On Thursday, January 5, 2023, the Federal Trade Commission (FTC) proposed a new wide-reaching rule that would ban non-compete agreements with workers in the United States and preempt all state laws that are inconsistent with the rule. If implemented as proposed, employers will be required to rescind all existing non-competes with current and former employees.
It is important to note that the proposed rule is not final and does not require employers to take immediate action. In addition, the rule remains subject to change following a public comment period. Moreover, it is likely to face legal challenges, as described further below. We will continue to monitor the progress of this rule as it proceeds through the rulemaking process and any associated court challenges.
Highlights of the Proposed Rule
- Both express and de facto non-competes are prohibited: The proposed rule broadly defines non-competes to include agreements between an employer and a worker that prevents the worker from seeking or accepting employment with another employer or operating a business. In addition, de facto non-competes are also banned, with the proposed rule stating that “the following types of contractual terms, among others, may be de facto non-compete clauses:”
- A non-disclosure agreement between an employer and a worker that 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.
- A contractual term between an employer and a worker that requires the worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specified time period, where the required payment is not reasonably related to the costs the employer incurred for training the worker.
Although customer and employee non-solicitation restrictions are not explicitly referenced in the rule, the comment section of the FTC’s Notice of Proposed Rulemaking states that such restrictions “can sometimes be so broad in scope that they serve as de facto non-compete clauses.” Therefore, it’s possible that certain non-solicitation restrictions may likewise be prohibited.
- Covers agreements with employees & independent contractors: The term “worker” includes any person who works (paid or unpaid) for an employer. This includes not only employees but also independent contractors, externs, interns, volunteers, apprentices and sole proprietors providing services to customers or clients.
- Applies retroactively and prospectively: If the proposed rule is implemented, employers must rescind all non-competes with current and former employees by providing individualized notices of the rescission within 45 days of the rescission. The rule contains model language for the notice.
- Includes limited exceptions: The rule provides two exceptions: (1) sale of business covenants where the restricted person is a “substantial” owner, member or partner in the sold entity, defined as holding at least 25% ownership interest in the business entity; and (2) non-competes between franchisors and franchisees (though it would still apply to non-competes between a franchisee and its employees). In both cases, these non-compete clauses still “remain subject to Federal antitrust law as well as all other applicable law,” such as state-specific restrictive covenant laws.
With respect to sale of business covenants, the FTC believes that a 25% threshold “strikes the appropriate balance” between a threshold that is too high and one that is too low and that establishing a threshold will avoid confusion as to which owners, members and partners fall within the exception.
Potential Changes and Legal Challenges
This new rule follows the FTC’s recent action to strike down three employers’ non-compete agreements, as well as the agency’s recent broader focus to curtail agreements among employers not to “poach” each other’s employees. In support of the rule, FTC Chair Lina M. Khan said, “Non-competes 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. By ending this practice, FTC’s proposed rule would promote greater dynamism, innovation and healthy competition.” The rule also follows through on President Biden’s July 9, 2021 Executive Order’s direction that the FTC consider exercising its authority to limit the use of non-compete agreements.
Nonetheless, it will take some time for the rule to make its way through the rulemaking process, and it will likely face challenges along the way as courts grapple with the limits of FTC’s rulemaking authority. As part of the rulemaking process, the FTC will open the proposed rule for public comment for 60 days following its publication in the Federal Register. Such publication has not yet occurred, and the publication date remains unknown at this time.
In recognition of the public comment process, the FTC’s Notice of Proposed Rulemaking states that potential alternatives may exist to the proposed rule, provided that such alternatives continue to address what the FTC views as inherent unfairness in subjecting workers to non-compete clauses. Potential alternatives include:
- A rebuttable presumption of unlawfulness of non-compete agreements, rather than a categorical ban. This would require employers to meet an evidentiary burden to prove that a non-compete is justified. The FTC recognizes that a test for rebutting the presumption would need to be developed, which could take various forms, such as requiring an employer to establish that the non-compete is justified based on its legitimate business interests and the facts at hand and that the provision is reasonably drafted in terms of geographic territory, duration and scope.
- Establishing different rules for different categories of employees. The FTC suggests that wage thresholds could be put in place, with a complete ban on non-competes with low-level earners (similar to the approach of Illinois’ restrictive covenant law). Alternatively, different standards could be put in place based on workers’ job functions or exempt/non-exempt status, with more lenient standards applying to senior executives or exempt employees.
- Combinations of the foregoing. The FTC also recognizes that the rule could include a combination of alternatives, such as a rebuttable presumption of unlawfulness or more stringent standards applying to non-competes with lower wage earners, and allowing non-competes with employees who make above a certain wage threshold.
The FTC invites comments specific to these alternatives, which suggests that any final rule could look different than this proposal and that the FTC may accept a less drastic approach.
Three of the four FTC Commissioners voted in favor of the proposed rule, with one dissenting. In her dissent, Commissioner Christine Wilson explained multiple legal obstacles that, in her mind, render the FTC without the power to impose the proposed rule. She asserted that the FTC lacks authority to engage in unfair methods of competition rulemaking, that this is too important of a political and economic issue for the FTC to decide on its own, and that Congress is the only body with the power to issue a rule of this caliber. As Commissioner Wilson’s dissent forecasts, the rule almost certainly will face legal challenges based on these and potentially other grounds if it takes effect.
Where Things Currently Stand
As noted, employers do not need to take action pursuant to the rule until it is final, which likely will not be for some time. Put simply, there are, at a minimum, 240 days from the final rule’s date of publication in the Federal Register before employers must comply with any final form of the proposed rule.
Specifically, following the 60-day comment period (which has yet to begin, as noted above), the FTC can proceed to informal hearings and publish a final rule. At that point, the rule is expected to face challenges in court, which could further delay the rule taking effect. But even absent a court challenge, the absolute soonest the rule could be enforced is September 2023, as a 180-day period must lapse following publication of a final rule.
- Stay tuned – no need for immediate action to comply with rule: As noted above, employers do not need to take any immediate action with respect to their current non-compete restrictions as the rule is not final. It will be some time before the rule is final and the final rule may very well look different than what has been proposed.
- Ensure compliance with state laws: The FTC’s proposed rule at the federal level follows a trend of states implementing strict restrictive covenant laws that either ban or otherwise significantly limit the scope of non-competes that can be obtained with employees. Employers are wise to confirm their restrictive covenant practices comply with applicable state laws.
- Evaluate restrictive covenants: Regardless of whether the FTC’s proposed rule becomes law, as drafted or in a narrowed form, the reality now is that state laws in the restrictive covenant space are changing at a rapid pace, and several new state laws already restrict non-competition and non-solicitation agreements, or require particulars as a prerequisite to entering into those agreements in the employment context. Businesses should ensure they use tailored restrictions that match their needs. Restrictions that avoid overreach, in any context, provide the best chance of enforceability and likelihood of standing the test of time.
For more information on this topic, or to learn how Godfrey & Kahn can help, contact a member of our Non-Competition & Trade Secrets Practice Group.