Key Takeaways

• The FTC has proposed a new rule under Section 5 of the Federal Trade Commission Act that would significantly ban non-compete agreements between employers and workers.
• If adopted, the Proposed Rule would supersede “inconsistent” state laws and also require employers to rescind certain existing non-compete clauses no later than 180 days after publication of the adopted rule.
• The FTC also recently filed enforcement actions against three companies and multiple executives for imposing non-compete restrictions on workers, and obtained consent orders.

On Jan. 5, the Federal Trade Commission voted 3-1[1] to propose a new rule under Section 5 of the Federal Trade Commission Act that would largely ban non-compete agreements between employers and employees. If passed, the Proposed Rule would become a federal regulation making it an “unfair method of competition” for an employer “to enter into or attempt to enter into,” “maintain” or “represent to a worker that the worker is subject to a non-compete clause.”[2] A preamble to the Notice of Proposed Rulemaking cites the harm that non-competes purportedly inflict on (i) workers whose compensation and mobility are stymied by non-competes and (ii) new business enterprises that find it difficult to break into an industry where skilled labor is locked into existing employment arrangements.[3]

Here are the highlights of the Proposed Rule:

• A prohibited non-compete is broadly defined as “a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment ... or operating a business, after the conclusion of the worker’s employment with the employer.” While other types of employment agreements are excluded, “de facto” non-competes are also prohibited, such as unduly restrictive “non-disclosures” and employment contracts with onerous training reimbursement provisions. The Proposed Rule does not, on its face, appear to affect federal enforcement of other types of labor agreements, such as no-poach and non-solicitation agreements between employers.
• The term “worker” is also broadly defined to include both paid and unpaid workers, including “independent contractors, externs, interns, volunteers, and apprentices.” However, the Proposed Rule contains an exemption for any “person who is selling a business entity” or “disposing” of a “substantial” “ownership interest in the business entity,” which is defined as a 25 percent ownership interest. Non-competes in those contexts are still permitted under the Proposed Rule.
• In recognition of the prevalence of non-competes, there is a “rescission requirement” in the Proposed Rule that would require “an employer that entered into a non-compete clause with a worker prior to the compliance date” to “rescind the non-compete clause no later than the compliance date,” which would be 180 days after publication, if the Proposed Rule were passed by the FTC. It would also require employers to individually notify employees about the rescission of their non-compete agreements. The Proposed Rule also applies this rescission and notice requirement to former workers.
• The Proposed Rule also purports to supersede “inconsistent” state laws. Because many states allow reasonable non-competes (those with limited geographic scope and time frames), the Proposed Rule would be a monumental shift in the way non-competes are treated. The reasonableness standard under which they are currently assessed in most jurisdictions would be supplanted by FTC review under what amounts to a bright-line rule. It would also represent a significant shift in power from the state legislatures and courts, where non-compete law has gradually evolved over more than a century, to an “independent” federal administrative agency.
• The Proposed Rule would not impact the FTC’s or DOJ’s ability to bring federal cases alleging that anticompetitive non-compete agreements violate existing federal antitrust laws such as the Sherman Act, based on existing judicial precedent.

PROSPECTS FOR ADOPTION OF PROPOSED RULE

However, the Proposed Rule faces a steep uphill battle. Commissioner Christine S. Wilson issued a statement criticizing the move as a “radical departure from hundreds of years of legal precedent that employs a fact-specific inquiry into whether a non-compete clause is unreasonable in duration and scope, given the business justification for the restriction.”[4] The Proposed Rule is subject to 60 days of public comment, and there will be vocal opposition. If the Proposed Rule is passed by the Commission in its current form without amendment, it will undoubtedly be vulnerable to legal challenges, including that (i) the Commission lacks authority to engage in “unfair methods of competition” rulemaking, (ii) the Commission lacks clear congressional authorization to ban non-competes, as required by the “major questions” doctrine the Supreme Court decided just last year in West Virginia v. EPA,[5] and (iii) it would violate the legislative non-delegation doctrine, rooted in Article I of the U.S. Constitution, even if Congress did authorize the FTC to engage in “unfair methods of competition” rulemaking. Wilson identified each of these vulnerabilities in her dissenting statement.

Moreover, while the Proposed Rule itself may be sweeping in scope, its application will undoubtedly be limited. After all, it is based on Section 5 of the Federal Trade Commission Act, which can only be enforced by the FTC itself, and the FTC can only obtain injunctive relief. Thus, it would not create a private right of action with the attendant threat of treble damages. Aggrieved “workers” would still need to enforce their rights under the Sherman Act and the Clayton Act, where courts generally apply the rigorous rule of reason test to non-compete agreements, or simply defer to state regulation entirely. Further, the FTC’s remedies were significantly curtailed last year in AMG Capital Management, LLC v. Federal Trade Commission, where the Supreme Court held the Federal Trade Commission Act does not authorize the FTC to seek equitable monetary relief such as restitution or disgorgement.[6] The FTC also cannot seek treble or punitive damages under Section 5, so it will be relegated to seeking equitable relief.

RELATED FTC ENFORCEMENT ACTIONS

Regardless of the Proposed Rule’s fate, the FTC has authority under the Sherman Act to challenge non-competes, which can result in costly investigations and invasive consent decrees. The move to ban non-compete agreements comes right after more aggressive actions against non-compete agreements by the Commission. On Jan. 4, the FTC filed actions against three companies and multiple executives for imposing non-compete restrictions on workers.[7] Although the Department of Justice has been active in criminally prosecuting alleged no-poach agreements under the Sherman Act,[8] albeit suffering a jury trial loss in its only criminal no-poach litigation, this is the first time the Commission has sued under Section 5 of the FTC Act to force a company to cease and desist from enforcing non-compete restrictions in employment contracts.[9] The complaints outline the Commission’s argument that the use of non-compete agreements by these companies “constituted an unfair method of competition and violated Section 5 of the FTC Act.”[10] These complaints were not brought under the Sherman Act.

One company facing the FTC’s wrath is Michigan-based Prudential Security Inc., its affiliate Prudential Command Inc., and its two sole co-owners and officers (collectively, Prudential). Prudential provided security guard services across several states and required all of its largely minimum wage security guards to sign non-compete agreements as a condition of their employment.[11] The agreements restricted employee movements for two years within a 100-mile radius of their job site following employment with Prudential, and contained a hefty $100,000 liquidated damages penalty clause in the event that any former employee contravened the agreement.[12] Although Prudential recently sold nearly all of its assets and exited the security guard business, approximately 1,500 of Prudential’s former employees were still subject to the non-compete restrictions.[13]

The FTC also targeted two of the largest manufacturers of glass food and beverage containers in the United States. One had required a variety of employees, including salaried employees such as engineers and quality assurance employees, to enter into one-year non-compete agreements. The other had required a variety of employees to sign two-year non-compete agreements.

In the face of the complaints, the parties entered into voluntary consent orders with the FTC requiring them to cease and desist use of their respective non-compete agreements. All the orders, as agreed to, prohibit the companies from enforcing, threatening to enforce or imposing non-competes against any relevant employees.[14] The orders additionally go a step further, requiring the companies to provide a copy of the order to current and past employees who were subject to the challenged non-competes, and for the next 10 years the companies must notify any new employees that they may freely seek a job with any company or person.[15]

The FTC claims it has the power to seek these orders pursuant to Section 5 of the FTC Act, which generally prohibits “unfair methods of competition.”[16] These complaints and consent orders are some of the first to employ the FTC’s Nov. 10, 2022, Section 5 Policy Statement (Statement).[17] In the Statement, the FTC laid out the general principles it would use in evaluating whether conduct is an unfair method of competition under Section 5. The Statement says that a person violates Section 5 by (1) engaging in a method of competition (2) that is unfair—i.e., conduct that “goes beyond competition on the merits.”[18] Conduct is unfair if it (a) is “coercive, exploitative, collusive, abusive, deceptive, predatory,” “involve[s] the use of economic power of a similar nature,” or is “otherwise restrictive and exclusionary,” and (b) “tend[s] to negatively affect competitive conditions” for “consumers, workers, or other market participants.”[19] The inquiry will focus on whether conduct has a “tendency to generate negative consequences,” and does not require a showing that the conduct directly caused actual harm.[20] Further, the Statement explains that unlike common Sherman Act analyses, Section 5 should not require any showing of market power or market definition, and should not focus on any “rule of reason” analysis.[21] No court has yet to agree with the FTC’s recent interpretation of Section 5.

Notably, Commissioners Alvaro Bedoya and Rebecca Kelly Slaughter joined FTC Chair Lina Khan in approving the complaints filed against the three companies. Commissioner Wilson dissented, expressing concerns that the new Statement would “condemn conduct summarily as an unfair method of competition based on little more than the assignment of adjectives.”[22] Among other concerns, Wilson was troubled that the FTC lacked a jurisdictional basis for the complaints and that the complaints did not provide a traditional Sherman-like analysis of anticompetitive effects in relevant markets, but instead based their reasoning on unsubstantiated claims of harm.[23]

CONCLUSION

The FTC’s Proposed Rule and related enforcement actions could have serious consequences for businesses. Although the prospect for adoption and actual enforcement of the Proposed Rule by the courts is uncertain, businesses would be prudent to review their non-compete agreements to evaluate whether they are defensible under existing law and to prepare for the possible onslaught of heightened challenge under Section 5.

[1] The FTC currently has only four commissioners.

[2] https://www.ftc.gov/legal-library/browse/federal-register-notices/non-compete-clause-rulemaking.

[3] Id.

[4] https://www.ftc.gov/system/files/ftc_gov/pdf/p201000noncompetewilsondissent.pdf.

[5] W. Virginia v. Env’t Prot. Agency, 142 S. Ct. 2587 (2022).

[6] AMG Cap. Mgmt., LLC v. Fed. Trade Comm’n, 141 S. Ct. 1341 (2021).

[7] https://www.ftc.gov/news-events/news/press-releases/2023/01/ftc-cracks-down-companies-impose-harmful-noncompete-restrictions-thousands-workers.

[8] Ann O’Brien and Lindsey Collins, DOJ Antitrust Division Loses Two Bellwether Criminal Antitrust No-Poach and Wage-Fixing Trials, Bakerlaw.com, available at https://www.bakerlaw.com/webfiles/DOJ%20Antitrust%20Division%20Loses.pdf.

[9] https://www.ftc.gov/news-events/news/press-releases/2023/01/ftc-cracks-down-companies-impose-harmful-noncompete-restrictions-thousands-workers.

[10] https://www.ftc.gov/legal-library/browse/cases-proceedings/public-statements/statement-chair-lina-m-khan-joined-commissioners-slaughter-bedoya-matters-prudential-security-o-i at 1.

[11] https://www.ftc.gov/system/files/ftc_gov/pdf/2210026prudentialsecuritycomplaint.pdf at 2-3.

[12] Id.

[13] Id. at 4.

[14] https://www.ftc.gov/news-events/news/press-releases/2023/01/ftc-cracks-down-companies-impose-harmful-noncompete-restrictions-thousands-workers.

[15] Id.

[16] 15 U.S.C. § 45(a).

[17] FTC, Policy Statement Regarding the Scope of Unfair Methods of Competition Under Section 5 of the Federal Trade Commission Act (Nov. 10, 2022), available at https://www.ftc.gov/system/files/ftc_gov/pdf/p221202sec5enforcementpolicystatement_002.pdf.

[18] Id. at 8-10.

[19] Id. at 9.

[20] Id. at 9-10.

[21] Id. at 10. Also see BakerHostetler’s recent client alert “Federal Trade Commission’s Historic Attempt to Drive a Mack Truck Through the Sherman Act” at https://www.bakerlaw.com/alerts/federal-trade-commission-historic-attempt-drive-mack-truck-through-sherman-act.

[22] https://www.ftc.gov/legal-library/browse/cases-proceedings/public-statements/dissenting-statement-commissioner-christine-s-wilson-regarding-matter-prudential-security at 1-2.

[23] Id.; https://www.ftc.gov/system/files/ftc_gov/pdf/wilson-dissenting-statement-glass-container-cases.pdf at 3-4.

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