On January 5, 2023, the Federal Trade Commission (“FTC”) issued a groundbreaking proposed rule that would, if finalized:
- prohibit most employers from entering into non-compete clauses with workers, including employees and individual independent contractors;
- prohibit such employers from maintaining non-compete clauses with workers or representing to a worker that the worker is subject to a non-compete clause; and
- require employers to rescind any existing non-compete clause with workers by the compliance date of the rule and notify the affected workers that their non-compete clause is no longer in effect.
The FTC’s notice of proposed rulemaking explains that the FTC considered possible limitations on the rule—such as excluding senior executives or highly paid employees from the ban—but it ultimately proposed a categorical ban on post-termination non-competes. The only exception is for non-competes related to the sale of a business. However, even this exception is unusually narrow: it would only apply to selling business owners who own at least 25% percent of the business being sold. (The proposal also would not apply to most non-profits, certain financial institutions, common carriers, and others who are also outside the scope of FTC regulation.)
As discussed in Covington’s January 5 client alert, the FTC explained that it issued the proposed rule due to its belief that non-competes reduce wages, stifle innovation and business, and are exploitative and unnecessary.
The FTC’s proposed rule leaves open a considerable number of questions, including:
- Workers Covered. The proposal specifically calls for comments on a number of issues, including whether the rule should impose a categorical ban on non-compete clauses or a rebuttable presumption of unlawfulness, whether the non-compete ban should apply uniformly to all workers or if there should be exemptions or different standards for different categories of workers (such as senior executives or highly paid employees), whether a 25% ownership threshold is sensible for the sale-of-the-business exception, and whether franchisees should be covered.
- Definition of Non-Compete Clause. The proposal adopts a functional test for what constitutes a “non-compete” clause, prohibiting anything that has the effect of preventing a worker from seeking or accepting employment or operating a business. For example, a non-disclosure clause may be considered a non-compete clause if it “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.” In addition, a contractual term requiring a worker to repay the employer or a third-party entity for training costs upon termination of the worker’s employment within a specified period could be treated as a de facto non-compete. Notably, the notice states that the definition of a non-compete clause would generally not include other types of restrictive covenants such as customer non-solicitation clauses.
- Future of Forfeiture Provisions. The proposed rule does not specify whether agreements requiring a worker who competes to forfeit a right to receive future payments—such as severance, equity awards or other forms of nonqualified deferred compensation—would be invalidated by the proposed rule.
- Impact of Retroactivity. The proposed rule would invalidate existing non-compete clauses, but it does not address the consequences of this retroactivity that employers would need to consider. Where a payment is contingent on future non-competition, could employers renegotiate existing severance arrangements that include non-competes? Could an employer recoup payments already paid in exchange for an existing promise not to compete? Could an employee demand payment of amounts previously forfeited on account of the employee’s violation of a non-compete? What will be the tax consequences of the nullification of a non-compete?
The FTC’s proposal provides for a 60-day comment period, and would be effective 60 days after publication of the final rule. Employers would be required to comply with a final rule within 180 days after it is published. We anticipate that there will be considerable opposition to the proposed rule on a number of grounds, including its broad scope and whether the FTC has authority to issue the rule in the first place because non-competes have historically been regulated by states.
Employers should consider whether to comment on the proposed rule and whether they should take any actions now—particularly with respect to new arrangements with workers—to be prepared if the proposed rule is ultimately finalized.