January 12, 2023 Article

FTC Proposes New Rule Impacting Legality of Non-Compete Agreements

Background

Over the last several years, non-compete agreements, which prevent workers from joining a competitor or starting a competing business for a time after separating from employment, have become less common as states enact legislation either banning them with few exceptions or prohibiting their use against workers who earn less than a prescribed income threshold.  Maine, Massachusetts, and New Hampshire each have laws restricting use of non-compete agreements.

Non-compete agreements have also been a focus of the Biden Administration.  In 2021, President Biden issued an executive order directing the Federal Trade Commission (“FTC”) to  “curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”  President Biden pronounced that banning or limiting non-compete agreements would make it easier for people to change jobs and result in higher wages.  Opponents of a ban on use of non-compete agreements believe that workers do not need this protection—they can decline a job if they wish to preserve the ability to join a competitor or they can negotiate higher compensation in exchange for agreeing to the restriction. Opponents also believe that non-compete agreements are critical to protecting employer investments in new employees as well as sensitive and proprietary business information. Some also say that innovation will be stifled if employers can no  longer use non-compete agreements.

Similar efforts by Congress to pass legislation to restrict use of non-compete agreements have not been successful.  For example, a proposed amendment to the federal Fair Labor Standards Act (“FLSA”) called “The Freedom to Compete Act” was introduced in July of 2021 and would have banned use of non-compete agreements with employees who are non-exempt under the FLSA.  This legislation was referred to the Committee on Health, Education, Labor, and Pensions after it was introduced and no further action has been taken.

Summary of FTC Rule

The FTC carried out the Biden Administration’s directive and proposed a new rule on January 5, 2023.  The proposed rule effectively bans all non-compete agreements, subject to a narrow exception.  Under the proposed rule, “non-compete” clause is defined broadly as any contractual requirement 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.”  Under this definition and the FTC’s proposed “functional test for whether a contractual term is a non-compete clause,” commonly entered into employee covenants including non-disclosure agreements or employee agreements to reimburse employers for training costs if employment is terminated within a specified time period could be considered unenforceable non-compete agreements.  The rule also requires employers to rescind existing non-compete agreements and to notify workers that non-compete agreements have been rescinded.

There is a small carve out preserving the ability to use non-compete agreements in connection with the sale of a business. The proposed FTC rule would supersede any inconsistent state laws, regulations, orders, or interpretations. The complete text of the rule can be reviewed here.

Deadlines

The contemplated compliance deadline is 180 days following publication of the final rule. The comment period on the new rule is open through March 10, 2023. The FTC will review the comments and may make changes in a final rule based on the comments and the Commission's continued analysis of the issues.

It is anticipated that the final rule will face legal challenges on the grounds that FTC has exceeded its rulemaking powers.

Take Aways

The fate of FTC’s proposed new rule is unknown.  The comment period is still open and legal challenges are certain to be made.  In the meantime, employers can verify that existing employee non-compete agreements are compliant with state law and begin strategizing about how other employee restrictive covenants could be used in place of non-compete agreements to protect their businesses.

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