The non-compete rule covers any 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.”
Just one day after entering into consent agreements invalidating non-competes with three companies, on January 5, 2023, the Federal Trade Commission (FTC) proposed a new non-compete rule that would prohibit employers from entering into, maintaining, enforcing or threatening enforcement of a non-compete clause with virtually any worker and invalidate existing non-compete clauses with both current and former workers. If the non-compete rule is finalized by the FTC in the same or substantially same form as proposed, and if it survives the legal challenges that are sure to follow, the non-compete rule would make non-compete clauses an unfair method of competition under Section 5 of the FTC Act, regardless of inconsistent state statutes, regulations, orders or interpretations, and would represent a sea change in the law relating to non-compete clauses in the United States.
Which Workers Are Covered by the Non-Compete Rule?
The non-compete rule applies to all “workers”―defined as anyone who works on a paid or unpaid basis 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 only exception is a franchisee in the context of a franchisee-franchisor relationship. (Employees of franchisees and/or franchisors, however, are included in the definition of “workers.”) Unlike many recently enacted state statutes, the non-compete rule does not prohibit non-competes only for lower-wage workers; it prohibits non-competes for all workers, regardless of the level of compensation or responsibilities―i.e., it applies to everyone, including the CEO.
Which Types of Contract Clauses Are Covered by the Non-Compete Rule?
The non-compete rule covers any 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.” The definition of “non-compete clause” would generally not include other types of restrictive employment covenants—such as non-disclosure agreements (NDAs) and client, customer or employee 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. Under the proposed non-compete clause definition, however, such covenants would be considered non-compete clauses where they are so unusually broad in scope that they function as such. The two examples of so-called de facto non-compete clauses cited in the non-compete rule are:
- 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; and
- 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.
How Does the New Rule Impact Non-Compete Clauses in Existing Agreements?
In addition to prohibiting employers from entering into new non-compete clauses with workers, the non-compete rule applies retroactively to prohibit employers from “maintain[ing]” non-compete clauses with workers. To comply with this requirement, “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 [180 days after publication of the final rule].” (Emphasis added.)
In addition, an employer must provide an “individualized communication” in writing (“on paper or in a digital format such as, for example, an email or text message”) notifying the worker that the worker’s non-compete clause is no longer in effect and may not be enforced against the worker. An employer must provide the notice to the worker within 45 days of rescinding the non-compete clause. The notice requirement is not limited to current workers: "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." The non-compete rule contains model language of an appropriate notice.
Are There Any Exceptions to the Non-Compete Rule?
The only exception to the non-compete rule is for a non-compete clause entered into by a substantial owner, member or partner (defined as a minimum 25 percent ownership, membership or partnership interest) of a business in connection with the sale of the business. The text of the non-compete rule appears to contemplate that the non-compete clause in this limited circumstance may be contained in a separate employment agreement with the substantial owner, member or partner.
What Impact Does the Non-Compete Rule Have on Existing State Laws?
The non-compete rule supersedes any state statute, regulation, order or interpretation to the extent that such statute, regulation, order or interpretation is inconsistent with the non-compete rule.
When Does the Non-Compete Rule Take Effect?
The non-compete rule is subject to the FTC’s rulemaking procedures, which permit comments within 60 days of publication of the rule in the Federal Register. The FTC will then review the comments in developing its final rule. Accordingly, the non-compete rule may be amended or altered before taking effect.
What Happens After the Non-Compete Rule Takes Effect?
If the non-compete rule takes effect in the same or substantially same form as currently drafted, it almost certainly will be subject to legal challenges. These include, but are not limited to, challenges relating to whether the FTC has the authority to issue the non-compete rule under Section 5 of the FTC Act, the primary section the FTC cites as providing its rulemaking authority. Section 5 gives the FTC authority to police both “unfair methods of competition” and “unfair or deceptive acts or practices” affecting commerce. Although Section 18 of the FTC Act contains an explicit grant of rulemaking authority to the FTC for unfair or deceptive acts or practices, the statutory authority for the FTC’s ability to make rules for unfair methods of competition is less clear. Even if the federal courts conclude that the FTC had the authority to make a rule under the FTC Act, there will be challenges to the legality of the non-compete rule itself. The FTC claims that the non-compete rule is based on a finding that non-compete clauses constitute an “unfair method of competition and therefore violate Section 5 of the Federal Trade Commission Act.” (For a further discussion on this issue, see our related article). FTC Commissioner Christine S. Wilson issued a 14-page dissent, in which she outlined the “numerous and likely successful legal challenges regarding the Commission’s authority to issue the rule.”
Regardless of whether the non-compete rule takes effect and the success of any challenges to it, employers need to keep in mind that many state and local jurisdictions currently have restrictions on and requirements for non-compete clauses and other post-employment restrictive covenants.
For More Information
If you have any questions about this Alert, please contact Lawrence H. Pockers, Shannon Hampton Sutherland, Andrew John (AJ) Rudowitz, any of the attorneys in our Non-Compete and Trade Secrets Group, Sean P. McConnell, any of the attorneys in our Antitrust and Competition Group, any of the attorneys in our Employment, Labor, Benefits and Immigration Practice Group or the attorney in the firm with whom you are regularly in contact.
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