FTC Proposes a Ban on Non-Compete Clauses

On January 5, 2023, the Federal Trade Commission (FTC) issued a notice of proposed rulemaking, alerting the public of its proposed ban on non-compete clauses. If the proposal becomes a final rule, employers would be prohibited from enforcing non-compete clauses, and they would be required to rescind existing non-compete clauses within six months of the effective date of the finalized rule.

Non-compete agreements prevent workers from working for competing companies after their employment ends. If the proposed rule became final, the regulation would impact employers across all industries. Indeed, a March 2022 Treasury Department report estimated that 1 in 5 Americans are currently subject to non-compete agreements.

Evidently, the FTC’s proposed ban on non-compete agreements is directly tied to the Biden Administration’s overall support of labor. In his July 2021 Executive Order on Promoting Competition in the American Economy, President Biden encouraged the FTC to ban or limit non-compete agreements. In response to the Executive Order, the FTC has been making a concerted effort to target unfair competition, relying on Section 5 of the Federal Trade Commission Act (FTC Act) dealing with unfair methods of competition. For example, just a day before proposing a ban on non-compete agreements, on January 4, 2023, the FTC announced that it had taken legal action against Prudential Security, Inc., Prudential Command Inc., United States, O-I Glass, Inc., and Ardagh Group S.A. The FTC ordered the companies to remove their non-compete restrictions and asserted that the agreements constituted unfair methods of competition pursuant to Section 5 of the FTC Act. Such action likely will be met with challenges from these employers.

According to FTC Chair Lina Khan, "[n]oncompetes block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand." The FTC has made a preliminary determination that it is considered an unfair method of competition when an employer enters into or attempts to enforce a non-compete clause.

The FTC 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." Importantly, the proposed rule creates a functional test, meaning that even provisions that are not labeled as non-compete clauses could be considered de facto non-compete clauses if they have the effect of prohibiting a worker from accepting new employment after their current employment ends. Examples of de facto non-compete clauses include broadly worded non-disclosure agreements that preclude employees from working in the same field after their employment ends and provisions requiring employees to pay training costs if their employment terminates within a certain period of time when the payment is not reasonably related to the costs of the training. Other types of restrictive covenants, such as non-disclosure agreements or non-solicitation agreements (unless they are unreasonably broad), are not included in the definition of non-compete clauses.

Not only is the definition of a "non-compete clause" very broad, but the definition of "workers" is also expansive and includes more than just employees. Independent contractors and even unpaid interns are considered “workers” for purposes of the proposed rule. Moreover, the FTC does not distinguish by job function or earning levels. However, the term “workers” does not apply to franchisees since the Commission considers the relationship between a franchisor and a franchisee to be similar to a relationship between two businesses.

Though the proposal is essentially a categorical ban on non-compete clauses, the Commission permits a limited sale of business exception. Employers may temporarily restrict owners or partners who are selling their company from re-entering the field. However, the exception only applies to individuals who have a substantial ownership interest in the company.

If the non-compete ban becomes a final, enforceable rule, employers could face significant compliance requirements. To ensure compliance with the regulation, employers would need to rescind existing non-compete agreements and decide whether to replace the agreements with alternatives, such as non-disclosure agreements. The final rule would include a safe harbor, allowing employers to comply with the rescission requirement by providing notice of the rescission to their workers. Thus, employers could notify current employees and former employees (if their contact information was readily available) that they had removed any existing non-compete agreements within 45 days after actually rescinding the agreements. In addition, the final rule would provide model language that employers could use to satisfy the notice requirement. Lastly, employers would be prohibited from enforcing non-compete agreements going forward. While employers would no longer be able to protect their investments through the use of non-compete agreements, employers would still be able to enforce trade secret agreements, non-solicitation agreements, and non-disclosure agreements.

It is not a foregone conclusion that the FTC’s proposed rule will become effective, as it is likely that the FTC will face significant legal challenges. In fact, the United States Chamber of Commerce has already weighed in on the issue, indicating that the proposed rule will likely be challenged under the "major questions doctrine." The major questions doctrine requires Congress to speak clearly when empowering agencies to regulate issues of great political or economic significance. If a court decides that the non-compete rule is a major question, because it concerns a matter of economic or political significance, the FTC will need to establish that it had clear Congressional authorization to issue the regulation. Recently, the United States Supreme Court embraced the major questions doctrine in the 2022 case West Virginia v. Environmental Protection Agency, in which the Court held that the EPA’s requirement that energy producers shift from fossil fuels to renewable sources constituted a major question; therefore the EPA’s action was unauthorized. Even if a court holds that the FTC does have Congressional authority to issue the rule, the rule may be challenged under the "non-delegation doctrine" as an impermissible delegation of legislative power. Pursuant to the non-delegation doctrine, Congress may not delegate its legislative power to another branch of the government like the FTC, an independent agency.

The FTC is currently accepting input related to the proposed Non-Compete Clause Rule from members of the public. It is important that employers are aware of their opportunity to provide commentary because the proposal lists several less restrictive alternatives to the categorical ban on non-compete clauses, such as applying different standards for different types of workers. Comments must be submitted within 60 days. The final rule, absent a successful challenge during the interim period, would take effect 180 days after the final version was published.