On January 5, 2023, the Federal Trade Commission (“FTC”) released a Notice of Proposed Rulemaking (“NPRM”), which “would, among other things, provide that 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.” The proposed Non-Compete Clause Rule (“Proposed Rule”) seeks to reinvigorate Section 5 of the Federal Trade Commission Act (“FTC Act”), 15 USC § 45, which provides that “unfair methods of competition in or affecting commerce” are “declared unlawful.” Accordingly, this Proposed Rule, along with recent enforcement actions, is part of the FTC’s broader initiative to promote fair competition in US labor markets.
In the NPRM, the FTC cites an abundance of evidence suggesting that the use of non-compete clauses prevents workers from pursuing better job opportunities, thereby decreasing competition, inhibiting entrepreneurship, and reducing wages. According to the NPRM, studies over the last decade regarding the use of non-compete agreements have identified substantial, negative economic effects of such agreements, which is especially significant considering that, according to the FTC, about one in five American workers, or approximately 30 million people are bound by non-compete clauses. The FTC states that federal enforcement is particularly appropriate given the known harms arising from the use of non-competes to limit competition by employees across state lines.
The FTC concluded that non-compete agreements: (1) significantly reduce workers’ wages; (2) stifle new businesses and new ideas; and (3) can exploit workers and hinder economic freedom. To address these concerns, the Proposed Rule seeks to eliminate the exercise of unfair bargaining power by employers by imposing a nationwide ban on the entering into and maintaining of non-compete agreements with workers. According to FTC estimates, the Proposed Rule would:
- increase workers’ earnings by nearly $300 billion per year;
- save consumers up to $148 billion annually on healthcare costs; and
- double the number of companies founded by a former worker in the same industry.
Relatedly, research cited by the FTC suggests that banning non-competes nationwide would close racial and gender wage gaps.
The Proposed Rule – A Nationwide Ban on Unfair Labor Practices
Under the Proposed Rule, “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 an employee 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 the worker is subject to an enforceable non-compete clause.” The Proposed Rule takes a functional approach, prohibiting not only non-compete agreements, but also clauses that operate as de facto non-compete clauses by “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.” Stated differently, the Proposed Rule captures other popular forms of restrictive covenants, which although not presented as a “non-compete clause,” are so unusually broad in scope that they effectively function like one.
Notably, the Proposed Rule makes no categorical distinctions among workers and provides no exemptions based on a worker’s earnings or job function. As currently drafted, the Proposed Rule defines “worker” as a natural person who works, whether paid or unpaid, for an employer, including an individual classified as an independent contractor. The Proposed Rule would require employers to rescind existing non-compete clauses no later than 180 days after the final rule is published. To rescind existing non-compete clauses, employers would be required to provide notice to the worker that the non-compete clause is no longer in effect and therefore unenforceable. To ensure compliance, the Proposed Rule includes model language that would satisfy the notice requirement.
The Proposed Rule contains a narrow exception for the use of non-compete agreements in connection with the sale of a business, which the FTC appreciates presents different incentives and motivations. Under the exception, the seller of a business may enter into a non-compete agreement with a buyer who has at least a 25% ownership stake in the seller’s business. As the FTC noted, “non-compete clauses between the seller and buyer of a business may be [different because] they may help protect the value of the business acquired by the buyer.”
In addition, the Proposed Rule would not apply to other types of restrictive covenants (eg, non-solicitation and non-disclosure covenants), as long as they do not function as non-compete agreements. The FTC found that “these covenants generally do not prevent a worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer.”
Moreover, certain entities are exempt from the FTC’s jurisdiction, including banks, insurance companies, non-profits, common carriers, and air carriers. Inasmuch as the Proposed Rule is an exercise of the FTC’s Section 5 authority under the Act, it would not cover such entities.
The FTC voted 3-1 to publish the NPRM, which is the first step in its rulemaking process. The Proposed Rule invites public comments, which must be submitted by March 10, 2023. The FTC will then decide whether to issue a final rule and, if so, what, if any, revisions to make based on the comments to the Proposed Rule.
Of course, we anticipate that any final rule will face significant legal challenges. The FTC claims authority to eliminate the use of non-competes by virtue of Section 5 of the FTC Act, which broadly empowers and directs the FTC “to prevent” businesses “from using unfair methods of competition.” The FTC has reasoned that its rulemaking authority is squarely rooted in its obligation to protect consumers from anti-competitive behavior that negatively affects a free and fair labor market. Historically, however, the authority to regulate the use and prohibition of non-compete agreements has been exercised by state legislatures and subject to court interpretation. Given this background and the breadth of the Proposed Rule, any final rule issued by the FTC will almost certainly be challenged in the courts for regulatory overreach.
While the Proposed Rule does not necessarily require immediate action, it clearly represents the FTC’s commitment to address unfair methods of competition in the US labor markets and signals its increasing activity in this arena. In the interim, those employers who use non-compete agreements should revisit those agreements to ensure they continue to comply with applicable law and should closely monitor these developments.