FTC Proposes Rule Banning Noncompete Clauses, Citing Harm to Workers and Competition

(updated) Employee non-compete agreements have been in the cross hairs of state and local lawmakers for several years. In July 2021, President Biden provided federal support for the effort, issuing an Executive Order calling on the Federal Trade Commission (“FTC”) to regulate the unfair use of noncompetition clauses that limit employee mobility. On January 5, 2023, FTC issued a proposed rule restricting the use of noncompete agreements that prohibit workers from working for an employer or starting a business in the same field.

FTC’s proposed ban would make it unlawful for an employer to:

• enter into or attempt to enter into a noncompete agreement with a worker;
• maintain a noncompete agreement with a worker; or
• represent to a worker, under certain circumstances, that the worker is subject to a noncompete agreement.

The proposed rule would also require employers to provide written notification to workers that their noncompetes have been rescinded.

The proposed rule defines the term “worker” broadly. It includes not only employees but also any person who performs work for an employer, whether paid or unpaid, including independent contractors, interns, volunteers and apprentices.

It also defines what qualifies as a noncompete clause expansively. As currently drafted, a noncompete clause would include any “contractual term between an employer and 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. The rule would also ban contractual provisions that are the functional equivalent of noncompete clauses, such as:

• A nondisclosure agreement that is written so broadly as to effectively preclude a worker from working in the same field after the conclusion of the worker's employment with the employer; and
• A contractual term that requires a worker to pay the employer or a third party for training costs if the worker's employment terminates within a specified period.

It is unclear whether clawback or similar provisions would be considered de facto noncompete clauses pursuant to the proposed rule.

The proposal contemplates a limited exception for noncompete agreements between sellers and buyers of businesses. This exception would only apply if the party restricted by the noncompete clause is an owner, member or partner with at least a 25% ownership interest in a business entity.

Chair of the FTC, Lina Kahn, explained that noncompetition agreements drive down wages and undermine competition, resulting in lost earnings totaling approximately $300 billion a year. Kahn said in a news conference announcing the proposed ban that:

“The freedom to change jobs is core to economic liberty and to a competitive, thriving economy . . .. Noncompetes block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand. By ending this practice, the FTC’s proposed rule would promote greater dynamism, innovation, and healthy competition.”

The Commission voted 3-1 to publish the Notice of Proposed Rulemaking, which is the first step in FTC’s rulemaking process. Chair Khan, Commissioner Rebecca Kelly Slaughter and Commissioner Alvaro Bedoya issued a statement. Commissioner Slaughter, joined by Commissioner Bedoya, issued an additional statement. Commissioner Christine S. Wilson voted no and also issued a statement.

FTC will accept public comments on the proposed rule for a period of 60 days. After the rule is final, companies will have six months to terminate noncompete agreements that violate the rule. The FTC notice also requested public comment on alternatives to the proposed rule, including:

• Banning non-competes for workers making less than a certain wage threshold and, either having no rule regarding the non-competes of higher-earning workers or having a rebuttable presumption of illegality with respect to their noncompetes;
• Having a rebuttable presumption of illegality for all noncompetes; or 
• Having a rebuttable presumption of illegality for the noncompetes of workers earning less than a certain wage threshold with no rule regarding the noncompetes of higher-earning workers.

The proposed rule is part of the FTC’s broader effort to eliminate noncompetition restrictions for employees.  The FTC recently took action against three companies, forcing them to drop noncompete restrictions they imposed on thousands of current and former works.  The FTC’s hostility towards post-employment restrictions is consistent with the growing state-level trend of prohibiting or significantly restricting employers’ right to demand compliance with noncompetition provisions.  California, Colorado, the District of Columbia, Illinois, Maine, Maryland, Massachusetts, Nevada, New Hampshire, North Dakota, Oklahoma, Oregon, Rhode Island, Virginia, and Washington have passed some of the more stringent laws with respect to post-employment restrictions.

Not surprisingly, in the days since the proposed rule was published, numerous business groups have threatened to assert legal challenges to the FTC’s proposed rule.  The Chamber of Commerce asserted in its press release that:

“Today’s actions by the Federal Trade Commission to outright ban noncompete clauses in all employer contracts is blatantly unlawful. Since the agency’s creation over 100 years ago, Congress has never delegated the FTC anything close to the authority it would need to promulgate such a competition rule. The Chamber is confident that this unlawful action will not stand.”

Employers, boards and executives should remain alert for further developments on the FTC’s proposed rule. Given the intense, recent focus on antitrust enforcement and the current leadership of the FTC, it is quite likely that FTC will finalize the rule in some from and enforce it. With restrictions looming it is critical for employers to focus on protecting their innovations through confidentiality clauses and trade secret laws. Restrictive covenants that may still be permissible under the FTC's proposal include reasonably tailored confidentiality clauses and nondisclosure agreements, customer non-solicitation covenants, and covenants prohibiting concurrent employment.

However, words in an agreement or a policy are simply that – words – that may or may not be enforced by courts or challenged by the FTC. After over 30 years of prosecuting and defending trade secret and noncompetition covenant cases, we know that actions speak louder than words. Employers need to ensure that their innovations and confidential data are locked down and properly protected. Sadly, departing employees are still able to walk out the door – electronically – with, to quote Judge T.S. Ellis III, “wheelbarrows full” of trade secrets and confidential information.