On January 5, 2023, the Federal Trade Commission (FTC) issued a Proposed Rule to ban employers from entering into non-competition agreements (also known as restrictive covenants) with their workers. A copy of the proposed rulemaking can be found here. This Proposed Rule is quite concerning to employers, given that the use of non-competition agreements is very important to many companies in order to protect their confidential information and trade secrets. The FTC, however, believes that such agreements are harmful to workers reasoning that these types of agreements suppress wages and prevent entrepreneurs from starting businesses.
It is important to note that the Proposed Rule is not an official rule yet. The FTC must first seek public comment on the rule before it can be finalized. The comment period ends on March 10, 2023. It is also likely that the Proposed Rule will face legal challenges, delaying and/or preventing it from going into effect. If the rule does end up becoming final, it will likely not go in into effect until late 2023 or sometime in 2024. Recently, the FTC announced that it would be holding a public forum on Thursday, February 16 aimed at supplementing the notice and comment period. We discuss the details of the Proposed Rule and potential challenges below.
Proposed Rule
As stated above, the FTC has taken the position that the use of noncompete agreements is an “exploitative practice,” that hinders innovation and the ability of workers to freely change jobs. The FTC has stated that noncompete agreements constitute unfair competition and violate Section 5 of the Federal Trade Commission Act. In its press release, the FTC asserts that without this hindrance, wages can increase by “nearly $300 billion per year and expand career opportunities for about 30 million Americans.” The FTC also added that employers are prevented from hiring the best available workers.
In an effort to combat these issues, the rule would make it unlawful for employers to:
- enter into or attempt to enter into a noncompete with a worker;
- maintain a noncompete with a worker; or
- represent to a worker, under certain circumstances, that the worker is subject to a noncompete.
With respect to number two on the list, an employer who has already entered into a noncompete agreement with a current worker or a former worker (and still has their contact information readily available), would have to rescind the noncompete clause by the rule’s effective date. Furthermore, the employer would have to give notice to the worker within 45 days of rescinding the noncompete clause stating that the clause is no longer in effect. The notice must be individually delivered to the worker, and it can be given on paper or through digital communication. The FTC has provided a model notice in the proposed rule.
If finalized, the rule making would apply to any contractual clause “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.” Presumably, this rule would not apply to other restrictive covenants such as non-disclosure or non-solicitation agreements, unless such agreements are broad enough that it will function as a noncompete. The proposed rulemaking identifies in general terms that there would be a “functional test” so as to determine whether the contractual clause is prohibited which includes whether the clause is overly broad so as to prevent an employee from employment in the same field or industry post-termination or requirement for repayment of training costs paid by the employer if the employee resigns their employment within a certain period.
Additionally, this rule would be applicable to independent contractors and paid and unpaid workers. The proposed rulemaking also provides for a narrow sale-of-business carve out.
The FTC seeks public comments on numerous topics including whether franchisees should be covered, whether employees should be treated differently under the rule based upon the amount of earned compensation, as well as, whether exemptions or rebuttal presumption should be applied to senior executives.
Challenges
As mentioned above, this rule has caused a lot of controversy. The only FTC commissioner who did not vote for this rule, Christine Wilson, said in a written statement that the Proposed Rule departs, “from hundreds of years of legal precedent that employs a fact-specific inquiry into whether a noncompete clause is unreasonable.” Additionally, Sean Heather, U.S. Chamber of Commerce Senior Vice President for International Regulatory Affairs and Antitrust, expressed in a statement, for “the Federal Trade Commission to outright ban noncompete clauses in all employer contracts is blatantly unlawful. Since the agency’s creation over 100 years ago, Congress has never delegated the FTC anything close to the authority it would need to promulgate such a competition rule.”
Main Takeaway
If the Proposed Rule is finalized and found to be lawful, this rule would significantly impact the way employers can safeguard their proprietary and confidential information, along with trade secrets. Employers would likely need to strengthen their non-disclosure and non-solicitation agreements, but not in a way to make these agreements function as a non-compete. However, this rule is currently not in effect. As discussed above, the FTC still needs to consider the public’s comments. Additionally, it is very likely this rule will be challenged in court and may not go into effect. We will continue to monitor the developments of this rule.