On January 5, 2023, the Federal Trade Commission (“FTC”) announced a new proposed “Non-Compete Clause Rule” (the “Rule”) that, if adopted in its current form, would result in a near-total ban on non-competition clauses in employment agreements. According to the FTC, non-compete clauses are “an unfair method of competition” and thus violate Section 5 of the Federal Trade Commission Act. The proposed Rule is a result of the FTC (and Biden Administration)’s view that non-compete clauses hamper competition in the labor market, suppress wages, and suppress innovation and entrepreneurship.
According to the FTC, approximately one in five American workers are bound by a non-compete clause. Thus, any change to existing law will have a significant impact on the rights of employers and workers. Though most states (including Kentucky and Indiana) already regulate non-compete clauses to varying degrees, the proposed Rule would preempt all contrary state laws.
The Rule would not simply bar the enforcement of non-compete clauses in court. Employers would be barred from enforcing existing non-compete clauses as well as requiring them as a condition of future employment. Specifically, the proposed Rule declares it to be a prohibited “unfair method of competition” for an employer to: (1) enter into or attempt to enter into a non-compete clause with a worker; (2) maintain with a worker a non-compete clause; or (3) represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe the worker is subject to an enforceable non-compete clause.
Without minimizing the significance of the FTC’s announcement, many commentators believe that the proposed Rule will change in the public comment process, will almost certainly be challenged in court for some time before going into effect, and may never become law. Keep reading to learn what you need to know about the proposed new rule.
How Will This Rule Affect Employers and Workers?
Every employer that has non-compete agreements with any worker would be affected by this new rule. The Rule broadly defines “non-compete clauses” and would further prohibit contractual terms that are “de facto non-compete clauses.” If adopted as currently drafted, the Rule would require employers to rescind both explicit non-compete clauses and any other contractual terms that “ha[ve] the effect of prohibiting the worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s [current] employment.” As is, this sweeping (and vague) language may affect customer non-solicitation agreements, broadly drafted non-disclosure agreements, and other similar restrictive covenants in addition to explicit non-compete clauses. Critically, the Rule defines “worker” very broadly, including employees, independent contractors, interns, externs, volunteers, apprentices, and sole proprietors.
Narrow Sale of Business Exception
Importantly, restrictive covenants reached as part of the sale of a business were spared by the FTC. The Rule contains a single, narrow exception that applies only when the person who is restricted by the non-compete (1) is either selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or is selling all or substantially all of a business entity’s operating assets; and (2) is an owner, member, or partner holding at least a 25 percent ownership interest in the entity at the time the person enters into the non-compete clause. This lenient approach is similar to that taken by the courts of most states, which have viewed the interests of business purchasers positively, and deserving of reasonable protection.
When Will the Rule Take Effect (If Ever)?
If implemented as proposed, the Rule would bar employers from entering into or enforcing non-competes with workers and require employers to rescind any existing non-competes within six months (180 days) after the date the final version of the Rule is published. The Rule requires the employer to provide notice of the recission to current and former workers within 45 days after the date of recission. (Regarding former workers, an employer must send notices only to those individuals whose contact information the employer has readily available.).
A more important question, however, is whether implementation of the Rule would be enjoined and delayed by a federal court at the outset of what would likely be hotly contested and protracted litigation initiated by business groups. Many commentators believe the FTC, an independent federal agency, has exceeded both the constitutional and statutory scope of its authority. Accordingly, much like the recent OSHA COVID vaccine requirement, the Rule could amount to a much-publicized overreach with political, but not necessarily legal, consequences.
What Can Employers Do Now?
Employers that wish to protect confidential information, trade secrets, employees, customers, and other key business relationships should revisit and review any existing non-competition, non-solicitation and non-disclosure agreements they are using (or have used in the recent past) to determine whether the Rule would bar their use. Even if non-competes end up banned, employers can still include strict confidentiality and other protective clauses into employment agreements that protect legitimate business interests. Employers may also wish to conduct an internal census accounting for the current and former employees who are presently subject to a restrictive covenant agreement. Employers that wish to comment on the FTC’s Rule directly may do so here: Regulations.gov Finally, employers should stay abreast of the Rule’s development in the media, and involve counsel whenever these types of unfair competition matters arise.
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