On January 5, 2023, the Federal Trade Commission (FTC) proposed a New Rule to ban noncompete clauses, which “hurt workers and harm competition.” The FTC’s proposed new rule builds upon President Biden’s Executive Order on Promoting Competition in the American Economy, issued on July 9, 2021, in which the President encouraged the FTC to adopt rules banning or limiting noncompete agreements. President Biden previously stated, “workers should be free to take a better job if someone offers it. If your employer wants to keep you, he or she should have to make it worth your while to stay. That’s the kind of competition that leads to better wages and greater dignity of work.” See Eversheds Sutherland’s previous Alert Regarding President Biden's Order.
The FTC’s Proposed Rule would ban employers from asking or requiring workers to sign noncompete agreements, stating that such agreements are “a widespread and often exploitative practice that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses.” The FTC estimated that banning the use of noncompete agreements would increase wages by nearly $300 billion per year.
The Proposed Rule will be open for public comment for 60 days after the Federal Register publishes it. It would add a new subchapter J to Chapter 16 in Title I of the Code of Federal Regulations. The Proposed Rule purports to restrict what it defines as “Unfair Methods of Competition’” stating that “[i]t is an unfair method of competition for an employer to enter into or attempt to enter into a noncompete clause with a worker; maintain with a worker a noncompete clause; or represent to a worker that the worker is subject to a noncompete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable noncompete clause.” See Proposed Rule at 910.2(a). “Worker” is defined broadly and includes paid and unpaid natural persons who work for an employer and includes “without limitation, an employee, individual classified as an independent contractor, extern, intern, volunteer, apprentice, or sole proprietor who provides service to a client or customer.” Proposed Rule 910.1(f). The Proposed Rule defines a noncompete 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.”
The Proposed Rule applies not only to noncompete agreements but also includes a “functional test” to determine whether a particular contractual term operates as a de facto noncompete. See Proposed Rule at 910.1(b)(2). Specifically, the Proposed Rule states:
The term noncompete clause includes a contractual term that is a de facto noncompete clause 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.
The Proposed Rule includes non-disclosure agreements written so broadly as to effectively preclude an employee from working with a competitor as an example of a de facto noncompete. Similarly, the Proposed Rule indicates that contractual terms requiring departing employees to repay training costs not “reasonably related to the costs the employer incurred” is another example of a de facto noncompete clause. Therefore, the consequence of the “functional test” is that the Proposed Rule could also apply to other types of restrictive covenants often found in employment agreements—such as non-solicitation of customers provisions. Plainly, under the FTC’s Proposed Rule, and based on the express non-disclosure example contained in the text, a non-solicitation of customers provision that effectively prevents the departing employee from working with a competitor would also be considered a de facto noncompete clause.
Moreover, the FTC’s Proposed Rule also contains a provision calling for retroactive enforcement that would require rescission of noncompete agreements by the proposed compliance date. See Proposed Rule 910.2(b)(1). To ensure compliance, “an employer that entered into a noncompete clause with a worker prior to the compliance date must rescind the noncompete clause no later than the compliance date.” Proposed Rule 910.2(b). The rescission mandate also contains a notice requirement to affected workers and requires employers to notify any such individuals, through an “individualized communication” that the noncompete clause is no “longer in effect and may not be enforced against the worker.” Proposed Rule 910.2(b)(2). In addition to being a written notice (via email, text, or on paper), the employer must provide the notice within 45 days of rescinding the noncompete in order to comply with the proposed rule. See Proposed Rule 910.2(b)(2). The notice requirement applies to both current and former workers with whom the employer entered into noncompete agreements. Proposed language for the notice was included in the Proposed Rule. Proposed Rule 910.2(b)(2)(C). Some agreements are exempt from the Proposed Rule such as a noncompete clause with the seller of a business entity who was a “substantial owner of, or substantial partner in, the business entity at the time the person enters into the noncompete clause.” Proposed Rule 910.3. However, any such agreements would still be subject to any other applicable prohibitions on restrictive covenants as well as Federal antitrust law. The proposed compliance date is 180 days after the date of the publication of any Final Rule.
Typically, restrictive covenants between an employer and employee have been governed by state law. The FTC noted this in its notice and also identified the variations amongst state laws regarding the enforceability of noncompete agreements. The result, the FTC stated, is “that employers and workers may face considerable uncertainty as to whether a particular noncompete clause may be enforced.” The FTC further highlighted that noncompete clauses are restraints on trade and, therefore, subject to Section 1 of the Sherman Act. Accordingly, the proposed rule contains a section (910.4) that states the rule “shall supersede any State statute, regulation, order, or interpretation the extent that such statute, regulation, order, or interpretation is inconsistent” with the rule.
While still in the infancy stage (and undoubtedly likely to face various legal challenges including to the Commission’s rulemaking), the broad description of noncompete agreements in the FTC’s proposed rule requires employers to take a very close look at its restrictive covenant agreements with its workforce. For instance, many employers forego a noncompete provision and opt instead for customized non-solicitation of customers provisions with non-disclosure obligations. Any such agreements, however, are not safe pursuant to the broad language used to define noncompete agreements in the Proposed Rule. Therefore, as the rule develops and ultimately comes into effect, it will be imperative that employers do a full review of their current employment agreements to assess whether there are potentially ambiguous covenants that could be deemed de facto noncompetes under the FTC’s Proposed Rule. Specifically, employers may want to examine non-solicitation of customers agreements to ensure they are narrowly tailored to protect the employers’ legitimate interests but not unreasonably broad to prevent employees from working in their specific industry—a requirement that is already applicable in many states. Finally, in a practical sense, although the proposed rule still faces many hurdles (i.e., legal challenges under the Administrative Procedure Act and possible injunctive action against a final rule), courts may start to be wary when having to rule on noncompete issues, and may decline to enforce noncompete provisions as comprehensively as they might have before the Proposed Rule. Employers would be wise to monitor these issues as they emerge.
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