Comments and Challenges Welcome: FTC Proposes New Rule to Ban Non-Compete Agreements with Employees, Independent Contractors, and Volunteers

7 min

On January 5, 2023, the Federal Trade Commission (FTC)—the federal agency tasked with protecting consumers from unfair and deceptive business practices and enforcing antitrust laws—proposed a rule that, if enacted, will prohibit the use of non-compete clauses in agreements by employers with their employees, independent contractors, or volunteers in almost all circumstances. This rule would apply to numerous, but not all, nonprofit organizations.

Although the FTC's authority under Section 5 of the Federal Trade Commission Act (FTCA) generally does not reach the activities of many 501(c)(3) nonprofit organizations, it does apply to trade associations, many professional societies, and industry groups and their constituents. Associations that wish to weigh in on the rules on behalf of their industries or memberships have until March 20, 2023 to comment. We expect the final rule will be challenged in court regardless of its final form, so associations across all industries should keep a close eye on the ongoing comments about and challenges to the rule, even if they are from the sidelines.

The FTC's Statutory and Rulemaking Authority

The FTC's proposed rule (Proposed Rule) responds to President Biden's Executive Order on Promoting Competition in the American Economy, where the chair of the FTC was "encouraged to consider working with the rest of the Commission 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." The Proposed Rule also builds on numerous other efforts by the FTC and the Department of Justice to use the antitrust laws to protect workers.

In order to exert regulatory authority over non-competition agreements, the FTC relies upon Section 5 of the FTC Act, which declares "'unfair methods of competition' to be unlawful" and further authorizes the FTC to "prevent persons, partnerships, or corporations . . . from using unfair methods of competition in or affecting commerce." Importantly, the term "corporation" is defined in the FTCA as an entity "organized to carry on business for its own profit or that of its members," thereby placing activity of many nonprofits beyond the FTC's reach. However, the FTC does have jurisdiction over trade associations, sham charities, or other nonprofits that in actuality operate for profit, such as for-profit affiliates of nonprofits. The FTC's jurisdiction also extends to members of associations in many industries, though it does not extend to banks, savings and loan institutions, federal credit unions, common carriers, air carriers, or packers and stockyard operators.

This is the first time that the FTC has promulgated a rule proscribing an unfair method of competition in many decades, and whether the FTC still has the authority to issue such rules is a matter of intense debate. This latest rule-making effort follows the first two cases brought by the FTC earlier this month challenging non-compete agreements. These are the first cases the FTC has brought challenging non-compete agreements. The Proposed Rule and the two non-compete cases strongly suggest that the FTC intends to expand the definition of "unfair method of competition" under the FTCA.

In justifying the need for the Proposed Rule, FTC Chairperson Lina M. Khan argues that "[n]oncompetes block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand." She argues that by ending non-competition agreements, the FTC's proposed rule would promote greater dynamism, innovation, and healthy competition."

The Proposed Rule Would Ban Most New and Existing Non-competes with Workers

The Proposed Rule would prohibit an employer from (1) entering into, or attempting to enter into, new non-compete agreements, (2) maintaining existing non-compete agreements, or (3) representing under certain circumstances that a non-compete agreement is in place.

A "non-compete clause" is defined as "a contractual term between an employer and 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 does not allow for any defense of the non-competition promise as necessary or justified to protect a nonprofit's or other employer's legitimate business interests, whether related to the protection of confidentiality information; the seniority of the employee; goodwill with customers, donors, members, or other stakeholders; or the expenditure of resources for the training of employees.

The Proposed Rule applies only to non-competition covenants; it does not generally apply to non-solicitation provisions (soliciting company clients or employees) unless those provisions are so broad in scope that they function as a non-competition agreement. The Proposed Rule provides the following examples: (i) a broad non-disclosure agreement that effectively precludes the worker from working in the same field after his or her employment; or (ii) a contractual term that requires the worker to pay the employer or a third-party entity for training costs if the worker's employment terminates within a specific time period, as long as the payment is not reasonably related to the costs the employer incurred to train the worker.

The Proposed Rule Applies to All Types of Workers

The Proposed Rule would apply to employees, independent contractors, interns, externs, volunteers, and individuals who provide services to the organization, whether paid or unpaid. It is not just prospective; it would require an organization to rescind already-existing non-compete obligations and notify current and former workers in an "individualized communication," on paper or in digital format, that such provisions or agreements are no longer in effect. The Proposed Rule provides template language for this notice, but organizations may use their own notice, as long as the notice contains the required information. This notice is required within 45 days of rescinding of the non-compete agreement.

Notably, the Proposed Rule focuses on the employment relationship and does not apply to non-compete covenants ancillary to the sale of a business or the divestment of an individual's ownership interest in businesses.

Next Steps

At this point, the FTC has only filed a Notice of Proposed Rulemaking. The Proposed Rule is not yet final, and it must first pass the notice and comment period. The FTC is specifically seeking comment on whether franchisees should be covered by the rule, whether senior executives should be exempted from the rule or be subject to a rebuttable presumption rather than a ban, and whether low-income and high-wage workers should be treated differently under the rule.

Companies with views on these issues or the rule generally should consider filing comments with the FTC. The comment period is currently open through March 20, 2023, at which point the FTC will review the comments and may make changes to the Proposed Rule before finalizing. The law will go into effect 180 days after the publication of the final rule. The rule will preempt any inconsistent state law, regulation, order, or interpretation, unless such law, regulation, order, or interpretation affords the worker greater protection.

What Should You Do Now?

Industry groups and trade associations that desire to shape the proposed rules should consider submitting comments to the FTC and possibly challenging the FTC's rulemaking authority. The current administration is keen on implementing some form of regulation on non-competes, so the comment period is a good opportunity to advocate for any specific details that may benefit your organization. The FTC has indicated that the public will have only one guaranteed opportunity to participate in commenting on the rulemaking. Comments are due by March 20, 2023.

Additionally, nonprofits considering a merger, acquisition, or combination should consider reviewing their due diligence processes, as the unavailability of non-competes may affect asset and deal valuations.

It is doubtful that the Proposed Rule will go into effect before the end of the year, and it will likely be subject to fierce legal challenges, which could delay its rollout even further. It is also unclear what the Proposed Rule will look like when (or if) it is finalized. What is clear, however, is that the FTC is not abandoning this issue anytime soon.