FTC Proposes Rule Banning Covenants Not to Compete

Our readers have probably seen or heard news reports that on January 5, 2023, the Federal Trade Commission (FTC) proposed a new federal regulation that would ban non-compete clauses (“noncompetes”) in agreements between employers and employees.  As employers consider how they may be affected by this new rule, perhaps a bit of context would be useful.

Many employers in the United States require their employees to enter into noncompetes -- contractual covenants that the employee will not accept employment with a competitor of the employer, or start a competing business, for some period of time after leaving their jobs. Noncompetes have been a somewhat controversial and much-litigated area for years.  Businesses seek to protect both their confidential information and their investments in employees; they do not want competitors benefiting from the knowledge and experience they provide to their employees.  Workers, on the other hand, want freedom to sell their skills and talents to the highest bidder, or to move to new employers where they think, for whatever reason, their experience will be better. 

Courts have generally enforced noncompetes with some reluctance, asking whether the employer is protecting a legitimate interest and whether the noncompete is reasonably tailored to proect that interest.  Some courts have refused to enforce noncompetes when the employee has been involuntarily terminated, rather than resigning.  State legislatures have increasingly imposed restrictions on noncompetes, and a few states, including California, have banned them altogether.

The FTC is the federal agency that enforces federal law against unfair competition.  Under the current administration, the FTC has been particularly hostile to noncompetes. In 2021, President Biden asked the FTC to ban noncompetes, and the FTC has incorporated bans on noncompetes into recent settlement agreements in antitrust cases. (See, for example, the FTC press release here and here.)  The agency has also gone after agreements between employers not to recruit or hire each other’s employees (“no-poach agreements”). 

Now, the FTC has proposed a federal regulation banning noncompetes in employment contracts, and requiring employers to rescind existing noncompetes.  In issuing this proposal, the FTC defined noncompete clauses as unfair methods of competition, thus bringing them within the agency’s regulatory authority.  The FTC claims that noncompetes significantly reduce wages, stifle new business and new ideas, and “hinder economic liberty.”  (According to the FTC, adoption of the proposed rule could increase workers’ earnings across industries and job levels by nearly $300 billion per year.)  The United States Chamber of Commerce promptly issued a statement opposing the proposal, arguing that the it exceeds FTC’s authority, and contending that “when appropriately used, noncompete agreements are an important tool in fostering innovation and preserving competition.”

In addition to rescinding existing noncompete clauses, employers would be required under the proposed rule to notify current and former employees of the rescission. The proposed regulation includes a recommended form of notification. The regulation would not apply in the context of a sale of a business if the employee entered into the noncompete when they were a “substantial owner,” “substantial partner,” or “substantial member” of the business. These terms are defined to mean an owner of at least 25% of the business. The regulation would not apply to agreements to keep trade secrets confidential, nor (apparently) to agreements prohibiting a former employee from soliciting the employer’s customers.  Once the FTC’s proposed rule is published in the Federal Register (which we would expect to occur very soon), public comments will be accepted for 60 days.

Although we have no crystal ball, we think it is a near-certainty that the proposed regulation will face legal challenges that will at least delay implementation for months or years.  Additionally, of course, if a Republican administration takes power in 2024 we may see the FTC change its position.  Employers considering how to position themselves for whatever is coming down the road might consider the following:

  • Eliminating noncompetes for lower-level employees who are less likely to cause significant harm by going to work for a competitor;
  • Using carefully-drafted confidentiality and non-solicitation agreements, rather than noncompetes, to protect employer interests;
  • To the extent noncompetes are considered necessary, draft them carefully and make them only as restrictive (in terms of time, geography, and type of business that is barred) as genuinely needed to protect the employer’s business.

We think a compromise legislative solution to the controversy the proposed new rule will generate may very well include provisions requiring or permitting the above.

If you would like advice concerning noncompetes and other measures to protect employer interests, feel free to contact an attorney in our Labor, Employment Law, & Employee Benefits practice group.

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