Earlier today, the Federal Trade Commission (“FTC”) published a proposed rule which would ban all non-compete agreements between employers and “workers” (broadly defined to include employees, independent contractors, interns, and others). If adopted, the proposed rule will bar both prospective and existing non-compete agreements. The FTC included an overview fact sheet describing the proposed rule.
The FTC is seeking public comment on the proposed rule, which is based on a preliminary finding that non-competes constitute an unfair method of competition and therefore violate Section 5 of the Federal Trade Commission Act. This proposed rule aligns with the FTC’s recent statement to attempt to reinvigorate Section 5 of the FTC Act, which bans unfair methods of competition.
The Commission voted 3-1 to publish the Notice of Proposed Rulemaking, which is the first step in the FTC’s rulemaking process. Chair Khan, Commissioner Rebecca Kelly Slaughter and Commissioner Alvaro Bedoya issued a statement in support. Commissioner Slaughter, joined by Commissioner Bedoya, issued an additional statement in support. Commissioner Christine S. Wilson voted no and also issued a statement in opposition.
The scope of restrictive covenants that may be banned is unclear because non-compete agreements are defined in the proposed rule to include any agreements which have “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.” Thus, non-disclosure, non-solicitation and other covenants designed to protect employers from unfair competition may also be prohibited by the FTC’s proposed rule. The proposed rule is very broad and does not currently include exclusions, such as for management, executives, or those provided access to trade secrets. One notable exception is that the rule will not ban restrictive covenants entered into in connection with the sale of a business. The rule will be subject to public comment for 60 days once it is placed in Federal Register, after which the FTC may move to make it final.
The FTC’s proposed rule comes after years of allegations that some employers were abusing non-compete agreements by deploying such agreements in ways that go well beyond preventing unfair competition or protecting trade secrets. As we have documented in this blog post, many states have responded to such alleged abuses by restricting the use of agreements with employees making less than certain compensation thresholds (e.g. Washington, Oregon Illinois, Colorado, DC, Massachusetts). Particularly given the extremely broad scope and the express language of the proposed rule, the FTC would supplant state law on non-competes.
But non-compete agreements can be effective tools for employers to protect themselves against unfair competition and misappropriation of trade secrets. For example, an employee may be provided access to strategic plans or other trade secrets of their employer. If the employee promptly quit and joined a competitor in a similar position, the employee would be in a unique position to exploit the strategic plans or other trade secrets of their former employer on behalf of their new employer. A well-drafted and narrowly tailored non-compete agreement restricts such unfair competition and misuse of trade secrets, while still permitting reasonable employee mobility. Such covenants are helpful tools in promoting innovation, fostering employee training and development, protecting trade secrets, and preventing unfair competition. The FTC’s proposed total ban of non-compete agreements (and arguably other covenants, including potentially even non-disclosure agreements as noted above) under the premise of promoting employee mobility, idea proliferation and wage growth ignores that employees are stakeholders in their employers. Employees, shareholders, customers, vendors and suppliers all benefit from fair competition, and restrictive covenants—including non-compete agreements—protect fair competition and trade secret protection.
While unfair competition is the purported justification for the FTC to attempt to ban such agreements, this rule, if it goes into effect, would arguably promote unfair competition. The FTC also states that the proposed rule will help employees bring “innovative ideas” to new employers—which ironically highlights the concern that a wholesale ban on non-competes (not to mention other covenants) could result in employees sharing their former employer’s intellectual property and trade secrets. Indeed, faced with the prospect of key employees sharing their “innovative ideas”—created or developed through the use of the employer’s capital—with competitors, businesses may find it difficult to invest as much in innovation, fearing that such ingenuity will simply be handed over to a competitor. While there are ways to curtail abuse of restrictive covenants (as many states have already done through reform legislation), this proposed rule paints with far too broad a brush. Moreover, it is unclear whether the FTC has the authority to implement the proposed rule, particularly following the Supreme Court’s decision in West Virginia v. EPA, making it likely that the rule will face serious constitutional challenges.
Other issues that may be implicated by this proposed rule include: 1) blurring of the distinction between independent contractors and employees; 2) the impact on franchise, license, or joint venture agreements; 3) attempted displacement of established state law by federal regulations; 4) discouragement of investment in innovation and an assumption that every worker is in some hourly fungible role; and 5) lack of recognition of company ownership in intellectual property and trade secrets.
The 60-day comment period provides an important opportunity for stakeholders to voice concerns about the FTC’s proposed rule. We recommend that businesses consult with their legal counsel about the proposed impact if this rule goes into effect, as well as voicing their opinion to this proposed rule to ensure that they are heard. We will be providing additional thought leadership in the coming days on this important new development.
