No More Non-Competes? FTC Proposes Rule Banning Nearly All Non-Compete Agreements with Workers

On January 5, 2023, the Federal Trade Commission (“FTC”) announced plans to prohibit employers from imposing or enforcing non-compete clauses in agreements with workers, including employees and independent contractors, in almost all contexts. The FTC’s issuance of the proposed rule and a Notice of Proposed Rulemaking (“NPRM”) on non-compete clauses is a dramatic step, confirming the FTC’s desire to aggressively tackle issues affecting workers as part of its intense focus on competition in labor markets. The proposed rule aims to implement sweeping nationwide changes to an area of law currently regulated at the state level. The FTC invited public comment on the proposed rulemaking.

Drawing upon its recently expanded interpretation of Section 5 of the FTC Act, the proposed rule would classify the use of non-compete clauses as an “unfair method of competition.” With respect to workers who are not senior executives, this conclusion is based on three justifications described in the NPRM. First, the FTC argues that the use of non-compete clauses is “restrictive conduct that negatively affects competitive conditions” by preventing workers from seeking a better job with more pay, better working conditions, more enjoyable work, or “whatever the worker may be seeking.” Second, the FTC argues that non-compete clauses are inherently “exploitative and coercive at the time of contracting” because they “take advantage of unequal bargaining power between employers and workers.” The FTC points to a variety of factors as indicative of employer power in the labor market, including a decline in union power, increased reliance on outsourcing by employers, and proliferation of no-poach agreements. Third, the FTC argues that non-compete clauses are “exploitative and coercive at the time of the worker’s potential departure” as they prevent workers from exploring better opportunities for employment and force employees to accept undesirable working conditions. As to senior executives, the FTC relies on the first of the three foregoing justifications, reasoning that restrictions on senior executives may hamper competition due to the high value of such individuals to new market entrants.

The proposed rule carves out one exception to the blanket ban, specifically, non-compete agreements by a person 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, provided that “the party restricted by the non-compete clause is an owner, member, or partner holding at least a 25% ownership interest in a business entity.” Given such threshold requirements, the standard use of non-competes in the context of business sales could become more limited.

The scope of the proposed rule is broad. Under the rule, the term “non-compete clause” would be defined 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. The NPRM clarifies that this definition generally would not include other types of restrictive employment covenants — such as non-disclosure agreements and client or customer non-solicitation agreements — because these covenants generally do not prevent a worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer. However, even those kinds of restrictive covenants would be considered non-compete clauses when they are broad enough that they would function as non-compete clauses. This “functional test” would bar “de facto non-competes,” which would be any clauses that “effectively preclude the worker from working in the same field after the conclusion of the worker’s employment with the employer.” The FTC gives the examples of such “de facto” non-compete clauses as any contractual term that requires the worker to pay the employer or a third party 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.”

Significantly, if an employer maintains any existing non-compete clauses with workers, the proposed rule would require those employers to rescind the non-compete clauses and actively inform workers, via an individualized communication, that the clauses are no longer in effect.

Although there exists a substantial body of state legislation and jurisprudence governing the use of restrictive employment covenants, the proposed rule purports to supersede any and all conflicting state laws relating to non-compete clauses. Specifically, 47 states currently permit non-competes to varying degrees. State non-compete legislation and jurisprudence typically balance the interests of employers and employees, dictating that only reasonable restrictions on future employment will be enforceable. If implemented, the proposed rule would replace the fact-intensive balancing of interests with a one-size-fits-all policy.

The NPRM was issued 3-1 on party lines and prompted a strong dissent from Republican Commissioner Christine Wilson, who lambasted the proposed rule as a “radical departure from hundreds of years of legal precedent” and lacking “clear evidence to support the proposed rule.” Wilson argues that the proposed rule ignores the fact-specific nature of non-compete clauses and instead imposes a blanket ban based on a limited record and without substantiating its conclusions. Wilson argues that the NPRM’s three justifications for classifying non-competes as unfair methods of competition rely on the “invocation of the adjectives ‘exploitative and coercive’” without providing legal or factual basis and ignores the myriad of business justifications that have been recognized as valid in the context of non-competes. Further, Wilson argues that the proposed rule will be successfully challenged as an invalid use of the FTC’s rulemaking authority, or in the alternative, as a violation of the U.S. Constitution based on the major questions doctrine or the nondelegation doctrine.

The FTC’s proposed rule would represent a nationwide sea change in the law of non-compete clauses and would be a dramatic use of the FTC’s rulemaking authority to enforce Section 5 of the FTC Act. As the FTC has requested public comment on the NPRM, due within 60 days of the proposed rule’s publication in the Federal Register, we expect industry, labor, and others to issue comments opposing or supporting the proposed rule. As Commissioner Wilson noted in her dissenting statement, this comment period will likely be the only opportunity for the public to express its opinion before the FTC issues its final rule. Regardless of whether the proposed rule becomes final, it is emblematic of the FTC’s emphasis on competition in labor markets, its expansive view of Section 5 of the FTC Act, and its aggressive stance regarding its rulemaking authority.

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.