In a Notice of Proposed Rulemaking issued January 5, 2023, the Federal Trade Commission (“FTC”) proposes prohibiting employers from entering into non-compete clauses with workers and requiring employers to rescind existing non-compete clauses. The FTC’s reasons for the proposed rule include its belief that non-compete clauses reduce workers’ wages, limit job mobility and hinder innovation. The proposed rule would supersede all state laws that are contrary to the FTC rule and it would invalidate non-compete clauses already in effect.
As written, the proposed rule would render it an unfair method of competition for an employer to enter 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. The proposed definition of “non-compete clause” is “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.” Thus, the rule would permit workers to voluntarily leave employment to start a business in direct competition with their former employer, for example.
The proposed rule’s definition of “worker” is incredibly broad, and includes all employees (no matter how senior) and independent contractors. If the proposed rule goes into effect, as written, companies that have existing non-compete agreements will be required to formally rescind the non-compete clauses by providing written notice to all workers with a non-compete clause, including former employees and contractors, informing the workers that the non-compete clauses are rescinded. The proposed rule contains model language for employers to use to rescind existing non-compete clauses.
There is a very limited exception, for the sale of a business, where non-compete agreements will be permitted under the proposed rule. The proposed rule’s requirements would not apply to a non-compete clause entered into by a person selling a business, or by a person selling all or substantially all of the operating assets of a business, when the seller holds at least a 25% ownership interest in the business entity.
The proposed rule does not ban non-disclosure, confidentiality, or non-solicitation clauses outright. However, the rule includes a functional test for whether a contractual term is a de facto non-compete clause. If a clause “has 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 employment” then it would be considered invalid under the proposed rule. For instance, a non-disclosure agreement that is written so broadly that it effectively precludes the worker from working in the same field would be considered a de facto non-compete.
The proposed rule seeks public comment on a number of topics, in particular:
- 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.
Public comments will be received until March 10, 2023, and will be reviewed before the FTC makes any changes in a final rule. Comments to the proposed rule may be submitted here.
The proposed rule, published under the authority of Section 5 of the Federal Trade Commission Act, 15 U.S.C. 45 and 46(g), has already come under considerable scrutiny. The FTC voted 3-1 to publish the proposed rule, and the single dissenting member has already issued a statement identifying multiple grounds for possible legal challenge. Certain trade groups are also contemplating legal challenges to the authority of the FTC to regulate issues of such vast economic and political significance. If the proposed rule becomes final without any revision by the FTC, the rule will likely be tied up in the federal courts for a significant period of time before it will become effective.
Winthrop & Weinstine continues to monitor the situation and we will update you on this topic as the public comment and review process unfolds. Employers who have a stake in the enforcement of non-compete agreements should consider reviewing the proposed rule and submitting comments to the FTC. Employers do not necessarily need to take immediate steps regarding their existing non-compete agreements in response to the proposed rule, but it would be advisable for employers to know which of their employees and former employees have existing non-compete clauses in their agreements. However, employers should keep in mind that narrowly-tailored agreements that protect legitimate business interests are more likely to be enforceable under the current framework of state and federal law. For more information about employment agreements, including non-competition, non-disclosure, and non-solicitation provisions, please feel free to reach out to any member of our Employment team.
In addition, our Employment Litigation team’s upcoming webinar, “Is Your Non-Compete Agreement Enforceable? These Common Mistakes Could Cost Your Company,” will address the proposed rule and other non-compete enforcement issues. If you are interested in attending, registration is available here.
