On January 5, 2023, the Federal Trade Commission published a proposed rule that, if it became final, would ban all non-compete agreements with limited exceptions. The rule would go into effect 60 days after it becomes final, but employers would have 180 days after publication of the final rule in the Federal Register to comply.

The Proposed Rule

What agreements are covered under the rule?

The 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.” Notably, the proposed rule goes beyond traditional non-competes and would sweep under its coverage any provision that the FTC determines functions as a non-compete. The FTC advises that while non-disclosure agreements and customer non-solicit agreements generally do not prevent a worker from seeking or accepting employment, if they are too broad, they would be covered within its definition of a non-compete clause. In this regard, the FTC’s proposed rule prescribes what it calls a “functional test for whether a contractual term is a non-compete clause.” This test evaluates whether a contractual term “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.” In addition to an overbroad non-disclosure or non-solicitation provision, another specific example of a non-compete clause under the proposed rule is a contractual term requiring (a) repayment of employer or third-party training costs if the worker’s employment “terminates within a specified period,” where (b) “the required payment is not reasonably related to the costs the employer incurred for training the worker.”  

In addition, the rule would cover agreements with any worker, including employees, independent contractors, externs, interns, volunteers, apprentices, or sole proprietors who provide a service to a client or customer. The term “employer” is also broadly defined to include “any natural person, partnership, corporation, association, or other legal entity, including any person acting under color or authority of State law.”

What about existing non-compete agreements?

Existing non-competes are impacted under the proposed rule. Section 910.2(b) of the proposed rule provides that “an employer that entered into a non-compete clause with a worker prior to the compliance date must rescind the non-compete clause no later than” the “compliance date,” which the proposed rule sets for 180 days after publication of the final rule. To rescind in compliance with the proposed rule, businesses/employers must provide formal written notice of rescission to both existing employees bound by a non-compete clause and former employees (except those whose contact information is not “readily available”) bound by non-compete clauses.  The proposed rule provides a template notice of rescission language that can be used to comply with this requirement.

Are there any exceptions to the rule?

Exempt from the rule are non-compete clauses between a seller and the buyer of a business so long as the party restricted is an owner, member or partner holding at least 25% ownership interest in the business entity.

What about state laws governing non-compete provisions?

Section 910.4 makes clear that the proposed rule “shall supersede” all state laws, regulations, orders, and interpretations of them that is not consistent with the proposed rule’s requirements discussed above. States could still impose requirements and restrictions with respect to non-compete clauses if they afford greater “protections” than those provided by the proposed rule.

History Leading Up to the Proposed Rule

On July 9, 2021, President Biden issued his Executive Order on Promoting Competition in the American Economy. Earlier in the day, the White House issued a press release announcing that the anticipated order would, “[m]ake it easier to change jobs and help raise wages by banning or limiting non-compete agreements and unnecessary, cumbersome occupational licensing requirements that impede economic mobility.”

On July 14, 2021, a group of almost 60 attorneys specializing in non-compete counseling and litigation¹ sent a letter commenting on President Biden’s executive order. In their 36-page letter, the attorneys suggested that that the FTC refrain from issuing orders on non-competes and leave regulation on this issue to the states, which already have robust existing and pending legislation addressing the enforceability of non-competes.  If the FTC still wants to issue regulations on this topic, the legal commentators suggested that the FTC rule be limited to regulating non-competes for low-wage workers and include other requirements such as providing advance notice to workers before requiring them to sign a non-compete.  The proposed FTC rule goes well beyond those suggestions and indicates an aggressive FTC interest in banning non-competes much more broadly.

On January 4, 2023, the FTC issued a press release announcing a crack-down on non-compete restrictions and had taken legal action against three companies, requiring them to “drop noncompete restrictions that they imposed on thousands of workers.” The administrative complaints sought to invalidate non-compete clauses between not only hourly workers but also engineers, “quality assurance” employees, and other salaried employees in certain positions. Consent agreements with the companies were reached, and the FTC will publish the consent agreement packages in the Federal Register soon for public comment. Then, on January 5, the FTC published its notice of proposed rulemaking along with the proposed rule discussed above.

For now, employers and businesses with employees, contractors, and others who are subject to non-compete agreements or clauses need to be mindful that a sea change in the restrictive covenant landscape may be coming. Now is a good time for businesses to take a close look both at existing non-compete clauses and other contractual provisions that may be deemed to be a non-compete provision under a final FTC rule, including non-disclosure, non-solicitation, and provisions requiring employees to reimburse employers for certain training expenses. Under standard rulemaking procedures, public comments to the proposed rule are due 60 days after it is published in the Federal Register, at which time the FTC may make changes before submitting a final rule. After publication of the final rule in the Federal Register, it will take effect after 60 days, with the “compliance deadline” coming 180 days thereafter.

Littler and its Unfair Competition and Trade Secrets practice group will continue monitoring these developments.