In July of 2021, President Biden issued Executive Order 14036 aimed at promoting competition in the economy. Among other things, the Executive Order directed the Federal Trade Commission (FTC) to consider promulgating a rule “to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”
Last week, the FTC issued a notice of a proposed rule to prohibit the use of non-compete clauses and to preempt all state laws providing lesser protection than the proposed, far-reaching FTC rule. The FTC takes the position that the use of non-compete agreements constitutes an “unfair method of competition” in violation of the Federal Trade Commission Act (“FTC Act”). The FTC approved the proposed rule voting 3-1 along party lines, with the Republican Commissioner noting in her dissent that the FTC lacks the rulemaking authority to ban non-compete agreements.
As well as banning the use of non-compete clauses in new employment contracts, the FTC would require employers not only to nullify any existing non-compete clauses within six months of publication of the final FTC rule, but also to affirmatively notify employees that such clauses are no longer valid. Other than certain agreements related to the sale of a business and businesses exempt from the FTC Act, the proposed rule applies across the board to all employees and independent contractors, paid and unpaid workers, and businesses no matter their size or location.
The proposed rule goes beyond banning standard non-compete agreements. Any contract term that effectively prevents the employee from seeking or accepting employment or from operating a business after leaving their employer violates the FTC’s proposed rule. Examples of such “de facto” non-compete clauses are non-disclosure agreements written so broadly to effectively prevent the worker from working in the same field, as well as provisions requiring employees whose employment ends before a certain period of time to pay their employer for training costs not reasonably related to costs the employer actually incurred to train them.
The single exception in the proposed rule is for a non-compete clause entered into by a person who is selling, or otherwise disposing of, their entire ownership interest in the subject 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 (at least 25% ownership stake) of, or substantial member or substantial partner in, the business entity at the time the person agrees to the non-compete clause.
Last, it is worth noting that while it remains to be seen whether courts will permit the FTC eventually to implement some version of the proposed rule, the FTC does not have the authority to create a private right of action for its enforcement. This point matters because enforcement will be left to the FTC, which has many higher priorities to address.
The proposed rule will be subject to a 60-day public comment period. There may be substantial revisions to the proposed rule following the public comment period. In addition, lawsuits challenging the FTC’s authority to issue such a rule seem almost assured.
We encourage our employer clients to consider auditing their employment contracts for non-compete and possible de facto non-compete provisions to assess what, if anything, needs to be addressed. Employers may want to continue the recent trend of relying more heavily on confidentiality and non-solicitation clauses rather than or in addition to non-compete agreements.
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