Federal Trade Commission Proposes Ban on Most Non-Compete Clauses

Earlier this month, the U.S. Federal Trade Commission (“FTC”) issued a proposed regulation that would effectively ban most non-compete agreements between employers and their workers. Specifically, the rule would prohibit employers from:

• entering into or attempting to enter into a non-compete clause with a worker;
• maintaining a non-compete clause with a worker; and
• under certain circumstances, representing to a worker that the worker is subject to a non-compete clause.

The first prohibition would preclude employers from entering into new non-competes with “workers”— not just employees, but also independent contractors, student interns, and volunteers, among others. The proposed rule defines the term “non-compete clause” 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.

Whether a contractual term is a prohibited non-compete clause would depend on a “functional test,” i.e., how the term functions, not what it is called. While non-disclosure agreements and similar confidentiality agreements will not be prohibited per se, they would be illegal if they are so broad that they effectively operate like noncompete agreements. On the other hand, an agreement that allows the employee to take any future job while protecting legitimate trade secrets and confidential information should not be prohibited.

The effect of the second prohibition above is that employers would need to proactively inform employees that existing non-competes in their employment agreements are cancelled. The third prohibition is meant to outlaw any behavior by an employer that makes an employee believe the employee is subject to a non-compete.

The proposed rule contains an exception for non-competes entered into by sellers of businesses. However, such non-competes would be permitted only where the seller is a “substantial owner,” “substantial member,” or “substantial partner” in the business being sold, defined as “an owner, member, or partner holding at least a 25% ownership interest in a business entity.” Employees with smaller shares are not included in this exception.

Interested parties may comment on the proposed rule, though the FTC website includes conflicting information about the deadline. To be safe, commenters should meet the earlier deadline of March 10, 2023. The FTC says it is seeking comments on several alternatives to the proposed rule, including whether noncompete clauses between employers and senior executives should be subject to a different standard than non-compete clauses with other workers. Also, the FTC is seeking comments on whether it should regulate the contents of employee handbooks.

In the first two weeks of the comment period, more than 7,500 comments have been submitted. Aside from addressing the substance of the proposed rule, many commenters and other interested parties are questioning the legality of this proposed regulation, i.e., asserting that it is outside of the FTC’s jurisdiction and authority to propound such a rule. (The FTC claims that non-competes are a form of “unfair competition,” which it is the agency’s job to prevent.) When a final rule is issued, perhaps in the summer of 2023, it is likely to be embroiled in litigation. So, stay tuned. In the interim, if you have questions or are interested in submitting comments to the FTC, please get in touch with your regular Brown Rudnick contact or this author.