Non-compete agreements are under attack yet again. On January 5, 2023, the Federal Trade Commission (FTC)—the federal agency tasked with protecting consumers from unfair and deceptive business practices—announced a new proposed rule that, if enacted, will prohibit the use of non-compete agreements by employers in almost all circumstances. According to the FTC, the proposed rule is needed to combat allegedly unfair methods of competition that violate the Federal Trade Commission Act (FTCA). The FTC also contends that the rule will increase American workers' earnings by as much as $300 million.
The FTC's Authority and the FTCA
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 FTCA, 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." Under Section 6(g) of the FTCA, the FTC is authorized to "make rules and regulations for the purpose of carrying out" the FTCA.
One important item to remember is that the FTC does not have jurisdiction over banks, savings and loan institutions, and federal credit unions. The FTC also lacks jurisdiction over non-profit corporations that do not confer substantial pecuniary benefits to the corporation's members.
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 were 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 claims that by ending non-competition agreements, the FTC's proposed rule would promote greater dynamism, innovation, and healthy competition."
The Proposed Rule
The Proposed Rule would prohibit an employer from entering into, or attempting to enter into, a non-compete clause with a worker; maintain a non-compete with a worker; or represent to a worker, under certain circumstances, that the worker is subject to a non-compete. 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 an employer's legitimate business interests, whether related to the protection of confidentiality information, customer goodwill, 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 were 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 would apply to employees, independent contractors, interns, externs, volunteers, and individuals who provide services to the employer, whether paid or unpaid. It is not just prospective; it would require employers 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 employers may use their own notice, as long as the notice contains the required information. This notice is required within 45 days of rescinding the non-compete agreement.
Notably, the Proposed Rule focuses on the employment relationship, and the Proposed Rule 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.
At this point, the FTC has only filed a Notice of Proposed Rulemaking. The Proposed Rule is not yet final, and it must first complete 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 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 agency. The comment period is currently open through March 10, 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?
For the time being, it is advisable to wait and see how the rulemaking process unfolds. 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.
For industry groups and trade associations, consider submitting comments to the FTC. 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.
For businesses considering a merger, acquisition, or combination, and for investors, consider reviewing your investment plans and due diligence processes as the unavailability of non-competes may affect asset and deal valuations.
Employers should examine their current use of non-compete agreements and consider potential alternatives to safeguarding their confidential information and customer goodwill, among other legitimate business interests. For example, an employer may want to consider whether non-solicitation and non-disclosure agreements can protect against unfair competition in the marketplace, such as instances where former employees misappropriate confidential information in order to poach clients or staff. Carefully drafted agreements, curated with an eye to the potentially forthcoming regulatory landscape, may save an employer headaches down the road.
For questions about the content of this article or to further discuss the FTC's regulation of non-competition agreements, do not hesitate to content the authors of this article or any member of Venable's Labor and Employment or Regulatory practice groups.
For additional details, please join us in the coming weeks for a webinar where we will dive further into the FTC's Proposed Rule.