On January 5, 2023, the Federal Trade Commission (FTC) announced its intention to propose a rule that would ban employers from using certain non-compete agreements. Specifically, the proposed rule would make it unlawful for an employer to enter a non-compete with an employee, an independent contractor, and any paid or unpaid person that works for the employer (e.g., interns, externs, apprentices, volunteers, and the like). This proposed rule would not apply to non-competition agreements between:
A franchisor and franchisee.
A person selling a business and the buyer.
A person selling the person’s ownership interest in a business and the buyer.
A person having 25% or more ownership in a business who sells all or substantially all of the business’s operating assets and the buyer.
Rationale for the Ban
While the objective of employer non-compete agreements is to protect an employer’s legitimate business interests from being used for the advantage of a competitor, the FTC has cited research suggesting that employers have abused the use of non-competes by requiring workers, regardless of title, job function, compensation, and access to valuable confidential information, to agree as a condition of employment. The FTC finds this tactic to be abusive and an unfair method of competition under Section 5 of the FTC Act.
Based on FTC cited research, non-compete agreements have resulted in suppressed worker wages, hindered worker mobility, impeded innovation, and blocked entrepreneurs from starting new businesses. The FTC projects that its proposed rule would rectify these issues and increase workers’ earnings by $250 billion to $296 billion per year.
FTC Definition of Non-Compete
The FTC’s proposed rule to ban certain non-compete agreements broadly defines a non-compete clause to be 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 in competition with the employer after the relationship with the employer ends. To determine whether a contractual term is a non-compete clause, the proposed rule establishes a functional test, which is as follows:
Does the contract term have the effect of blocking a worker from seeking or accepting employment with a person or from operating a business after the relationship with the employer ends?
If the answer is yes, then the contractual term would be deemed a de facto non-compete clause, an unfair method of competition in violation of Section 5 of the FTC Act, and unlawful.
FTC Versus State Non-Compete Laws
States have long-standing laws governing employment non-competition agreements, although they vary in scope, application, and requirements for enforceability. If the FTC's proposed rule becomes effective, this rule would supersede any state law that is inconsistent with it, except for those state laws providing greater worker protection than the FTC rule.
Existing Non-Compete Agreements
The FTC’s proposed rule to ban employer non-compete agreements extends to pre-existing non-compete agreements. This means it would apply to an employer’s existing non-compete agreements with current and former employees, independent contractors, and any other paid or unpaid worker. Per the rule, employers would be required to rescind all such non-compete agreements and provide written notice to each affected current and past employee, independent contractor, and paid or unpaid worker within 45 days of the rescission date.
Confidential Business Information and Valuable Relationship Interests
Employers have legitimate reasons to protect their valuable business interests from being used by competitors, such as their confidential business information, trade secrets, customer relationships, and professional relationships, among others. If the FTC's proposed rule passes and the only agreement protecting these types of legitimate business interests is a non-compete agreement or clause, the contractual legal protection afforded would be lost. If an employer’s main agreement contains a non-compete clause but also includes provisions that separately cover confidential information, including trade secrets, the proposed rule would unlikely impact the validity or enforceability of such provisions. Of course, this largely depends on the language of the contract.
Date of Rule Becoming Final
There is no set date for when this proposed rule will be decided at the time of this writing, but it won’t happen any time soon. First, the submission for public comments concerning the rule just closed on April 19, 2023. The FTC will need time to review those comments, consider arguments made against and for the proposed rule, and make any revisions it deems appropriate or necessary. Following this, the FTC will publish a final rule in the Federal Register, which would become effective 60 days thereafter. When this occurs, employers would have 180 days from the publication date of the final rule to become compliant.
However, there is controversy over this proposed rule, and this may lead to the rule being challenged in court. The U.S. Chamber of Commerce has already announced its opposition to this rule and its intent to challenge the FTC's authority to declare this type of sweeping substantive regulation that would bind private parties. Assuming this proposed rule becomes final, litigation may likely follow, and this would further delay the rule from going into effect, if at all. The delay could be six months, one year, or many years to come.
Final Remarks
The FTC’s proposed rule to categorically ban employer non-compete agreements is a heated, controversial topic that is unlikely to take effect any time soon, if at all. Notwithstanding, employers with non-compete agreements should remain mindful of the FTC's position and consider how to handle future non-compete agreements pending the outcome of the proposed rule. In addition, employers should review their current non-compete agreements to determine how this proposed rule, if enacted, would impact the protection of their confidential business information, including their trade secrets. Part of this process should include identifying what steps can be taken to help mitigate the risk of such loss.
The information provided in this article is for general informational purposes only. Nothing stated in this article should be taken as legal advice or legal opinion for any individual matter. As legal developments occur, the information contained in this article may not be the most up-to-date legal or other information.