On January 5, 2023, the Federal Trade Commission (“FTC”) issued a Notice of Proposed Rulemaking to prohibit employers from entering into or attempting to enter into non-compete clauses with workers.[i] The proposed rule is part of a broader trend among certain federal agencies to regulate employment relationships and among some states to prevent or discourage use of non-compete clauses with certain segments of business work forces.
As currently written, the proposed FTC ban on “non-compete clauses” (defined below) would, among other things:
- apply to non-compete clauses with a broad range of workers, including employees, individuals who are independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide a service to a client or customer.
- apply even to non-compete clauses with workers having an ownership interest in the employer, if their percentage ownership interest is less than 25 percent. Presumably, the ban would apply regardless of the type or purpose of the agreement containing the non-compete clause (e.g., employment agreement, shareholder agreement, LLC operating agreement, partnership agreement or “sale of business” agreement).
- preempt all state and local rules inconsistent with its provisions (but not those that provide greater protections to workers).
- require companies to rescind existing non-compete clauses in agreements (with required written notices to affected employees) within 180 days of publication of the final rule.
The FTC is expected to soon publish the Notice in the Federal Register, which will trigger a 60-day public comment period. The proposed rule can be found on the FTC website.
What Would the Proposed Rule Ban?
The proposed rule provides that “it is an unfair method of competition” for an employer to:
- enter into or attempt to enter into a non-compete clause with a worker;
- maintain a non-compete clause with a worker; or
- represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause.
What Clauses are “Non-Compete Clauses” under the Proposed Rule?
For purposes of the proposed rule, a “non-compete clause” means “a contractual term between an employer and a 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 provides a “functional test” for determining whether a contractual term is a “non-compete clause”:
The term non-compete clause includes a contractual term that is a de facto non-compete clause because it has the effect of prohibiting 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. For example, the following types of contractual terms, among others, may be de facto non-compete clauses:
i. A non-disclosure agreement between an employer and a worker that is written so broadly that it effectively precludes the worker from working in the same field after the conclusion of the worker’s employment with the employer.
ii. A contractual term between an employer and a worker that requires the worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specified time period, where the required payment is not reasonably related to the costs the employer incurred for training the worker.
Notably, the proposed rule does not contain language banning an employer’s use of other provisions intended to protect its legitimate business interests (e.g., business goodwill, customer relationships, and proprietary information), such as customer and employee non-solicitation and non-interference clauses and non-disclosure clauses. (The validity and enforceability of these clauses would still be subject to scrutiny under other applicable law.)
Rescission and Notice Requirements as to existing non-compete clauses.
As to existing non-compete clauses, the proposed rule would require an employer that entered into a non-compete clause with a worker prior to the rule’s compliance date to (a) rescind the non-compete clause no later than the compliance date, and (b) provide notice to the worker that the worker’s non-compete clause is no longer in effect and may not be enforced against the worker. The employer would be required, within 45 days after rescinding the non-compete clause, to provide the notice to the worker in an individualized communication, provided on paper or in a digital format such as an email or text message provide the notice to the worker. Notices would need to be provided to all workers who currently work for the employer, as well as those workers who formerly worked for the employer, provided that the employer has the worker’s contact information readily available. The proposed rule also provides some “model language” for the notice which, if sent to a worker per the rule, would provide the employer a “safe harbor” from violation of the proposed rule’s rescission requirements. Notably, model notice language states that “The FTC’s new rule does not affect any other terms of your employment contract.”
What Should Employers Do Now?
The FTC’s proposed ban on non-compete clauses is not cause for businesses to immediately rescind or nullify any non-compete clauses in place or to rashly alter or curtail an otherwise appropriate and reasonable business interest protection program. First, the proposed rule will likely be the subject of much negative comments from various business groups and industries during the public comment period and, if made final, will likely be subject to court challenges. Second, and in any event, as to existing non-compete clauses, employers will have 180 days to adjust to and comply with any rule after it becomes final.
That said, there are several steps businesses should now consider vis-à-vis the proposed rule and protecting their business interests, including the following:
- If the proposed FTC proposed rule is of serious concern, businesses should consider submitting public comment to the FTC during the 60-day public comment period.
- In any event, businesses should monitor the status of the proposed rule so that, if and when there is a need to adjust their current approach to use of non-compete clauses, they have ample time to do so.
- Businesses should use this as an opportunity to review and evaluate their current business interest protection program to ensure that all elements of that program – including contracts with employees, independent contractors and others – are adequate, appropriate, effective, enforceable under applicable law, and properly implemented.
- Businesses that do not have a business interest protection program or do not use agreements to protect their customer relationships, proprietary information and business interests should promptly consider doing so, with the advice and assistance of appropriate counsel.
About the Author
Michael J. Allen dedicates his practice to protecting clients’ rights and assets, including their contract rights and intellectual property rights. and he has decades of experience dealing with restrictive covenants. His rare blend of experience in negotiating, contracting, counseling, and litigation helps him provide meaningful insight to clients at all stages of their business relationships. Mike can be reached at 336-478-1190 or firstname.lastname@example.org.
[ii] The proposed rule provides that the ban shall not apply to a non-compete clause that is entered into by a person who is selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or by a person who is selling all or substantially all of a business entity’s operating assets, when the person restricted by the non-compete clause holds at least a 25 percent ownership interest in the subject business entity. The proposed rule also provides that the ban would not apply to franchisees in the context of a franchisor-franchisee relationship. Non-compete clauses covered by both exceptions would remain subject to federal antitrust law as well as all other applicable law.