Federal Trade Commission Signals Attempt to Bar Non-Competes Nationwide
On January 5, 2023 the Federal Trade Commission (“FTC”) announced a proposal to broadly ban employers from limiting their employees’ post-employment activities through non-compete agreements or “de facto” non-compete provisions. Employers often use these agreements to prevent their employees from leaving their employment to work for a competitor or from starting a competing business. This restriction would apply to both paid and unpaid employees as well as independent contractors.
The proposed rule, if it becomes final, would require employers to rescind existing non-competes and actively inform their employees and former employees that these restrictions are no longer in place. The FTC provides model language for this notice requirement, which will provide a safe harbor for employers using this exact language. The proposed rule also makes it illegal for an employer to enter into a non-compete or suggest that a worker is bound by one where there is no good faith basis for enforcement.
As mentioned above, the proposed rule also applies even more broadly to “de facto” non-compete clauses that 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” which could include the following:
- a non-disclosure clause that is written so broadly that it effectively precludes workers from working in the same field post-termination; and
- a contractual term which requires the former employee to pay the employer or a third-party entity for training costs if employment is terminated within a certain time, where the payment is not reasonably related to the costs the employer incurred.
Note that under this “functional test” for de facto non-competes, the proposed rule could apply to other types of restrictive covenants like non-solicitation provisions, which prevent employees from working with clients of their former employer, if such provision effectively works as an overly broad non-compete, precluding the employee from working in the same field post-termination.
These restrictions will not apply in a very narrow exception where the noncompete is “entered into by a person who is selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or by a person who is selling all or substantially all of a business entity’s operating assets.” However, the proposed rule maintains that non-compete clauses covered by the exception remain subject to federal antitrust law.
As far as state law, this proposed rule provides that the FTC rule will supersede any state statute, regulation, order, or interpretation to the extent that such state rule is inconsistent.
The FTC anticipates that compliance will be required within 180 days after publication of the final rule. However, before that happens, this proposed rule will be subject to public comment for 60 days and further consideration of the FTC. The FTC is specifically interested in public comment on the following issues:
- whether franchisees should be covered by the rule;
- whether senior executives should be exempt form the rule, or subject to a rebuttable presumption rather than a ban; and
- Whether low- and high-wage workers should be treated differently under the rule.
Several states, including California, North Dakota, and Oklahoma already prohibit the use of non-competes in most employment relationships and all states place limitations on their use which vary from state to state.
Typically, the primary rationale for allowing non-compete agreements is the need to protect trade secrets as well as the investment made in developing customer relationships and goodwill. The FTC in its proposal asserts that existing trade secret law and other legal protections are sufficient, and points to California as a specific example of how the prohibition on non-competes in that state has not hindered technological innovation and growth.
This initiative is consistent with the FTC’s recent policy statement purportedly broadening its authority and committing itself to protecting workers from unfair competition. In fact, the FTC recently brought action against various companies using non-competes in a manner that, according to the FTC, impeded competition.
We anticipate challenges to the FTC’s rulemaking authority and their attempt to universally ban non-competes. Although the FTC has broad authority under federal antitrust law to regulate potential anti-competitive activity, it has not previously used this authority to regulate the non-compete agreements in the employment context and the regulation of non-compete agreements has been the exclusive province of the states.
We will continue to monitor this issue. Please contact a Franczek attorney with any questions