable presumption rather than a ban; and
- Whether low- and high-wage workers should be treated differently under the rule.
What should employers do now?
There is no reason at this point to panic given the anticipated time period between the 60-day public comment period, the unknown time period thereafter for any proposed rule to become final, the uncertain outcome of the language in any final rule, and the 180-day grace period thereafter for employers to become compliant with any final rule. As such, there is no reason to immediately stop using such restrictive covenant agreements in your business, provided such agreements are otherwise reasonable and enforceable under applicable state law. However, given the position the FTC has taken on this issue, as well as the increasing scrutiny covering such agreements around the country, it may be prudent to evaluate their utility and what steps may be needed to take in the event some variation of the proposed rule takes effect in the future.