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On July 9, 2021, President Biden issued an Executive Order on Promoting Competition in the American Economy wherein he, among other things, directed the Federal Trade Commission (“FTC”) to “exercise the FTC’s statutory rulemaking authority under the Federal Trade Commission Act to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”

This Executive Order signaled the recent seriousness of the federal government’s intent to regulate non-compete agreements, which have typically been regulated by state law with increasing restrictions on enforceability.[1]

The FTC’s Proposed Rule

Consistent with President Biden’s Executive Order, on January 5, 2023, the FTC released a Notice of Proposed Rulemaking that would completely ban employers from maintaining non-competes with their workers, with a very limited exception. The 218-page Proposed Rule, which includes 212 pages of justification for the rulemaking, would specifically supersede any less protective state law and would make it illegal for an employer to:

• enter into or attempt to enter into a non-compete agreement with any worker;
• maintain a non-compete agreement with a worker; or
• represent to a worker, under certain circumstances, that the worker is subject to a non-compete agreement.

“Worker” is Broadly Defined

Notably the Proposed Rule uses the term “workers” instead of “employees” because the term worker includes independent contractors, interns, and anyone who works for an employer, whether paid or unpaid.

Potential Reach Beyond Traditional Non-Competes?

The term “non-compete” is defined broadly under the Proposed Rule to include “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 employee.”  The Proposed Rule articulates a “functional test” for determining whether an agreement term is a “de facto” non-compete subject to the proposed ban.  A de facto non-compete clause is one that “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.”  The Proposed Rule cites the following non-exclusive examples of de facto non-compete clauses:

• A non-disclosure agreement between an employer and a worker that is written so broadly that it effectively precludes the worker from working in the same field after the conclusion of the worker’s employment with the employer.
• A contractual term between an employer and a worker that requires the worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specified time period, where the required payment is not reasonably related to the costs the employer incurred for training the worker.

While the Proposed Rule maintains that the ban generally would not apply to other types of employment restrictions, like non-disclosure agreements, the FTC’s examples suggest that the FTC might find an overbroad non-disclosure agreement to be illegal under the Proposed Rule. 

The Proposed rule is silent as to customer (and employee/worker) non-solicitation agreements and assignment of invention agreements.  Presumably, such clauses in agreements are unaffected by the rule.  Yet, again, the FTC’s position regarding de facto non-compete clauses suggests any clause limiting a worker’s ability to seek employment with competitive entities could run afoul of the Proposed Rule, particularly in industries with limited customer bases.

Worker Notification Requirement

The Proposed Rule also would require that employers rescind existing non-competes and actively notify current and former workers that are subject to non-compete clauses that the banned restrictions are no longer in effect.  This rescission and notification requirement lacks clarity on how it might apply to scenarios such as a non-compete clause agreed-upon by a former owner (under 25%) of a company in the course of selling the company—particularly where such individual negotiated as an owner rather than as a “worker.” 

Exception to Non-Competes Incident to a Sale of Business

The Proposed Rule creates a limited exception to allow non-compete clauses that are part of a sale of business agreement.  State legislatures and courts across the country have recognized that prohibiting non-competes in the sale of business context would deprive the buyer of some benefit of the bargain. 

However, the sale of business exception in the Proposed Rule is narrower than almost every jurisdiction’s current exception because it only would apply to “persons” holding at least a 25 percent ownership interest in the selling entity. Therefore, owners who served as employees, executives, consultants, or advisors of a seller and fall under this 25% ownership threshold would be allowed to engage in competitive business activities immediately after the transaction.  Such an outcome would have serious ramifications for buyers or investors who may find themselves competing against a minority owner or executive who decides to deny the purchaser the benefit of the bargain and begin competing against them.  Moreover, the Proposed Rule would invalidate existing bargained-for non-compete agreements for those worker-sellers who had less than a 25% ownership interest in the sold business and would require buyers to find and notify such individuals of the non-compete agreements’ rescission.

Challenges on the Horizon

The Proposed Rule is unlikely to survive in its current form.  Several critics anticipating the Proposed Rule, including the U.S. Chamber of Commerce, previously challenged FTC’s statutory authority to promulgate a rule banning non-compete agreements noting, among other reasons, that “[n]owhere, for example, does the [FTC] Act state that the FTC ‘shall or may’ promulgate rules to determine whether certain types of business practices are per se fair or unfair, to supplant state law, or to invalidate or proscribe entire categories of business contracts.” Indeed, FTC Commissioner Christine S. Wilson issued a Dissenting Statement noting, in part:

The NPRM is vulnerable to meritorious challenges that (1) the Commission lacks authority to engage in “unfair methods of competition” rulemaking, (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.  In short, today’s proposed rule will lead to protracted litigation in which the Commission is unlikely to prevail.

In particular, the Supreme Court has taken a strong stance on the “major questions” doctrine in recent years. 

Moreover, critics have noted that non-competes have a legitimate role in employment contracts to prevent unfair competition. Decades of legal jurisprudence in most states have generally found non-compete agreements reasonable so long as they are narrowly tailored in scope and duration, and taking into account the employee’s prior job and duties, to prevent unfair competition by the departing employee.  Many employers have bargained-for non-compete agreements for which they have provided tangible consideration, whether in the form of access to confidential information, cash, or post-employment benefits such as stock or severance.  The FTC’s Proposed Rule would set aside these judicially recognized and contractual employer interests with the potential for unintended consequences.

Given the partisan divisions between the House and Senate, Congress is unlikely to pass legislation to overturn or otherwise intervene. However, in addition to litigation on any final rule, we anticipate hearings, open letters, and other activity as members of Congress voice their opinions and try to influence the rulemaking. 

Your Time to be Heard

The FTC seeks public comment over the next 60 days on several topics that could serve to create additional exemptions, narrow, and/or clarify the Proposed Rule, in particular:

• 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 should be treated differently under the rule
• Whether franchisees should be covered by the rule

The Proposed Rule also notes that the FTC considered alternatives that more closely tracked some of the limitations passed in states such as Colorado, Illinois, Massachusetts, or Washington.  The comment period is a critical time in the rulemaking process.  If your company would like to voice its opinion to the FTC, please contact your Michel Best attorney for assistance.

Impact on Your Business and Next Steps

The Proposed Rule is just that, proposed.  At this point, it does not invalidate or prohibit the use of non-compete agreements.  Employers should continue to monitor the development of this rule and participate in the comment process to allow their voices to be heard.

However, employers should take the opportunity to ensure that any existing post-employment restrictions are narrowly tailored to protect their legitimate business interests.  Now is a good time to reexamine other clauses and practices that presumably would not be impacted by the NPRM.  For instance, protecting company confidential information and trade secrets will be even more crucial if non-compete clauses are prohibited or substantially limited.  Employers should revisit their agreements to ensure compliance with applicable state law and should examine whether non-compete agreements and other restrictive covenants are needed for the employees from whom they seek to prevent unfair competition.  Our Michael Best team stands ready to help protect business interests while monitoring for compliance across jurisdictions.