FTC Proposes Banning (Almost All) Non-Compete Agreements

The New Year has certainly started with a bang at the Federal Trade Commission (FTC). First, the agency announced enforcement actions against three employers prohibiting those companies from using non-competition agreements with their employees and ordering other relief. Then, the next day, the FTC followed up that unprecedented action with another one – the announcement of a proposed federal regulation that would ban non-compete clauses in almost all employment agreements nationwide (the “Proposed Rule”).

Specifically, on January 5, 2023, the FTC issued a Notice of Proposed Rulemaking and issued the Non-Compete Clause Rule for public comment. In the Notice, the FTC explained that “[t]he proposed rule would provide that it is an unfair method of competition – and therefore a violation of Section 5 [of the FTC Act] – for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non-compete clause; or, under certain circumstances, represent to a worker that the worker is subject to a non-compete clause.”

The Proposed Rule seeks to harmonize at the federal level what is currently a patchwork of state laws on the enforceability of non-compete agreements in the employer/employee context. Several such laws have been enacted within the last few years. For example, in 2020, Virginia enacted a statute prohibiting non-compete agreements between employers and “low-wage” employees. More recently, the District of Columbia implemented an even broader ban on the use of such non-competition agreements for most D.C. employees. Notably, the FTC’s Proposed Rule would provide a minimum federal standard on non-compete clauses, while still permitting states to provide even greater employee mobility and flexibility.  

How Did We Get Here?

The Proposed Rule is the outgrowth of President Biden’s 2021 Executive Order on Promoting Competition in the American Economy, in which the President directed the Chair of the FTC “to consider working with the rest of the Commission to exercise the FTC’s statutory rulemaking authority under the Federal Trade Commission Act to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.” Since this Executive Order, the FTC issued a Policy Statement on November 10, 2022, stating that Section 5 of the Federal Trade Commission Act “encompass[es] various types of unfair conduct that tend to negatively affect competitive conditions,” a broader mandate than the FTC’s previous focus on anticompetitive harm or intent.

The Proposed Rule relies upon this broadened view of Section 5 of the Federal Trade Commission Act, with the FTC Commissioners stating that non-compete clauses can cause a “decline in job mobility,” resulting in “fewer job offers and an overall drop in wages as firms have less incentive to compete for workers by offering higher pay, better benefits, greater say over scheduling, or more favorable conditions.” In a Joint Statement endorsing the Proposed Rule, FTC Chair Lina Khan, Commissioner Rebecca Slaughter, and Commissioner Alvaro Bedoya declared that the issue of non-compete clauses was “especially ripe for enforcement through rulemaking rather than adjudication” due to “the magnitude and scope of the apparent harms,” claiming that the Rule, if enacted, could increase workers’ earnings by $300 billion per year and reduce racial and gender pay gaps.

Republican Commissioner Christine Wilson (the sole Republican Commissioner) issued a dissenting opinion to the Proposed Rule, saying it “represents 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.” Commissioner Wilson further noted “the Commission … proposes a rule that prohibits conduct that 47 state legislators have chosen to allow” and “bans conduct that courts have found to be legal.” Commissioner Wilson emphasized how the proposal “expressly discounts business justifications and makes no effort to distinguish and determine circumstances where investment incentives are important.”

The Non-Compete Clause Rule, Exceptions, and Unresolved Issues

As recognized by Commissioner Wilson, laws governing non-compete agreements have always been state laws – whether through a state statute or under the common (judge-made) law of the state. Under the Proposed Rule, any such state law that provides less protection to employees than the federal law would be superseded and invalid. 

The key provision of the Proposed Rule provides: “It is an unfair method of competition for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non-compete clause; or represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause.” The only exception to this near absolute prohibition on non-compete clauses is in the context of a sale of all or substantially all of a business, where the person being restricted by the non-compete clause is an owner or substantial owner of the business entity at the time the person enters into the non-compete agreement.

The Proposed Rule defines non-compete clauses 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 also prohibits contractual terms that may amount to de facto non-compete clauses based on a “[f]unctional test” – in other words, if contract provision looks and operates like a non-compete, but it is not called a non-compete, it may still be prohibited. For example, the Proposed Rule identifies certain non-disclosure agreements and training-repayment agreements as prohibited if such agreements or clauses function like non-compete clauses. For now, the Proposed Rule is silent on non-solicitation provisions, but that functional test will likely come into play for these types of restrictive covenants. The FTC goes on to broadly define covered workers to include employees and independent contractors, among others.

If the Proposed Rule becomes law, employers will be expected to rescind existing non-compete clauses and provide notice of the rescission to current workers as well as to former workers who would have been subjected to the non-compete provision. All employers would have to comply with the new federal regulations within 180 days of the finalized rule’s publication. Those who rescind and provide notice to existing and former workers as required by the Proposed Rule will be considered within the rule’s safe harbor provision.  

The Enforcement Actions

As noted, the Proposed Rule comes on the heels of the FTC’s announcement of unprecedented enforcement actions against three companies and two individuals for their use of noncompete agreements. In the first action, Prudential Security, Inc. and Prudential Command Inc. required workers “to sign contracts containing restrictions that prohibited them from working for a competing business within a 100-mile radius of their job site … for two years after leaving Prudential” with a $100,000 penalty for those who violated the clause. The FTC particularly noted how Prudential kept trying to enforce the non-compete clauses even after a Michigan state court found the clauses to be “unreasonable and unenforceable under state law.”

In a second action, O-I Glass, Inc. had 1,000 lower-wage workers subject to non-compete provisions that prevented workers from being broadly involved in working with similar products or services in the United States for one year without the employer’s written consent. In the third enforcement action, Ardagh Group S.A. had two-year restrictions that “banned workers … from … performing ‘the same or substantially similar services’ … to any business in the United States, Canada, or Mexico that is ‘involved with or that supports the sale, design, development, manufacture, or production of glass containers’ in competition with Ardagh.”

The FTC found these non-competition provisions to be unlawful restraints on trade. Prudential, O-I Glass, and Ardagh are now prohibited from claiming that an employee is subject to a non-compete clause; the non-compete agreements were voided and nullified; they were ordered to “provide a copy of the complaint and order to current and past employees who were subject to the challenged noncompetes;” the companies were ordered to provide a copy of the FTC order to current and future company personnel in charge of hiring/recruitment; and the employers were directed to provide “a clear and conspicuous notice to any new relevant employees that they may freely seek or accept a job with any company or person, run their own business, or compete with them at any time following their employment.”

The Path Forward: So, What Happens Now?

These FTC actions are unprecedented, and the resulting shockwaves from these actions are rippling through the business community. Yet, the FTC Notice of Proposed Rulemaking makes clear that the Commission is open to potential modifications to the Proposed Rule based upon the comments it receives. The public has sixty (60) days after the date of the Proposed Rule publication in the Federal Register (January 5, 2023) to file comments on the Proposed Rule, and it is anticipated that the FTC will receive many, many comments, most notably from companies in competitive industries, as well as business and trade organizations.  

The FTC also noted that it is specifically seeking comments on whether franchisees should be covered, whether senior executives should be exempted from the prohibition, and whether there should be different treatment for so-called high-wage workers versus low-wage workers, among other issues. These statements suggest that the Proposed Rule is likely to change in respect of these issues before it ultimately becomes law.

We will continue to monitor the Proposed Rule and other actions by the FTC and update this client alert accordingly.