On January 5, 2023, the Federal Trade Commission (FTC) published a proposed rule seeking to ban non-compete agreements with very limited exceptions. The FTC’s proposed rule is based upon the agency’s preliminary finding that non-compete agreements unfairly restrict employee job opportunities and suppress wages, in violation of Section 5 of the Federal Trade Commission Act. Although the FTC is seeking public comment on the rule before it goes into effect, there are a couple of key takeaways for employers monitoring this issue: First, the proposed rule’s reach is very broad, and will preempt all state laws affording less protection to employees. Second, the proposed rule will even affect non-compete agreements already in place.
The Proposed Rule’s Reach Is Broad
The proposed rule broadly defines a “non-compete clause” 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.” The proposed rule goes even further than traditional non-compete clauses, however, and captures any provision that merely functions as a non-compete clause. This “functional” test considers whether the provision “has 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.” Therefore, while the proposed rule acknowledges that non-disclosure agreements and non-solicitation agreements are generally not regarded as “non-compete agreements” limiting employment, if those contractual clauses are drafted too broadly, they may be prohibited under this “functional” definition.
Additionally, the non-compete ban would extend to contractual terms requiring an employee’s repayment of training costs when the employment ends within a specified time and where that required payment is not reasonably related to the actual cost of training. The proposed rule also broadly covers agreements with independent contractors and any worker, whether paid or unpaid. The only exception to this ban exists in a very limited sale-of-business context between a buyer and seller of a business. As written, the exception would apply to sellers who own more than 25% of the business being sold. That is, a small business owner selling his or her business could still enter into a non-compete agreement as part of what is being sold to the buyer.
Existing Non-Competes Will Be Invalidated
If it becomes final, the FTC rule will require employers to rescind existing non-compete agreements no later than the “compliance date,” which is 180 days after publication of the final rule. To properly rescind a noncompete clause under this proposed rule, employers must send written notice to both current and former employees notifying them of the contract’s rescission. The proposed rule offers a sample rescission notice that can be used for compliance with this requirement.
Critically, the proposed rule will override any state law, regulation, or order that affords lesser protection than what may be set out in the new rule. Strong resistance is expected in the comment period. Moreover, it is quite probable that one or more business groups will mount court challenges to the proposed rule. The first step in any anticipated legal challenge will be seeking of a nation-wide injunction barring the FTC from implementing the rule. Accordingly, employers with non-competes in effect should regularly monitor the status of this proposed rule. Employers should not act unilaterally to void non-competes until the rule actually goes into effect. If an employer voids a non-compete during the comment period and the rule is then enjoined, the employer most likely will not be able to re-instate the non-compete. During this comment period, employers can still require non-compete agreements, but, if doing so, employers should familiarize themselves with the steps necessary to comply with rescission of the non-compete should the rule go into effect.
For questions about this alert, please contact the authors or the Steptoe & Johnson Labor & Employment Team.