The Federal Trade Commission (“FTC”) continues to pursue its campaign against non-compete clauses. On January 5, 2023, the FTC voted 3–1 to publish a notice of proposed rulemaking, which, if implemented, would bar employers from entering into non-compete agreements with their workers and require employers to rescind existing non-compete restrictions with current and former workers. Originally, the deadline for submitting comments was March 20, 2023. Recently, the FTC voted 4–0 to extend the public comment period for an additional thirty days following numerous requests from the public. As such, the FTC will now accept comments on the proposed rule until April 19, 2023.
Although all four current commissioners voted to approve the extension, Commissioner Christine S. Wilson—the sole Republican—filed a concurring statement regarding the extension. Commissioner Wilson explained that because of the number of requests the FTC had received to extend the comment period by thirty days and the fact that the proposed rule “is a departure from hundreds of years of precedent and would prohibit conduct that 47 states allow,” she would have supported a longer, sixty-day extension. Commissioner Wilson additionally encouraged the public to submit comments on the proposed rule.
To date, the FTC has received more than 16,000 comments related to the proposed rule, a number that is sure to climb over the coming days.
Scope of the Proposed Rule
The proposed rule supersedes state laws that are less protective of employees, but keeps in effect state law that provides employees greater protection. The proposed rule excludes franchisees from the definition of “worker” and has a single, limited exception that applies to the sale of a business.
First, the FTC’s proposed rule would effectively ban worker non-compete provisions by deeming them an “unfair method of competition” under Section 5 of the FTC Act. The proposed rule would make it unlawful for employers to enter into or keep in place any non-compete provisions with current or former workers. Non-compete provisions are defined as contract terms that “prevent . . . worker[s] from seeking or accepting employment” or “operating a business” after their employment with the employer ends.
The proposed rule does not apply to customer or employee non-solicitation provisions or generally to confidentiality or non-disclosure agreements. The proposed rule applies a functional test for determining whether a clause is covered by the rule. A provision is considered a “de facto” non-compete provision if it “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 includes as an example of a de facto non-compete term 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.”
The proposed rule defines the term “worker” very broadly to include any “natural person who works, whether paid or unpaid, for an employer,” including “independent contractor[s], extern[s], intern[s], volunteer[s], apprentice[s], or sole proprietor[s] who provide a service to a client or customer.”
Notice Obligations Imposed by the Proposed Rule
If the rule becomes effective, employers who have existing non-compete provisions that violate the rule would be required to affirmatively rescind existing non-compete clauses with current workers and give individualized notice to workers that they are no longer subject to the non-compete clause. Employers would also be required to rescind non-compete clauses in effect with former workers, and give former workers notice of such rescission as long as the employer has the former worker’s contact information readily available. Employers would be prohibited from representing to a worker that the worker is covered by a non-compete clause when the employer has no good-faith basis to believe the worker is subject to an enforceable non-compete clause.
Exception for Sale of Business
The proposed rule provides a single, limited exception related to the sale of a business. The exception provides that the rule “shall not apply to a non-compete clause that 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.” The exception applies, however, only to a person who owns at least a 25% ownership interest in a business entity at the time the person enters into the non-compete clause. The proposed rule is unclear as to whether the exception applies to existing non-compete terms applied to future sales of a business or only to non-compete terms entered into at the time of the sale.
Relation to State Laws
The proposed rule provides that it supersedes any state statute, regulation, order, or judicial interpretation that is inconsistent with the proposed rule. A state statute, regulation, order, or interpretation is not inconsistent with the proposed rule, however, if it provides greater protections to workers than the proposed rule. As a result, the proposed rule would essentially set a floor for worker protection against non-compete agreements but also keep in effect state and federal law that provides workers greater protection.
The FTC’s extended comment period on the proposed rule runs until April 19. The FTC has asked specifically for comments on several different alternatives to this non-compete ban, such as whether non-compete clauses between employers and senior executives should be subjected to a different rule than non-compete clauses between employers and other workers. The FTC also seeks comments on the possible benefits and costs of the proposed rule, the impact of the proposed rule on businesses, and possible compliance costs should the proposed rule be implemented. Commissioner Wilson’s recent and original statements seek to strongly encourage commenters to submit their views on the proposed rule.
The proposed rule would establish a separate effective date and compliance date. The proposed rule’s effective date will be sixty days after the final rule is published in the Federal Register. The compliance date will be 180 days after the final rule is published in the Federal Register.
The time between the effective date and the compliance date is the “compliance period,” during which employers will need to be prepared to comply with the proposed rule’s provisions by the compliance date.
Effect on Congress
The FTC’s proposed rule has also sparked movement within Congress. In response to the proposed rule, Sen. Chris Murphy (D-Conn.) reintroduced the Workforce Mobility Act (the “Act”), which was cosponsored by Sens. Todd Young (R-Ind.), Tim Kaine (D-Va.), and Kevin Cramer (R-N.D.). This Act had been previously introduced to Congress in 2018, 2019, and 2021 but stalled each time. The Act, like the proposed rule, seeks to ban the enforcement of non-competes across the United States. However, the Act differs from the proposed rule in many ways. Of note, the Act would not retroactively ban non-compete agreements, whereas the FTC proposed rule would apply to all existing and future non-compete agreements.
The Act is currently sitting in committees for additional review.
What Does This Mean for Employers?
Employers should carefully monitor the status of the proposed rule. It will likely face significant legal challenges, and its fate is far from certain. Employers should consider, however, conducting an audit of their non-compete agreements and practices with respect to such agreements to determine whether and to what extent they may be impacted should the proposed rule become the law of the land.
For example, employers who have previously relied primarily on non-compete restrictions to prevent unfair competition or theft of trade secrets may consider strengthening or modifying their non-solicitation and non-disclosure restrictions. Specifically, employers should evaluate their confidentiality agreements, which are often very broad, to evaluate the risk that they may be considered “de facto non-competes” that are invalidated by the proposed rule and ensure that they comply with the antitrust laws. Employers may also consider conducting an audit to evaluate and identify vulnerabilities within their organization in the event that key current and former employees suddenly have unenforceable non-compete restrictions. Having a contingency plan in place now could save resources and potentially prevent significant impacts to the bottom line.
Additionally, although Section 5 of the FTC Act applies to “persons, partnerships, or corporations,” its definition of the term “corporation” covers only entities “organized to carry on business for [their] own profit or that of [their] members.” Therefore, arguably, the proposed rule would not apply to nonprofit entities. The courts, however, apply a fact-sensitive analysis, suggesting that the nonprofit legal status of an entity is not dispositive of Section 5’s applicability. Further, the FTC can also challenge non-competes under other antitrust statutes, such as the Sherman Act. Nonprofits should tread carefully given the other tools available to the FTC and other state and federal authorities and the apparent skepticism toward non-competes.
Should the proposed rule be adopted in its current state, this will also place much greater importance on policing corporate confidential and trade secret information, as companies would lose the ability to prevent former employees from immediately going to work for a direct competitor. This provides additional incentive for companies to proactively take stock of their confidentiality practices and agreements to ensure they are fully prepared in the event the proposed rule is implemented in its current form by the FTC.