FTC Proposes Ban on Non-Competition Agreements

On Jan. 5, 2023, the Federal Trade Commission released a proposal for a new rule that would effectively ban all non-competition clauses. The FTC is the government agency responsible for enforcing federal consumer protection laws that prevent fraud, deception and unfair business practices, including such practices that lead to less competition. In its newest proposed rule, the FTC identified non-competition clauses as an unfair method of competition. A non-competition clause is a contract between an employer and an employee that prohibits the employee from working for a competing employer or starting a competing business for a specified period of time and within a limited geographic region after the employer-employee relationship ends. If effected, the proposed regulation would apply to all employers, forbidding them from including a non-compete clause in their contracts and retroactively invalidating existing non-competes.  

The Proposed Rule

The FTC’s proposed rule defines non-compete clauses broadly, beyond the strict employer-employee relationship, to include independent contractors and other similar service providers. Its definition covers “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,” and even contractual terms that are de facto non-compete clauses are forbidden. A clause is a de facto non-compete if on its face it does not appear to prohibit competition, but it has the ultimate effect of prohibiting a worker from obtaining new employment or operating a new competing business. For example, the FTC said a non-disclosure agreement can be a de facto non-compete if it is written so broadly as to effectively preclude the worker from working in the same line of work as the employer upon the termination of the worker’s employment. Not only does the proposed rule prohibit employers from requiring workers to enter into non-compete agreements or from representing to a worker that they are subject to a non-compete, but the rule also includes a rescission requirement. This requirement would call for employers to rescind existing non-competes and notify their workers that they have done so.  

The proposed regulation includes a limited exception for persons selling a business entity or disposing of their ownership interest in a business entity. If a person is a substantial partner, owner or member of a business entity at the time of entering into a non-competition agreement and later sells their business or interest, such non-competes will remain intact and subject to federal antitrust law. The FTC has also publicly stated that this proposed regulation will not affect employers’ ability to protect trade secrets and other confidential information.

What’s Next?

The FTC’s proposed rule doesn’t go into effect yet, nor will it necessarily be enacted in its proposed form. Like all federal agency proposed rules, the FTC’s proposed rule is subject to a 60-day notice and comment period once officially published in the Federal Register. During the comment period, anyone may submit comments to the rule. Following the 60-day period, the FTC will review the public’s comments and make any changes it deems appropriate. When and if a final rule is issued, the compliance date for all employers will be 180 days after the date of the final rule’s publication.

A high response rate is expected during the comment period, especially from large industry leaders, given that one in five U.S. workers, or approximately 30 million people, are bound by a non-compete clause. The U.S. Chamber of Commerce has already expressed opposition to the proposed rule, and legal challenges are likely to follow.

Eleven states have adopted limits on non-compete agreements that are tied to income or earning thresholds, rather than an outright ban on non-competes as to all employees in the state. Many of the laws ultimately enacted in those states started as proposals for outright bans much like the FTC’s current proposal, which could follow a similar path. Ultimately, tying the enforceability to an earning threshold is a reminder of a basic requirement of non-competes: that they must be designed to protect a legitimate business interest. The income of the employee subject to the non-compete is often a reasonable proxy for the importance of the business interest the non-compete serves.

The FTC’s Rulemaking Authority: Is a Regulatory Ban on Non-Competes Enforceable?

While the FTC has used its power to enforce consumer protection laws frequently, the FTC has historically laid low in the antitrust and unfair competition arena. The FTC has just once adopted an antitrust rule, back in 1967, which it later repealed. Such historical lack of unfair competition regulation has resulted in some questions as to whether the FTC has the power to make rules governing antitrust or unfair competition laws. However, in their 2022 regulatory agenda, FTC commissioners made clear their intent to ramp up regulations on unfair methods of competition under the Biden administration. With the newly proposed ban on non-compete clauses being the first step toward this goal, challenges to the FTC’s authority are likely to arise.

The FTC purports to possess rulemaking authority to regulate non-compete agreements under Section 5 of the Federal Trade Commission Act. Such an interpretation of Section 5 may result in a long legal battle ahead with those who contend this is an impermissible expansion of the agency’s rulemaking authority — a question that could be decided by the U.S. Supreme Court, which has imposed more restrictions on agency regulation in recent years.

For now, non-competition agreements are still valid and enforceable in each state that allows them. As we await the final scope of the FTC’s proposed rule, this proposed action is a reminder to continually evaluate whether each restrictive covenant you require with your employees is designed to protect a legitimate business interest. For assistance handling your non-compete agreements, please contact a member of the Robinson Bradshaw Employment & Labor Practice Group.