By Peter Moser, Tavish Brown January 18, 2023
On January 5, 2023, the Federal Trade Commission (“FTC”) proposed a sweeping new regulation (available here) that, if it were to go into effect, would essentially ban all worker non-compete agreements. It would also ban other restrictive covenants that could be interpreted as “de facto” worker non-compete agreements, including for example certain non-disclosure and non-solicitation agreements.
The FTC bases its authority to implement the proposed regulation on Section 5 of the Federal Trade Commission Act (the “FTC Act”), 15 U.S.C. § 45, which makes it unlawful for businesses to engage in unfair methods of competition. The FTC’s new proposed regulation follows recent FTC enforcement actions, state and federal legislative activities, and court decisions that reflect increasing hostility toward non-compete agreements.
Public comments on the proposed regulation are due to the FTC by March 10, 2023. This is likely the only comment period available before the agency issues a final rule.
The FTC’s proposed regulation provides that it would be an “unfair method of competition” for an employer to (i) enter into or attempt to enter into a non-compete clause with a worker, (ii) maintain with a worker a non-compete clause, or (iii) represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe the worker is subject to an enforceable non-compete clause.
The proposed regulation defines a “non-compete clause” 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 definition could encompass other restrictive covenants, such as non-disclosure, non-solicitation, and no-hire/recruit agreements, among others, if such agreements meet the regulation’s “functional test” by serving as a “de facto” non-compete clause. Any agreement that has the practical effect of being a non-competition agreement will be invalidated.
The proposed regulation will also require employers to rescind all non-compete agreements entered into before the effective date of the regulation, and to provide written notice to all workers subject to a non-compete (current and former) that their non-compete is no longer in effect and may not be enforced.
The proposed regulation would only apply to companies within the FTC’s jurisdiction, thereby excluding regulated banks, savings and loan institutions, federal credit unions, common carriers, air carriers, and non-profits, among others.
There is also a limited exception applicable in the sale-of-business context. The proposed regulation provides that it will not apply to non-compete clauses entered into by a person selling or disposing of a business interest when the person is a “substantial” owner, member, or partner in the business entity at the time they entered into the non-compete. “Substantial” is defined as having at least a 25 percent ownership interest, rendering this exception narrow and potentially problematic in application. For example, under the proposed definition there is no sale-of-business scenario in which a non-compete could bind more than four people, rendering the exception potentially meaningless if the selling business was comprised of more than four owners, members, or partners.
Yes. The new rule would supersede any state statute, regulation, order, or interpretation thereof to the extent the statute, regulation, order, or interpretation is inconsistent with the proposed regulation.
The FTC is accepting comments on the proposed rule through March 10, 2023. Once the comment period ends, the FTC will consider whether to amend the proposed regulation prior to publication. The final rule will then be published in the federal register and will go into effect 180 days after publication.
It is likely that a final rule banning all non-compete agreements will be met with strong resistance, and may be held up in the courts for some time before going into effect (if at all).
Even if the proposed regulation does not go into effect, non-compete agreements are coming under increasing scrutiny by courts, administrative agencies, and legislatures. Notably, the day before the FTC announced its new regulation it ordered three employers to halt the use of non-compete agreements with workers after finding their practices were unlawful under Section 5 of the FTC Act. Each of the employers were using non-compete agreements to limit the ability of low-wage/non-exempt workers from working for competitors.¹ As recently as 2021, a bill was introduced in the U.S. Senate that would have banned non-compete agreements with non-exempt employees. Taken together, the use of non-competes to limit low-wage/non-exempt workers in particular is clearly undergoing increasing scrutiny. The FTC’s recent enforcement actions suggest that it may continue to view low-wage/non-exempt worker non-compete agreements with hostility even if changes are made to the proposed regulation, it is not implemented, or it is successfully challenged in court.
If the proposed FTC regulation does go into effect, employers will be required to rescind all previously entered into non-compete agreements in writing, including with past workers. Employers may therefore wish to make preparations now to identify all previously entered into non-compete agreements and update and maintain contact information.
In addition, employers should review their existing non-disclosure agreements, non-solicitation agreements, no-hire/recruit agreements, and no-service agreements, and other restrictive covenants, to ensure their enforceability if the proposed regulation goes into effect.
And of course employers should keep an eye on further developments, as the public comment period expiration date approaches, and with the proposed regulation set to go into effect within 180 days of the publication of the final rule.
Even if the proposed rule does not go into effect, employers should take stock now of their current practices to ensure compliance with existing law, and to reassess how to most effectively and sustainably protect legitimate business interests.
The Massachusetts legislature passed the Massachusetts Noncompetition Agreement Act in 2018, imposing certain requirements on employers wishing to enter into valid non-compete agreements, including prior notice, providing the opportunity to seek legal counsel, and a requirement of independent consideration. This law is currently in effect.