FTC Proposes Sweeping Ban on Non-Compete Agreements

January 10, 2023

On January 5, 2023, the Federal Trade Commission (“FTC”) proposed an expansive new rule to implement a near total ban on the use of non-compete agreements. This proposal is the latest in a series of aggressive steps by the FTC to effectuate President Biden’s July 9, 2021 executive order to curtail the unfair use of non-compete agreements. The issuance of this proposed rule commences a 60-day comment period, after which the FTC will likely adopt a final rule. Employers will have 180 days thereafter to comply.

Below is a summary of the proposed rule’s key terms and what employers who use non-competes should know and do now.

What is banned under the FTC’s proposal?

The proposed rule imposes a ban on “non-compete clauses,” defined 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.” This ban would supersede all inconsistent state laws and regulations.

It is crucial to note that the definition of “non-compete clause” is a functional one and applies regardless of whether an agreement is labeled a non-competition agreement. The FTC provides two examples of such “de facto” non-compete agreements, including (a) an over-broad non-disclosure agreement that effectively prevents the worker from working in the same field after departing his or her employment and (b) an agreement to repay training costs if the worker’s employment terminates within a specified period, where the required payment is not reasonably related to the training costs incurred by the employer. The FTC stresses that these examples are non-exclusive, and one can imagine other types of broadly worded restrictive covenants—including customer non-service and non-solicit clauses—potentially running afoul of the FTC’s functional test.

The proposed rule covers non-compete agreements with any worker, whether paid or unpaid, including employees, independent contractors, externs, interns, volunteers, apprentices and sole proprietors who provide a service to a client or customer. It does not include a franchisee in the context of a franchisee-franchisor relationship but protects workers of those entities.

Are there any exceptions to the ban

In line with traditional restrictive covenant law, the proposed rule provides an exception for non-competes entered into by a person who is selling a business entity (or their ownership interest in the business entity) or selling all or substantially all of the business’s operating assets. However, the exception only applies when the person restricted by the non-compete clause is a “substantial owner, substantial member, or substantial partner” who holds at least a 25 percent ownership interest in the business entity sold.

What about existing non-compete agreements?

The proposed rule not only forbids employers from entering, or attempting to enter, into a non-compete agreement with a worker—it also expressly requires that existing non-competes be rescinded. Section 910.2(b) of the proposed rule provides that “an employer that entered into a non-compete clause with a worker . . . must rescind the non-compete clause no later than” 180 days after publication of the final rule.

To do so, employers must provide written notice of the rescission to both existing employees as well as former employees (for whom the employer retains contact information) who are bound by a non-compete agreement. The proposed rule provides a safe harbor for employers who use the model notice language set forth in the proposed rule.

Will the proposed ban in its current form go into effect?

That remains to be seen. Legal challenges to the FTC’s authority to ban non-competes are likely and changes to the proposed rule may be made in response to public comment. By expressly seeking comment on whether the proposed ban should apply to senior executives as well as other “highly paid or highly skilled” workers, the FTC may be signaling that it is prepared to take an alternative approach to those workers. See Proposed Rule at page 123 (“several alternatives to a categorical ban may also accomplish the objectives of the proposed rule to some degree, including different standards for senior executives”).

What should employers do now

Employers who have existing non-compete agreements, or intend to enter into such agreements, should be aware of the proposed rule and stay abreast of developments as it goes through the public comment period. Employers, especially those who have entered into non-compete agreements with low wage workers, are well-advised to inventory their non-compete agreements and prepare themselves in the event the FTC’s proposed ban goes into effect. Such preparations should include taking alternative steps to protect trade secrets and other valuable business assets, including through carefully drafted non-disclosure, non-service and non-solicitation agreements.

Please contact the Herrick Employment Group with any questions or requests for further guidance or advice.

John H. Chun at +1 212 592 1546 or [email protected]
Carol M. Goodman at +1 212 592 1465 or [email protected]

© 2023 Herrick, Feinstein LLP. This alert is provided by Herrick, Feinstein LLP to keep its clients and other interested parties informed of current legal developments that may affect or otherwise be of interest to them. The information is not intended as legal advice or legal opinion and should not be construed as such.