On January 19, 2023, the FTC published a notice of proposed rulemaking (NPRM) that would prohibit the use of non-compete clauses in agreements between employers and employees, with few exceptions. The proposed rule seeks to facilitate labor mobility and “promote greater dynamism, innovation and healthy competition” by regulating agreements between employers and paid staff, as well as those with independent contractors, apprentices, and volunteers.
I. A Broader Definition of “Non-Compete Clause”
In a move that significantly broadens its potential reach, the FTC proposes to regulate contractual clauses based on their functions and broadly defines the term “non-compete clause” in the proposed rule 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.” (Emphasis added). Given this broad definition, the proposed rule will prevent the use of not only traditional non-compete clauses, but also other clauses, for example nondisclosure, non-solicitation, or liquidated damages clauses, that are written so broadly as to function similarly to “non-compete clauses.” Further clarification will be required to discern how the FTC will determine when a clause functions as a “de facto non-compete.” The proposed rule, however, provided two examples of provisions that would run afoul of the rule:
a. A non-disclosure agreement between an employer and a worker that is written so broadly that it effectively precludes the worker from working in the same field after the conclusion of the worker’s employment with the employer.
b. A contractual term between an employer and a worker that requires the worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specified time period, where the required payment is not reasonably related to the costs the employer incurred for training the worker.
II. Prohibition on Past, Present, and Future Non-Competes (with a Few Exceptions)
While the proposed rule would prohibit non-compete clauses between an employer and an employee, the rule would not apply to non-compete clauses that restrict “an owner, member, or partner holding at least a 25 percent ownership interest in a business entity” “who is selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or by a person who is selling all or substantially all of a business entity’s operating assets.” At this stage in the rulemaking process, the FTC is specifically seeking input on whether non-compete clauses between employers and senior executives should be regulated separately from those between employers and other workers. Notably, in addition to preventing new non-compete clauses, the proposed rule would also require employers to rescind those clauses already in place and to individually notify all employees and former employees subject to non-complete clauses that the provisions will no longer be enforced.
III. Legal Challenges Are Likely
The FTC claims the authority to promulgate this rule by defining non-compete clauses as “unfair methods of competition” and regulating them pursuant to the power granted by section 5 of the FTC Act to “prevent persons, partnerships, or corporations . . . from using unfair methods of competition in or affecting commerce.” This move is in line with the FTC’s recently-articulated policy to extend its consideration of unfair methods beyond the contours of the Sherman and Clayton Acts to “conduct that tend[s] to undermine ‘competitive conditions’ in the marketplace.” It also no longer requires a showing that the conduct in question impacts competition. Because this shift in policy is very recent, however, the FTC’s authority to act on it has not yet been tested in the nation’s courts. Many question whether this new policy of aggressive regulation will withstand judicial scrutiny, especially in light of the 2021 Supreme Court decision in AMG Capital v. FTC. In AMG Capital, the Court significantly curtailed the FTC’s enforcement capabilities by ruling that the FTC does not have the authority to obtain equitable monetary relief, such as restitution or disgorgement of profits, in enforcement actions in federal court — remedies the FTC has routinely sought for nearly half a century.
IV. What Comes Next and How to Prepare
The NPRM’s publication on January 19, 2023, marked the start of the 60-day public comment window; comments on the proposed rule must be received by the FTC on or before March 20, 2023. Given the broad and far-reaching implications of the proposed rule, employers may consider providing feedback and advocating for limitations as to the rule’s potential scope. The final rule would take effect 60 days after its publication in the Federal Register and would require full compliance with its terms 180 days after its publication.
Regardless of whether this rule is eventually finalized, or what form such a regulation may take, employers should take steps now to prepare for what appears to be a movement towards greater scrutiny of non-compete agreements between employers and workers:
(1) Employers should review all such agreements currently used and presently in effect — like employment contracts, and settlement and severance agreements — to discern the scope of existing non-compete clauses and other provisions that could potentially be deemed “de-facto non-compete clauses.” With this new heightened scrutiny in mind, efforts should be made to ensure that explicit non-compete clauses are only used in new agreements where there is a legitimate business need and any such provision is as narrowly tailored as possible with respect to geographic scope, timeframe and prohibited conduct.
(2) Employers should ascertain all employees and former employees who will be subject to the terms of a non-compete clause as of January 1, 2024, the earliest possible compliance date if this rule is finalized. Beginning to collect the names of these employees now, as well as their known contact information and the dates on which their non-compete clauses expire, will allow employers to more easily manage the distribution of individualized rescission notices, should it become necessary.
(3) Employers should assess alternative means of protecting confidential information and customer goodwill, such as through appropriately tailored confidentiality/non-disclosure and non-solicitation provisions. It will be important to consider whether such provisions are currently in use, and if so, whether they drafted effectively enough to protect the employer’s information and competitive advantage, but narrowly enough to avoid being deemed overly broad de-facto non-complete clauses under the proposed rule.
(4) Employers should consider alternate means of incentivizing former employees to safeguard the employer’s sensitive information. Agreements might include paid notice or similar extended leave provisions to achieve the same protective effects, but without imposing the hardship on the employee that the proposed rule seeks to avoid.
For additional information about the FTC’s Non-Compete NPRM, contact Mariel Belanger (973-943-0819) or Caitlin Cascino (973-757-1024).
Joseph L. Linares
