E-Alerts

FTC Proposes New Rule Prohibiting Non-Compete Agreements

Last week, the Federal Trade Commission (“FTC”), the federal agency responsible for policing fraud and enforcing consumer protection laws, announced a proposed rule that would ban nearly all non-compete agreements between employers and employees, as well as nearly all other categories of workers.

The proposed rule would supersede state laws in this area, prohibiting non-compete agreements in almost all situations. The FTC is seeking public comment on the rule, which the FTC claims will increase wages by almost $300 billion per year.

The proposed rule would represent a massive shift in employment law and have an enormous effect on employers. However, the proposed rule appears likely to be challenged in court by employers on multiple grounds, so its future prospects are unclear.

Overview Of Proposed Rule

The proposed FTC rule would make it an “unfair method of competition” for an employer to “enter into a non-compete clause with a worker; maintain with a worker a non-compete clause;” or represent to a worker that the worker is subject to an enforceable non-compete clause. Employers would also be required to rescind any currently existing non-compete agreements and notify current and former workers that their non-compete agreements have been rescinded.

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.” An “employer” is defined as any person or business who contracts with a worker to perform work for that person or business. Finally, a “worker” is defined as any person who works, whether or not for pay. The proposed rule specifically includes employees, independent contractors, externs, interns, volunteers, apprentices, and even sole proprietors who provide a service to a client.

Included in the definition of a non-compete clause is any contractual term which operates as a de facto non-compete 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.” This includes any non-disclosure agreement between an employer and a worker which 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.”

Also included is any contractual term that requires a worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specific time period, unless the required payment is “reasonably related to the costs the employer incurred for training the worker.”

Rescission And Notification Requirements

Since the proposed rule prohibits maintaining non-compete agreements, employers would be obligated to rescind any currently existing non-competes entered into with workers. The proposed rule specifies that this must be completed within 180 days after the final rule is published.

Further, employers that rescind non-compete agreements would be required to provide written, individualized notice to each affected worker – including both current and former workers – stating that the non-compete agreement has been rescinded and is no longer enforceable.

Exceptions

The new rule would not apply to a non-compete agreement 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, if “the person restricted by the non-compete clause is a substantial owner of, or substantial member or substantial partner in, the business entity at the time the person enters into the non-compete clause.” A substantial owner, substantial member, or substantial partner is defined as one holding at least a 25 percent ownership stake in the entity.

In addition, the definition of “worker” explicitly does not include “a franchisee in the context of a franchisee-franchisor relationship.” However, a person who works for a franchisee would be considered a worker for purposes of the rule.

Non-compete agreements entered into in connection with the sale of a business entity or in the context of a franchisee-franchisor relationship would still be covered by federal antitrust law.

Implications For Employers

The proposed FTC rule has major implications for employers. In addition to barring future non-compete agreements outright, it would require employers to immediately rescind all current non-compete agreements, and comply with the burdensome notice requirements. More generally, employers that have relied on non-compete agreements in order to protect trade secrets and other vital interests would have to consider other means of doing so.

The breadth of the proposed rule and the inclusion of a prohibition on de facto non-compete agreements also calls into question whether other types of restrictive covenants, such as customer non-solicitation agreements, could be prohibited under the rule. Employers would have to closely examine any active restrictive covenant agreements to determine whether they might be implicated.

Assuming that the proposed rule is finalized after the public comment period, it will almost certainly be challenged in court. In particular, employers are likely to argue that the rule exceeds the FTC’s delegated authority as an administrative agency, particularly since non-competes have, up until now, been governed almost exclusively by state law. Employers may also argue that the rule’s purported nullification of existing non-competes violates due-process rights under the Constitution.

Nonetheless given the importance of these issues and the uncertainty surrounding them, employers that use non-competes or similar agreements should pay close attention to future developments relating to the FTC’s proposed rule.

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If you have questions about the FTC’s proposed rule, non-compete agreements, or restrictive covenants in general, please feel free to reach out to one of our experienced employment attorneys.