On January 5, 2023, the Federal Trade Commission (“FTC”) issued a notice of proposed rulemaking (“NPRM”) that would “provide that it is an unfair method of competition – and therefore a violation of Section 5 [of the FTC Act] – for an employer to enter into or attempt to enter into a non-compete clause with a worker; [or to] maintain with a worker a non-compete clause . . .” If this rule becomes final, it would effectively prohibit employers from entering into non-compete agreements—as broadly defined by the proposed rule—with their workers.
The FTC’s NPRM comes on the heels of the FTC issuing complaints against three companies and two individuals seeking to force them to ditch non-compete agreements they imposed on thousands of their workers. The FTC’s moves signal that the agency intends to take aggressive measures to try and regulate competition in the workplace.
The proposed rule would apply to employers who “hire or contract with a worker to work for the person,” meaning it will cover all private employers. It broadly defines non-compete agreements 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.” To determine whether a clause in an agreement is a non-compete clause, the proposed rule would require a functional test to determine if it would have “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 with the employer.”
It identifies two types of agreements that would constitute impermissible non-competes: (i) a clause “written so broadly that it effectively precludes the worker from working in the same field” after the worker’s employment; and (ii) obligations for workers to cover training costs if they end their employment too soon, provided the obligation isn’t “reasonably related to the costs the employer incurred for training the worker.” The current language of the proposed rule also may impose upon other, typical agreements into which employers enter with their workers, for example, agreements not to disclose an employer’s confidential information. If a non-disclosure agreement is drafted too broadly, it risks running afoul of (i) above.
The proposed rule would also require employers to rescind their existing non-compete agreements within 180 days of publication of the final rule, and to provide current and former employees notice of the rescission. If employers do so, they may take advantage of a safe harbor in the rule against FTC enforcement.
However, the proposed rule also contains certain carve-outs to the ban on non-competes. Under those carveouts, it would still be lawful for an individual to enter into a non-compete agreement if it is in connection with the sale of a business or substantially all of a business’s assets where the individual subject to the non-compete is a substantial owner—defined as an individual “holding at least a 25 percent ownership interest in a business entity.”
The FTC will publish the NPRM in the Federal Register soon and the public will have 60 days to comment on the proposed rule. Once the public comment period is over, the FTC has indicated that it intends to move the rule quickly to finalization after considering the public’s comments, and enforcement of the rule may begin 180 days after the FTC publishes the final rule.
However, this rule will face significant challenges in the courts, which will likely delay its enforcement. As FTC Commissioner Christine S. Wilson—currently the sole Republican Commissioner—wrote in her dissent to the NPRM, the proposed rule is a “radical departure” from “years of legal precedent that employs a fact-specific inquiry into whether a non-compete clause is unreasonable in duration and scope, given the business justification for the restriction.” Further, as Commissioner Wilson notes:
The NPRM is vulnerable to meritorious challenges that (1) the Commission lacks authority to engage in “unfair methods of competition” rulemaking [because Congress did not delegate that authority to the agency], (2) the major questions doctrine addressed in West Virginia v. EPA applies, and the Commission lacks clear Congressional authorization to undertake this initiative; and (3) assuming the agency does possess the authority to engage in this rulemaking, it is an impermissible delegation of legislative authority under the non-delegation doctrine, particularly because the Commission has replaced the consumer welfare standard with one of multiple goals.
The legal fight over this proposed rule will likely lead to protracted litigation in the courts over the scope of the rule and the powers that have been delegated to the FTC by Congress to regulate competition.
The FTC’s NPRM is the latest in the Biden Administration’s effort to increase oversight and regulation in the workplace and also enforcement. We have seen similar, recent efforts by the Department of Labor and National Labor Relations Board, and we expect this trend to continue. We are closely monitoring these developments and are available to assist employers regarding their own non-compete agreements and the potential implications of the NPRM. Additional depth analysis and cross practice coverage is available here.