As we noted in an August 2022 blog updating the current landscape on non-competition clauses, , "[i]n 2021,  President [Biden] issued an executive order encouraging the [Federal Trade Commission ("FTC")] to 'consider working…to curtail the unfair use of non-compete clauses and other clauses that may unfairly limit worker mobility.'" The FTC apparently did as it was ordered, and on January 5, 2023, it published a proposed rule that would ban non-competition clauses in virtually all contracts for employment, including those involving independent contractors, and regardless of whether the worker is paid or unpaid. According to the FTC, the use of non-competes must be banned because it is a "widespread and often exploitative practice that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses."
The decision to announce the Notice of Proposed Rule Making ("NPRM"), however, was not unanimous. Commissioner Christine Wilson dissented, stating that "the proposed Non-Compete Clause Rule represents a radical departure from hundreds of years of legal precedent that employs a fact-specific inquiry into whether a non-compete clause is unreasonable in duration and scope, given the business justification for the restriction. The Commission undertakes this radical departure despite what appears at this time to be a lack of clear evidence to support the proposed rule."1 Commissioner Wilson further admonished:
"Despite the importance of context and the need for fact-specific inquiries, the Commission instead applies the approach of the newly issued Section 5 Policy Statement2 to propose a near-complete ban on the use of non-compete clauses. Pursuant to this approach, the Commission invokes nefarious-sounding adjectives – here, 'exploitive and coercive' – and replaces the evaluation of actual or likely competitive effects with an unsubstantiated conclusion about the 'tendency' for the conduct to generate negative consequences by 'affecting consumers, workers or other market participants.'
Using the approach of the Section 5 Policy Statement that enables the majority summarily to condemn conduct it finds distasteful, the Commission today proposes a rule that prohibits conduct that 47 state legislatures have chosen to allow. Similarly, the Commission's proposed rule bans conduct that courts have found to be legal, a concern the Commission dismisses with a claim that the Section 5 prohibition on 'unfair methods of competition' extends beyond the antitrust laws. But the majority's conclusions and today's proposed rule forbid conduct previously found lawful under Section 5 of the FTC Act. Specifically, applying FTC Act Section 5, the Seventh Circuit found that '[r]estrictive [non-compete] clauses . . . are legal unless they are unreasonable as to time or geographic scope[.]'3 In other words, the Seventh Circuit found that a fact-specific inquiry is required under Section 5.
The NPRM announced today conflicts not only with the Seventh Circuit's holding, but also with several hundred years of precedent. With all due respect to the majority, I am dubious that three unelected technocrats have somehow hit upon the right way to think about non-competes, and that all the preceding legal minds to examine this issue have gotten it wrong. The current rulemaking record does not convince me otherwise." Dissent, p. 3.
Given this backdrop, employers and business owners should understand that while the proposed rule, as currently written, is scary for numerous reasons, it is important to remember that the proposed rule is just that – a proposed rule. It is in the first stages of the FTC's rulemaking process, with the next step being public comments regarding the proposed rule. ("The FTC will review the comments and may make changes, in a final rule, based on the comments and on the FTC's further analysis of this issue. Comments will be due 60 days after the Federal Register publishes the proposed rule. The public comment period will be open soon."). The FTC is admittedly aware of the challenges the proposed rule presents and welcomes comments, which is why it is all the more troubling that the FTC, nonetheless, decided to publish the proposed rule in the form that it did. Still, any rule promulgated only will go into effect 180 days after made final, and how the rule will actually look when "final" still remains to be seen. Employers and business owners should take advantage of the public comment opportunity and voice clearly the concerns that are evident in the proposed rule as it currently stands, particularly with respect to the broad definitions of what constitutes a non-compete and who is a worker that cannot be bound by such clauses.
While still in the rule-making process, given the proposed rule's sweeping language, employers should be aware of the proposed rule now for planning purposes. Below we discuss the provisions of the proposed rule as they currently are written, what challenges are presented by the terms as written, and what they may mean for employers if not changed in whatever final form the rule takes.
First, the definitions.
"§ 910.1 Definitions.
(a) Business entity means a partnership, corporation, association, limited liability company, or other legal entity, or a division or subsidiary thereof.
(b) Non-compete clause.
(1) Non-compete clause means 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.
(2) Functional test for whether a contractual term is a non-compete clause. The term non-compete clause includes a contractual term that is a de facto non-compete clause because it has the effect of 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. For example, the following types of contractual terms, among others, may be de facto non-compete clauses:
i. 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.
ii. 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.
(c) Employer means a person, as defined in 15 U.S.C. 57b-1(a)(6), that hires or contracts with a worker to work for the person.
(d) Employment means work for an employer, as the term employer is defined in paragraph (c) of this section.
(e) Substantial owner, substantial member, and substantial partner mean an owner, member, or partner holding at least a 25 percent ownership interest in a business entity.
(f) Worker means a natural person who works, whether paid or unpaid, for an employer. The term includes, without limitation, an employee, individual classified as an independent contractor, extern, intern, volunteer, apprentice, or sole proprietor who provides a service to a client or customer. The term worker does not include a franchisee in the context of a franchisee-franchisor relationship; however, the term worker includes a natural person who works for the franchisee or franchisor. Non-compete clauses between franchisors and franchisees would remain subject to Federal antitrust law as well as all other applicable law." NPRM, pp. 211-213. (Emphasis added).
Under these definitions, any employer who hires or contracts with a worker, no matter the classification such as independent contractor or volunteer, and regardless of whether the person is paid or not, is subject to the terms of the rule. The only exception to the definition of "worker" is the franchisor-franchisee relationship. In addition, the definition of "non-compete clause" is extremely (and overly) broad. It is defined to mean not only a clause that prohibits a worker from seeking any employment or operating a business after conclusion of employment, but also any clause that becomes a "de facto" non-compete under the FTC's "functional test," "because it has the effect of 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." Under this "functional test," a de facto non-compete would include a non-disclosure agreement "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." Id. at 212. (Emphasis added).
This vague definition of a de facto non-compete is very problematic for employers because it calls into question the validity of non-solicitation agreements and other contractual provisions that are there to protect against the unauthorized disclosure of an employer's confidential business or trade secret information. It is easy to see that any employee, no matter the field, could argue that a non-solicitation clause that prohibits him from soliciting his employer's clients, even if the employee had nothing to do with obtaining those clients, "effectively precludes" him from working in the same field. What about liquidated damages provisions provided in lieu of non-competes? Would those effectively preclude an employee from working in the same field and thus be considered a banned non-compete? And what about an employee that works for a business in a specialized field with trade secrets? Couldn't that employee also argue that without the benefit of his employer's trade secrets, he is effectively precluded from working in the same field? While it would be stretch to believe that trade secrets would no longer be protected by this new FTC rule, the definitions may leave the door open to argue otherwise.
The FTC is cognizant of these concerns, but still decided to go forward with its broadly written proposed rule. In its Notice of Proposed Rulemaking, the FTC states (p. 4):
"As the Commission explains below, the definition of non-compete clause would generally not include other types of restrictive employment covenants—such as non-disclosure agreements ('NDAs') and client or customer non-solicitation agreements—because 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. However, under the proposed definition of 'non-compete clause,' such covenants would be considered non-compete clauses where they are so unusually broad in scope that they function as such." (Emphasis added).
Given this statement, one could argue that the FTC rule is unnecessary, because the traditional reasonableness test applied to non-competes throughout the United States (see Ohio's Raimonde v. Van Vlerah, 42 Ohio St.2d 21, 325 N.E.2d 544 (1975)) already recognizes that non-competes that are too broad in scope are not reasonable and not enforceable.
Nonetheless, the FTC identified (pp. 10-12 of the NPRM) the following as potential "de facto non-competes."
"In addition to non-compete clauses, other types of contractual provisions restrict what a worker may do after they leave their job. These other types of provisions include, among others:
- Non-disclosure agreements (NDAs)—also known as 'confidentiality agreements'—which prohibit the worker from disclosing or using certain information;
- Client or customer non-solicitation agreements, which prohibit the worker from soliciting former clients or customers of the employer (referred to in this NPRM as 'non-solicitation agreements');
- No-business agreements, which prohibit the worker from doing business with former clients or customers of the employer, whether or not solicited by the worker;
- No-recruit agreements, which prohibit the worker from recruiting or hiring the employer's workers;
- Liquidated damages provisions, which require the worker to pay the employer a sum of money if the worker engages in certain conduct; and
- Training-repayment agreements (TRAs), a type of liquidated damages provision in which the worker agrees to pay the employer for the employer's training expenses if the worker leaves their job before a certain date.
These other types of restrictive employment covenants can sometimes be so broad in scope that they serve as de facto non-compete clauses.
In addition to restricting what workers may do after they leave their jobs, employers have also entered into agreements with other employers in which they agree not to compete for one another's workers. These include no-poach agreements, in which employers agree not to solicit or hire one another's workers, and wage-fixing agreements, in which employers agree to limit wages or salaries (or other terms of compensation)."
With respect to the issue of trade secrets in its Notice of Proposed Rulemaking (pages 94- 98), the FTC identifies the numerous already existing state and federal laws that protect against trade secret disclosures and explains these are alternative viable means for addressing trade secret theft, suggesting that non-competes are unnecessary for this purpose. Still, "the Commission explicitly has asked for comments on its description of a non-compete clause and has encouraged workers, employers, and other members of the public to submit comments."
Employers who currently use non-competes or other contractual clauses identified by the FTC as possible "de facto" non-competes, should be reviewing those clauses and deciding (1) whether they are necessary, and (2) whether they can be revised so that they are not unusually broad in scope such that they would become "de facto" non-competes. Employers should also be looking at their policies on protecting their confidential business information and trade secrets to ensure that these important business assets are protected under all applicable trade secret protection laws.
Second, the prohibition on non-compete clauses that meet the rule's definition and the mandatory recission and notice requirements placed on employers.
"§ 910.2 Unfair methods of competition.
(a) Unfair methods of competition. 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 a worker 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 that the worker is subject to an enforceable non-compete clause.
(b) Existing non-compete clauses.
(1) Rescission requirement. To comply with paragraph (a) of this section, which states that it is an unfair method of competition for an employer to maintain with a worker a non-compete clause, an employer that entered into a non-compete clause with a worker prior to the compliance date must rescind the non-compete clause no later than the compliance date.
(2) Notice requirement.
(A) An employer that rescinds a non-compete clause pursuant to paragraph (b)(1) of this section must provide notice to the worker that the worker's non-compete clause is no longer in effect and may not be enforced against the worker. The employer must provide the notice to the worker in an individualized communication. The employer must provide the notice on paper or in a digital format such as, for example, an email or text message. The employer must provide the notice to the worker within 45 days of rescinding the non-compete clause.
(B) The employer must provide the notice to a worker who currently works for the employer. The employer must also provide the notice to a worker who formerly worked for the employer, provided that the employer has the worker's contact information readily available.
(C) The following model language constitutes notice to the worker that the worker's non-compete clause is no longer in effect and may not be enforced against the worker, for purposes of paragraph (b)(2)(A) of this section. An employer may also use different language, provided that the notice communicates to the worker that the worker's non-compete clause is no longer in effect and may not be enforced against the worker.
A new rule enforced by the Federal Trade Commission makes it unlawful for us to maintain a non-compete clause in your employment contract. As of [DATE 180 DAYS AFTER DATE OF PUBLICATION OF THE FINAL RULE], the non-compete clause in your contract is no longer in effect. This means that once you stop working for [EMPLOYER NAME]:
- You may seek or accept a job with any company or any person—even if they compete with [EMPLOYER NAME].
- You may run your own business—even if it competes with [EMPLOYER NAME].
- You may compete with [EMPLOYER NAME] at any time following your employment with [EMPLOYER NAME].
The FTC's new rule does not affect any other terms of your employment contract. For more information about the rule, visit https://www.ftc.gov/legal-library/browse/federal-register-notices/non-compete-clause-rulemaking.
(3) Safe harbor. An employer complies with the rescission requirement in paragraph (b)(1) of this section where it provides notice to a worker pursuant to paragraph (b)(2) of this section." NPRM, pp. 213-214.
Under this section of the FTC proposed rule, not only does the rule prohibit entering into a non-compete clause with any employee, but it also requires the employer to rescind any non-competes it has already entered with its employees and provide, within 45 days, specific notice to those employees – both current and former – that the non-competes are no longer valid or enforceable and that they are able to compete with the employer at any time after the employment relationship has ended. The notice must be given "on paper or in a digital format such as, for example, an email or text message." For large companies with many employees, this notice requirement may be onerous, and if an employer attempts to provide notice via email or text, it runs the risk of an employee claiming not to have received the notice. However, the safe harbor provision in section (b)(3) should protect the employer in that situation if it maintains proof that the notice was given to all employees required to receive it.
Third, the exception.
"§ 910.3 Exception.
The requirements of this Part 910 shall not apply to a non-compete clause that is entered into by a person 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, when the person restricted by the non-compete clause is a substantial owner of, or substantial member or substantial partner in, the business entity at the time the person enters into the non-compete clause. Non-compete clauses covered by this exception would remain subject to Federal antitrust law as well as all other applicable law." NPRM, p. 215. (Emphasis added).
Under the proposed rule, selling a business under certain circumstances is the only exception. There are no others. In some state statutes recently passed to limit the validity of non-compete clauses, those statutes have salary cap limitations, that is, the non-compete prohibition applies mostly to employees who earn a certain lower income, not to high level earners. See, e.g., the Illinois Freedom to Work Act (820 ILCS 90/10) which imposes new conditions on non-compete and non-solicitation agreements entered into on or after January 1, 2022 and banning non-competes for Illinois employees making less than $75,000 per year and non-solicitation agreements for employees making less than $45,000 per year; Nevada Rev. Stat. §§ 613.195 and 613.200 (effective October 1, 2021) which provide that "a noncompetition covenant may not apply to an employee who is paid solely on an hourly wage basis, exclusive of any tips or gratuities"; New Hampshire Rev. Stat. § 275.70 makes void and unenforceable any noncompete agreement between an employer and a low-wage employee (someone who earns an hourly rate less than or equal to 200% of the federal minimum wage); Oregon Rev. Stat. 653.295 (signed into law on May 21, 2021) provides that non-competition agreements entered into on or after January 1, 2022 is void if it extends longer than 12 months, or if the employee earns less than $100,533.00 in 2021 dollars.4
Here, there is no salary cap limitation or type of worker (salary vs. hourly; executive or not) limitation. The only exception is in the case of one selling all or substantially all of the assets of a business that he owns. While the FTC is, again, cognizant of the issue, it still chose to write the proposed rule as it currently stands, perhaps because it was just easier to do it this way. Employers should provide comments to the FTC on this point.
Fourth, the preemption effect on state laws.
"§ 910.4 Relation to State laws.
This Part 910 shall supersede any State statute, regulation, order, or interpretation to the extent that such statute, regulation, order, or interpretation is inconsistent with this Part 910. A State statute, regulation, order, or interpretation is not inconsistent with the provisions of this Part 910 if the protection such statute, regulation, order, or interpretation affords any worker is greater than the protection provided under this Part 910." NPRM, p. 215.
The FTC proposed rule states that it will supersede any state law that is "inconsistent" with the provisions of the rule based on the Supremacy Clause of the United States Constitution (U.S. Const. art. VI, cl. 2). The FTC's intent is that its non-compete rule would "establish a regulatory floor, not a ceiling." NPRM, p. 133. Any state law inconsistent with the federal rule would be prohibited. "One example would be a state law providing that an employer may enforce a non-compete clause against a worker where the non-compete clause is tailored to a legitimate business interest and reasonably limited in duration, geographic area, and scope of activity prohibited. Id. This is currently Ohio's law on non-competes. Under the proposed federal rule then, Ohio law would no longer be good law.
Fifth, the compliance date.
"§ 910.5 Compliance date.
Compliance with this Part 910 is required as of [DATE 180 DAYS AFTER DATE OF PUBLICATION OF THE FINAL RULE].: Id. at p. 216.
Employers will have 180 days to comply with the rule after final publication. (It should be noted, too, that there is no private right of action for violation of an FTC Rule promulgated under the FTC Act. Put differently, rule enforcement and actions against a non-complying employer remain the domain and responsibility of the Agency. An aggrieved worker being subjected to an employer or former employer seeking to enforce a non-compete agreement after the Compliance date is precluded from seeking direct relief in court for such a violation, and would need to seek relief through administrative channels -- raising the alleged violations to the attention of the FTC. Given the vast number of employee/employer non-compete relationships currently in place, from a practical perspective It remains to be seen how enforcement of the rule would take shape.)
Finally, and again, it is important to emphasize that this proposed rule is still in its infancy and has a long road to go before it becomes final. In the Statement of Chair Lina M. Khan provides:
"This proposal is the first step in the FTC's rulemaking process. It identifies several potential alternative rules, including those that would cover only a subset of workers or that would apply different legal standards to different categories of workers. Receiving input from a broad set of market participants, including those who have experienced firsthand the effects of noncompete clauses, will be critical to our efforts. I urge members of the public to review our proposal and submit comments.
A few topics are especially worthy of close consideration.
First, should the rule apply different standards to noncompetes that cover senior executives or other highly paid workers? As the NPRM notes, these workers may be less vulnerable to coercion, but restraining them through noncompetes may still harm competition— for example, by making it harder and more expensive for potential entrants to recruit individuals for leadership positions. I am keen for input on this question, including on how any such category of workers should be defined and what standards should be applied. For example, if the Commission were to adopt a 'rebuttable presumption' of illegality for noncompetes affecting these workers, what showing should be required to overcome the presumption?
Second, should the rule cover noncompetes between franchisors and franchisees? The current proposal does not cover noncompetes used by franchisors to restrict franchisees, but we recognize that in some cases they may raise concerns that are analogous to those raised by noncompetes between employers and workers. We welcome the public's views on this topic, as well as data or other evidence that could inform our consideration of this issue.
Third, what tools other than noncompetes might employers use to protect valuable investments, and how sufficient are these alternatives? The proposal identifies several potential mechanisms that employers may use—including trade secrets law and confidentiality agreements—and we preliminarily find that these alternatives reasonably achieve the goal of protecting investments without unduly burdening competition." (Emphasis added).
Employers and business owners should take advantage of the public comment avenue to make their concerns known to the FTC. Employers have until March 10, 2023 to publish comments.
1 Commissioner Wilson also challenges the FTC's authority to make this new rule: "Setting aside the substance of the rule, the Commission's competition rulemaking authority itself certainly will be challenged. The NPRM is vulnerable to meritorious challenges that (1) the Commission lacks authority to engage in "unfair methods of competition" rulemaking, (2) the major questions doctrine addressed in West Virginia v. EPA applies, and the Commission lacks clear Congressional authorization to undertake this initiative; and (3) assuming the agency does possess the authority to engage in this rulemaking, it is an impermissible delegation of legislative authority under the non-delegation doctrine, particularly because the Commission has replaced the consumer welfare standard with one of multiple goals." (Dissent, pp. 1-2). She also emphasizes that "[s]takeholders should note that this solicitation for public comment is likely the only opportunity they will have to provide input not just on the proposed ban, but also on the proposed alternatives. For this reason, I encourage all interested parties to respond fully to all parts of the NPRM's solicitation of public comments." (Id. at p. 2).
In addition to the concerns raised above (and also beyond the scope of this blog), one should also consider whether, and to what extent, Chevron judicial deference will be given to any final FTC rule, given the serious questions raised as to the reasonableness of the FTC's proposed rule. Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-44 104 S.Ct. 2778 (1984) ("When a court reviews an agency's construction of the statute which it administers…[and] the statute is silent or ambiguous with respect to the specific issue[,]…[the] court may not substitute its own construction of [that] statutory provision for a reasonable interpretation made by the…agency.") (emphasis added).
2 The new Section 5 Policy Statement was issued on November 10, 2022, and for the FTC, "this statement makes clear that Section 5 reaches beyond the Sherman and Clayton Acts to encompass various types of unfair conduct that tend to negatively affect competitive conditions."
3 Snap-On Tools Corp. v. Fed. Trade Comm'n, 321 F.2d 825, 837 (7th Cir. 1963).
4 The FTC provides an overview of the various state laws on non-competes on pages 49-56 of its Notice of Proposed Rulemaking.