On Jan. 5, the United States Federal Trade Commission (the “FTC”) proposed a new rule which acts as a complete ban—both prospectively and retroactively—on all non-competition agreements (“non-compete(s)”) (the “Proposed Rule”), impacting restrictive covenants as a whole, with an impact extending to both confidentiality and non-solicitation provisions. While those in support of the FTC’s Proposed Rule argue that its implementation does not cross into the realm of impermissible rule making, opponents have already contested its constitutionality altogether. Regardless of potential hurdles facing the Proposed Rule and its implementation, it is important that employers begin working to understand its impact and ways in which they can ensure full compliance should the need arise.
The FTC’s Proposed Rule on Non-Competes
Following President Biden’s July 2021 Executive Order[1] directing the FTC to issue rules limiting non-competes and the FTC’s position that non-competes are an unfair method of competition[2] in violation of Section 5 of the Federal Trade Commission Act (the “FTCA”), the Proposed Rule would ban employers throughout the U.S. from: (1) entering into—or attempting to enter into—a non-compete with a worker; (2) maintaining a current non-compete with a worker; or (3) representing to a worker that they are subject to a non-compete, absent a good faith basis for the employer to believe that the worker would be subject to an enforceable non-compete as set forth in the Proposed Rule’s limited exception.
The Proposed Rule defines “worker” to include all employees, as well as going so far as to include even those individuals classified as independent contractors, volunteers, interns, and externs, and defines an “employer” to include any natural person, partnership, corporation, association, or other legal entity that hires or contracts with a worker to work for the person. Given the Proposed Rule’s broad definitions, the ban will effectively apply to most employer/employee relationships and carves out exceptions for only the most limited of circumstances. As currently written, the only exception exists in relation to non-competes entered into by a worker who holds at least a 25% ownership interest in a business entity when they are: (1) selling the entity or otherwise disposing of all of their ownership interest in the same; or (2) selling all or substantially all of the entity’s operating assets.
The Proposed Rule defines a non-compete clause as 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.”[3] In addition to prohibiting standard non-compete clauses, the Proposed Rule also proposes a functional test for determining whether other contractual terms are de facto non-compete clauses based on their potential effects. For example, the ban will also apply to clauses—such as non-disclosure provisions—that are so broad as to preclude a worker from working in the same field after the conclusion of that worker’s employment with the employer, or terms requiring a worker to repay training costs if the worker’s employment terminates within a specified period, where the required payment is not reasonably related to the costs the employer incurred for training the worker. Concerningly, these examples lend themselves to subjective interpretation rather than an objective analysis, requiring clarity to come through litigation, likely at the expense of employers.
Implementation Guidance
In addition to mandating that employers cease the implementation of new non-competes going forward, the Proposed Rule also requires employers to rescind existing non-compete clauses prior to the compliance date as set forth in the final rule, which will be 180 days after its date of publication. For an employer to be fully compliant, the employer must provide notice to both current and former workers that are subject to the non-compete that the non-compete clause is no longer in effect and may not be enforced against them. The requisite notice must be: (1) provided in an individualized communication; (2) in paper or digital format; and (3) within 45 days of rescinding the non-compete clause. While the Proposed Rule provides model language employers may use by which to be fully compliant with the notice requirement, employers are free to craft their own notice as long as the language is sufficient to inform the worker that the non-compete clause is no longer in effect and may not be enforced.
Variable Outcomes on FTC’s Proposed Rule
While the Proposed Rule contains several items of immediate concern, it must be noted that the FTC has requested comment on alternatives to its Proposed Rule. For example, the agency has requested comment on whether to establish a categorical ban on non-competes, include a rebuttable presumption of unlawfulness, or provide for exemptions to the rule. The agency has further requested comment on four distinct alternatives, as summarized here: (i) a categorical ban on the use of non-competes for employees earning below a threshold income (or qualifying for an FLSA exemption) and a rebuttable presumption of unlawfulness for other workers; (ii) a categorical ban on non-competes for employees below a certain threshold and a full exemption for those above; (iii) a blanket rebuttable presumption of unlawfulness; and (iv) a rebuttable presumption of unlawfulness below an established threshold and a full exemption for employees above that threshold. In addition to these broader categories, the FTC has also requested comment on whether senior executives, highly compensated employees, or highly skilled employees should be exempt from the protections of the rule entirely and if so, how to define such exempt categories.
Potential Constitutional Challenges to the Rule
While many—including FTC Commissioner Christine S. Wilson—have already voiced opposition to the Proposed Rule in light of its departure from previous precedent allowing non-competes, the most difficult hurdle will likely be based on the “major questions doctrine” as expanded last year by the Supreme Court in West Virginia v. EPA.[4] There, the Supreme Court held that when administrative agencies enact rules amounting to “major policy decisions” or “decisions of vast economic and political significance,” they can only do so upon “clear congressional authorization.” In light of the extensive policy change that will take place under the Proposed Rule, many will argue that this is the exact type of decision requiring Congress’s express authorization.
Conclusion
Regardless of the potential challenges and hurdles looming over the Proposed Rule and its enactment, employers who have customarily used non-competes should take this time to review the structure of their agreements and determine appropriate alternative avenues to protect their interests should the rule ultimately take effect.
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[1] https://www.whitehouse.gov/briefing-room/presidential-actions/2021/07/09/executive-order-on-promoting-competition-in-the-american-economy/
[2] https://www.ftc.gov/news-events/news/press-releases/2023/01/ftc-proposes-rule-ban-noncompete-clauses-which-hurt-workers-harm-competition
[3] https://www.ftc.gov/system/files/ftc_gov/pdf/p201000noncompetenprm.pdf
[4] 142 S. Ct. 2587 (2022).
