Jan 11, 2023

FTC Proposes a Rule to Ban Non-Competition Clauses in Employment Agreements

On January 5, 2023, the Federal Trade Commission (“FTC”) published a Notice of Proposed Rulemaking (NPRM) to prohibit the use and enforcement of non-competition (a.k.a. “non-compete”) clauses in employment agreements. The Commission voted 3-1 in favor of publishing the proposed rule, and Commissioners distributed two statements in support of it. Commissioner Christine S. Wilson was the sole vote against the proposed rule, and she published a statement in opposition to it. In the next stage of the regulatory process, the proposed rule is open for public comment for 60 days, after which the FTC will make it final. Employers would have 180 days to comply after the final rule is issued. The proposed rule and an accompanying fact sheet can be found here.

The proposed rule would classify non-compete clauses as an unfair method of competition and would ban all employers from entering into non-compete agreements with their workers. The ban on these provisions would not only apply to employees, but would also cover independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide service to a client or customer. As drafted, the proposed rule is broad and does not include any exceptions for the protection of trade secrets or for those in management or executive positions. The proposed rule’s sole exception is for an agreement between a seller and buyer of a business where the restricted individual is a substantial owner, member or partner (meaning that the individual possesses at least a 25% ownership interest in the business entity). Pre-existing non-compete clauses would need to be rescinded by the compliance date, according to Section 910.2(b) of the rule. The same section would require employers to notify current and former employees that the non-compete clauses were no longer effective. The FTC would be responsible for enforcing the rule, and it provides no right of action for workers.

A non-compete clause is defined in the rule 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, the rule also prohibits the use of a “de facto non-compete clause,” or a contractual term that has the effect of a non-compete clause, as defined. Two examples of a de facto non-compete include: 1) a broadly-written non-disclosure provision that effectively prevents a worker from working in the same field after the conclusion of a worker’s employment with the employer, and 2) a contractual term that requires a worker to repay the employer or a third-party entity for training costs in the event that the worker’s employment ends within a specified time period where the payment is not reasonably related to the costs the employer incurred in training the worker. The proposed rule does not prohibit or regulate reasonably tailored customer or employee non-solicitation agreements.  However, the proposed rule includes a functional test to determine whether a contractual term has the effect of a non-compete clause, and non-solicitation covenants would be considered non-compete clauses where they are so unusually broad in scope that they function as such.

According to the FTC, about 1 in 5 workers are subject to a non-compete clause. The FTC claims that non-compete clauses stifle innovation, harm competition in the labor market and significantly reduce workers’ wages. The agency predicts that the proposed rule would increase workers’ income between $250 billion and $296 billion a year. The NPRM was published shortly after the FTC announced settlement agreements that it reached with companies in which non-compete clauses were at issue. But in her statement opposing the rule, Commissioner Wilson noted that the proposed rule is likely vulnerable to legal challenge and urges that the legality of a non-compete requires a case-by-case analysis.

Many states have statutes governing non-competition agreements and several states already constrain or ban the use of non-compete clauses in employment agreements, including California, North Dakota, Oklahoma, Colorado, Illinois, Maine, Maryland, New Hampshire, Oregon, Rhode Island, Virginia, Washington and Washington, D.C.  The proposed rule would supersede any state statute, regulation, order, or interpretation to the extent it is inconsistent with the proposed rule.

If you have any questions regarding this proposed rule, please contact your labor and employment or corporate counsel at Smith, Gambrell & Russell, LLP.

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