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FTC’s Proposal to Ban Non-compete Clauses

on Monday, 9 January 2023 in Labor & Employment Law Update: Sarah M. Huyck, Editor

On January 5, 2023, the Federal Trade Commission (“FTC” or the “Commission”) released a Notice of Proposed Rulemaking which aims to ban non-compete clauses in employment contracts.  A non-compete clause is a contractual term that typically blocks an employee from working for a competing employer, or starting a competing business, within a certain geographic area and period of time after employment ends.

According to a newly released factsheet, the FTC contends that non-compete clauses are harmful to the American labor force, to both employees and employers alike.  The FTC claims that non-compete clauses:

  • Significantly reduce workers’ wages;
  • Stifle new businesses and new ideas; and
  • Exploit workers and hinder economic liberty.

Based on this reasoning, the Commission proposes to “declare that non-compete clauses are an unfair method of competition” and prevent employers from entering into or enforcing non-compete provisions.  The FTC reports that employers have “other ways to protect trade secrets and other valuable investments that are significantly less harmful to workers and consumers” while citing to several states in which employers currently cannot enforce non-compete clauses.

The FTC’s proposal comes following the Executive Order on Promoting Competition in the American Economy issued by President Biden on July 9, 2021.  This Executive Order signaled support for limiting post-employment non-compete restrictions and encouraged the FTC to “curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”

Proposed Rule: Definitions

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.”  Notably, this includes any contractual term that is a de facto (“in fact” or “in effect”) non-compete clause 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; or
  • It requires the worker to pay for training costs if the worker’s employment terminates within a specified time period, where the payments are not reasonably related to costs the employer incurred for training the worker.

The FTC’s proposed rule, however, is not intended to include other types of restrictive employment covenants, such as non-disclosure agreements, client or customer non-solicitation agreements, and training repayment agreements—unless such restrictions are so broad that it would constitute a de facto non-compete.  The FTC reasons that these other types of covenants may affect the way a worker competes with their former employer after leaving the job, but do not generally prevent a worker from competing with the former employer altogether.  For those employers in Nebraska, this distinction is a familiar one under Nebraska case law.

In the FTC’s proposed rules, the term “worker” is also broadly defined to include any natural person working (paid or unpaid) for an employer.  This definition expressly includes:

  • Independent contractors,
  • Externs and interns,
  • Volunteers,
  • Apprentices, and
  • Sole proprietors.

The definition expressly excludes franchisees; however, a natural person working for the franchisee or franchisor may still be considered a “worker.”

Proposed Rule: Prohibitions

Under the proposed rules, the FTC would consider it an “unfair method of competition” for an employer to:

  • Enter into or attempt to enter into a non-compete clause with a worker;
  • Maintain a non-compete clause with a worker; or
  • Represent to the worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe so.

This would effectively ban or prohibit the use of non-compete clauses.  Not only would this impact employment agreements going forward, the proposed rule would also require an employer to rescind existing non-compete clauses with a worker prior to the compliance date—or within 180 days following the publication of the final rule.

Further, an employer would be required to provide notice to workers that a non-compete clause has been rescinded in an individualized communication (for example, an email or text message).  The FTC provides model language of this required notice within the proposed rule.  Such notice must be given within 45 days of rescinding the non-compete clause to both current workers and former workers, if the employer has the former worker’s contact information readily available.

The only limited exception to this prohibition against non-compete clauses is for situations involving:

  • A person who is selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity; or
  • 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 of entering into the non-compete clause.

Currently, non-compete provisions are governed by state law.  We have increasingly seen a trend of state legislatures banning non-compete agreements, specifically for low-wage earners.  The FTC’s proposed rule is intended to supersede any inconsistent state statutes, regulations, or orders.  Any existing state statutes or regulations consistent with the proposed rule and offering greater protection than the rule would still stand.

The broad nature of a rule like this would undoubtedly impact the employment landscape.  Non-compete clauses are a staple for some industries and professionals.  Several estimates indicate that one in five American workers (or approximately 30 million people) are bound by a non-compete clause.

The Breakdown

At the moment, this is a proposed rule—meaning there are no final guidelines or required compliance yet.  The FTC is currently seeking public comments on the proposed rule.  We expect changes to the proposed language because the Commission indicated they will be considering, based on comments:

  • 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.

Interested parties have 60 days to comment after the Federal Register publishes the proposed rule.  From there, the Commission will review comments, make changes, and set forth a final rule.

As the FTC moves forward with the rulemaking process, a final rule would almost certainly be met with legal challenges.  Executive agency rule-making has been increasingly scrutinized in past years—as recently illustrated in the legal battles over COVID-19 vaccination requirements proposed by the Occupational Safety and Health Administration (“OSHA”) and Centers for Medicare & Medicaid Services (“CMS”) in 2021. 

Similar to OSHA or CMS, critics of the FTC’s rule are likely to argue that the agency is overstepping its authority under the “major questions doctrine” which addresses agency decisions of “vast economic and political significance.”  The FTC’s banning of non-compete clauses would have sweeping effects on the American workforce and economy.  Will the FTC’s proposal and forthcoming final regulations stand up to such test?  Time will tell.

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