FTC Proposes Rule to Ban Non Compete Clauses: What Does This Mean for Employees and Employers?

FTC proposes a new rule that would ban non-competes in most situations; brings enforcement actions challenging non-competes as unfair methods of competition.

On January 5, 2023 the Federal Trade Commission (FTC) proposed a new rule that would abolish employee non-compete agreements in the United States. The FTC’s Proposed Rule and enforcement actions follow President Biden’s July 9, 2021 Executive Order on Promoting Competition in the American Economy, in which the administration encouraged the FTC to use its rulemaking authority to “curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”

Employers would be prohibited from entering into any agreements with employees or individual independent contractors that explicitly prohibit working for a competitor, as well as any other agreements that amounts to a “de facto” non-compete agreement. 

Roughly one in five American workers- nearly 30 million people- are bound to noncompete clauses across a variety of jobs and industries, forcing them to remain in their current, which may pay less than other companies, or risk being shutout of their industry all together.

“Noncompetes are basically locking up workers, which means that they’re not able to match with the best jobs for them,” FTC Chair Lina Khan said on a call with reporters. “If this rule were to be finalized and go into effect…[it] would force employers to compete more vigorously over workers in ways that should lead to higher wages and improved working conditions, basically injecting competition into the labor market.”

What is the Proposed Rule?

To address these problems, the FTC’s proposed rule would generally prohibit employers from using noncompete clauses. Specifically, the FTC’s new rule would make it illegal for an employer to:

• enter into or attempt to enter into a noncompete with a worker;
• maintain a noncompete with a worker; or
• represent to a worker, under certain circumstances, that the worker is subject to a noncompete.

The proposed rule would apply to independent contractors and anyone who works for an employer, whether paid or unpaid. It would also require employers to rescind existing noncompetes and actively inform workers that they are no longer in effect. The proposed rule would generally not apply to other types of employment restrictions, like non-disclosure agreements. However, other types of employment restrictions could be subject to the rule if they are so broad in scope that they function as noncompetes.

Historically, the enforceability of non-compete clauses has been largely left to state common law, under which employment-based non-compete clauses are generally enforceable in most states to the extent they are reasonable and necessary to protect legitimate employer interests. In more recent years, an increasing number of state legislatures have passed statutes to restrict the use of non-compete clauses; however, none of these recent changes has gone so far as to ban post-termination non-compete clauses broadly, though some states have banned non-compete clauses with low-wage earners

Pros and Cons of The Federal Trade Commission’s Proposed Rule on Noncompetes

• Pros: The talent pool may widen significantly and your organization may have an opportunity to attract professionals eager to make a change.
• Cons: Your business contacts and proprietary details may be at risk if not protected by other policies so now is the time to check your employee handbook and free-form policies to ensure you have agreements in place to protect client information.  Consider that you may loose talent should this covenant pass, and how you should go about protecting intellectual and client information in spite of the change.

What does this mean for Employers?

Within 45 days of the rescission, employers would need to provide individual notices to all current and former workers stating that they are no longer subject to the post termination non-compete clause. Even if the Proposed Rule does not take effect, given the current FTC’s general disdain for certain restrictive covenants and its recent enforcement actions, companies may wish to begin evaluating with counsel the business justification, necessity, and scope of their non-compete clauses and similar covenants. It is best practice to be prepared on how your Company might move forward should this covenant prevail.  Human Resources should be in constant review of policies, but especially those under impending spotlight. 

Now is the time to have the internal conversations and to consult with not only your HR and General Counsel, but your industry colleagues to understand what external opportunities and threats may lie ahead. Companies should do so both in the contexts of employment agreements generally and M&A activity, to determine if they would be better served with limiting their reliance on such clauses and covenants or eliminating them entirely. Start with HR determining which positions have these clauses or policies signed and if there was a specific need. Look to see if there were ever any violations on file for employees or former employees who broke the agreement?  Beginning with the environmental scanning will allow the organization to determine what risks and how much of a risk may be involved.  Some organizations give out the non-compete agreements to every employee hired to the Company; even when unnecessary. Now is the time to do a gut-check to see if they were necessary or simply a habit or old practice in need of an update.  Doing so may help avoid being targeted by the FTC and stay ahead of future bans or restrictions in this space.

When Would the Proposed Rule Become Effective?

The future of the proposed rule is uncertain. It will need to clear several hurdles before it becomes effective. First, it will be published in the Federal Register, where interested parties will have opportunity to propose comments for sixty days. Once the comment period closes, the FTC may elect to modify the Proposed Rule before deciding whether to invite further comments or issue final rule making. The FTC would issue the final rule upon a majority vote of the then-sitting FTC Commissioners. However, significant opposition to and litigation over the proposed rule is expected, and could further delay its implementation. 

Exemplar Legal & HR to Help Employers Navigate Changes with Non-compete Clauses

Exemplar team of lawyers and HR professionals are here to support all clients for the important transition as we navigate the new landscape of not using non-competes going forward. Please email us to learn more rise@exemplarcompanies.com