FTC Proposes Near-Total Ban on Non-Compete Agreements

On January 5, 2022, the Federal Trade Commission issued a proposed rule that would ban nearly all non-compete clauses in employment agreements – both existing and future. As set forth in the FTC’s accompanying Fact Sheet, non-compete provisions violate the Federal Trade Commission Act, which prohibits “unfair methods of competition in or affecting commerce.” If and when a final rule is eventually issued, however, it will almost certainly be subject to legal challenge.

What is a non-compete clause? As the FTC explains, non-compete clauses bar an employee or independent contractor from working for a competing employer or starting a competing business, typically within a certain geographic area and for a certain period of time after leaving employment.

A contractual provision, however, need not be termed a “non-compete” or expressly bar competitive conduct in order to be covered by the proposed ban. The FTC would apply a “functional test” – as long as the provision is so broad that it has a non-competitive effect, the FTC would consider it to be a de facto non-compete clause. These can include provisions such as non-disclosure agreements, client or customer non-solicitation agreements, non-recruiting (i.e., “no raiding” of employees) agreements, and liquidated damages provisions (requiring the payment or repayment of sums, such as training costs, if the worker engages in certain conduct).

The enforceability of non-compete clauses is currently a creature of state law, with all states imposing some limitations on such clauses, whether by statute or through court decisions. Most states permit the use of non-compete clauses; only California, North Dakota and Oklahoma ban them altogether. Eleven other states and the District of Columbia have complete bans for non-competes affecting low-wage workers and/or impose other limitations.

Why do employers use non-compete clauses? There are several reasons that may come into play. Some employers are concerned about investing in training and sharing information with workers who could then take those valuable skills and knowledge to a competitor. (The FTC recognizes this a “the primary justification for use of non-compete clauses”). Some employers find that non-competes reduce recruitment and training costs by lowering turnover. Some argue that non-competes actually increase wages, as companies may offer a wage premium in exchange for the agreement.

How do non-compete clauses violate the FTC Act? According to the FTC, such clauses prevent workers from pursuing better opportunities and prevent employers from hiring qualified workers who are bound by these contracts. The FTC further asserts that they also reduce wages, stifle new businesses and ideas, and exploit workers who have less bargaining power.

In its Fact Sheet, the FTC offers several examples from “public reporting” on how non-competes harm workers:

• A security guard was fired from a new job that paid more because his previous employer sent a letter notifying the new employer of the guard’s two-year non-compete.
• An Amazon vice president was sued to block him from taking a job as the head of product for a tech startup. After “unfavorable media coverage,” Amazon dropped the suit and the new company thrived under the VP’s leadership.
• A factory manager lost all his savings in a three-year battle over a non-compete that prevented him from accepting a better position with a big raise from a rival company.
• A phlebotomist (a technician who draws blood) had a job offer with better hours, increased pay, and less travel, but it was rescinded when the company discovered she had a non-compete

Not everyone agrees with the FTC’s position, however, including one of its own commissioners. Commissioner Christine Wilson issued a detailed and strongly worded dissenting statement, in which she questioned the validity of the FTC’s assertions as well as its authority to issue such a rule.

Who are the individuals covered by the proposed rule? The rule defines “workers” broadly – far beyond traditional employees. The definition includes, but is not limited to, the following: an independent contractor, extern, intern, volunteer, apprentice, or sole proprietor who provides a service to a client or customer. It specifically does not cover franchisees, although it does cover individuals who work for a franchisee or franchisor.

What does the proposed rule do? The proposed rule asserts that it is illegal for an employer:

• To enter into or attempt to enter into a non-compete clause with a worker;
• To maintain with a worker a non-compete clause; or
• To represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause.

Based upon these assertions, the proposed rule then provides that any existing non-compete clauses must be rescinded. The employer must provide an individualized, written notice to current and former workers that the non-compete clause is no longer in effect and may not be enforced. The FTC sets forth model notice language as follows:

A new rule enforced by the Federal Trade Commission makes it unlawful for us to maintain a non-compete clause in your employment contract. As of [DATE 180 DAYS AFTER DATE OF PUBLICATION OF THE FINAL RULE], the non-compete clause in your contract is no longer in effect. This means that once you stop working for [EMPLOYER NAME]:

• You may seek or accept a job with any company or any person—even if they compete with [EMPLOYER NAME].
• You may run your own business—even if it competes with [EMPLOYER NAME].
• You may compete with [EMPLOYER NAME] at any time following your employment with [EMPLOYER NAME].

The FTC’s new rule does not affect any other terms of your employment contract. For more information about the rule, visit https://www.ftc.gov/legal-library/browse/federal-register-notices/non-compete-clause-rulemaking.

The FTC would permit employers to use notices of their own, as long as the notice communicates that the non-compete clause is no longer in effect and may not be enforced against the worker.

Are there any exceptions? The sole stated exception to the non-compete ban is in the context of the sale of a business. A non-compete would be permitted if entered into by the person selling the business or its operating assets, as long as they are an owner, member, or partner holding at least a 25 percent ownership interest in the business.

However, there are some entities that are exempted from coverage under the FTC Act, and therefore would not be subject to the proposed rule. These include certain banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers, and persons subject to the Packers and Stockyards Act of 1921, as well as an entity that is not “organized to carry on business for its own profit or that of its members” (i.e. certain non-profit entities). The proposed rule also does not apply to entities (both governmental and private) engaging in action protected by the state action doctrine (i.e. where the state is acting as a sovereign).

What does the FTC want to know? The proposed rule requests public comment on a number of issues, including the following:

• Its proposed definition of non-compete clauses, including those other provisions that function as de facto non-competes
• Whether there is additional data it should consider, beyond the studies cited in the notice of proposed rulemaking
• Whether a federal standard would provide certainty for employers and workers, and prevent employers from imposing choice-of-law provisions to avoid states that disfavor non-competes
• 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
• Whether low- and high-wage workers, or other categories of workers (g., based on job functions), should be treated differently under the rule
• Whether there are reasonable alternatives to non-compete clauses
• Whether handbook policies can also serve as illegal non-compete clauses
• Whether the FTC should adopt, in place of or in addition to the non-compete ban, disclosure requirements or a rule requiring employer reporting to the Commission on their use of non-compete clauses
• Whether the FTC should adopt a rebuttable presumption of unlawfulness (under which a non-compete might be permitted if the employer meets certain evidentiary burdens) rather than a categorical ban on non-competes, and what the test for rebutting the presumption should be

What are the alternatives to non-competes? The FTC argues that employers have other ways to protect trade secrets and valuable investments, as evidenced by flourishing businesses in states that already prohibit non-compete clauses. Such alternatives identified by the FTC include existing protections under trade secret laws and “appropriately tailored” non-disclosure agreements. The FTC also identifies employment contracts of fixed duration that allow employers to recoup their training investment, as well as improving worker retention by paying workers better wages and offering them better working conditions.

What happens now? Interested members of the public will have 60 days following publication of the proposed rule in the Federal Register to comment on the proposed rule (comments may be submitted on the forthcoming Federal Register webpage for the proposed rule). The FTC must consider such comments prior to issuing a final rule. Compliance with the final rule would be required 180 days after its issuance. However, we expect that there will be a number of legal challenges to the rule that may prevent it from ever taking effect.

As noted above, however, while most states permit non-compete provisions subject to certain conditions, a number of states have taken action to limit or prohibit the use of non-competes. Thus, it is important for employers to check for any applicable laws in the jurisdictions in which they are seeking to utilize non-compete agreements.

We will keep you updated concerning developments related to this proposed rule.