FTC Seeks To Ban Noncompetition Agreements

On January 5, 2023, the Federal Trade Commission (FTC) released a proposed rule that, if adopted, would ban employers from using noncompetition agreements to restrict employee mobility.  Currently, the enforceability of noncompetition agreements varies among states.  While some states (like California) have deemed noncompetition agreements largely unenforceable, other states (like Ohio) continue to enforce these types of restrictions to the extent necessary to protect a legitimate business interest.

Why did the FTC publish this proposed rule?

On July 9, 2021, President Biden issued an Executive Order aiming to “promote competition in the American economy.”  President Biden encouraged the FTC to, among other things, “curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”

The FTC recently went after two glass companies, a security company, and two individuals for requiring employees to sign noncompetition agreements.  The FTC took the position that the noncompetition agreements at issue in those cases constituted unfair methods of competition and, therefore, violated Section 5 of the Federal Trade Commission Act.

To support its newly proposed rule, the FTC maintains that noncompetition agreements suppress wages, stifle innovation and make it harder for entrepreneurs to start new businesses.  The FTC estimates that prohibiting the use of noncompetition agreements would increase American workers’ earnings by $250 billion to $296 billion per year.

Who is considered a “worker” under the FTC’s proposed rule?

Under the proposed rule, employers would not be able to ask paid or unpaid employees, independent contractors, interns, volunteers or apprentices to sign noncompetition agreements.  The term “worker,” however, does not apply to franchisees.  The FTC considers the relationship between a franchisor and franchisee to be akin to that of two businesses.

Does the proposed rule have any effect on confidentiality agreements or non-solicitation agreements?

In the proposed rule, the FTC broadly defines a “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.” The proposed rule would apply to explicit noncompetition agreements but also “de facto” noncompetition agreements which have the effect of prohibiting workers from seeking or accepting new employment.

Although the FTC maintains that the proposed rule is not intended to prohibit reasonably tailored non-solicitation agreements, other types of agreements (such as non-disclosure agreements) may fall under the proposed rule’s purview.

Are there any exceptions to the ban in the proposed rule?

Under the proposed rule, noncompetition agreements may be used as part of a sale-of-business contract.  Purchasers of a business may use a noncompetition agreement to prevent the owner who is selling the business from competing in the same industry.  The purchaser may only enter into a noncompetition agreement with an owner that has at least a 25% ownership interest in a business entity.

If adopted, would the FTC’s proposed rule be retroactive?

Yes.  The proposed rule would apply retroactively.  The proposed rule not only prohibits employers from entering into noncompetition agreements, but also requires employers to rescind existing noncompetition agreements.   If the proposed rule passes, employers will be required to give individualized written notice to former employees that their existing noncompetition agreements have been rescinded within 45 days of the rule’s implementation.

If adopted, when would the ban take effect?

If adopted, the rule would take effect 180 days after the final version is published.

What can employers do?

Many employers have raised concerns that the proposed rule will limit their ability to protect trade secrets.  Meanwhile, trade and advocacy groups are questioning whether the FTC has exceeded its statutory authority.  The public, employers and trade groups have 60 days (from the date the proposed rule is published) to submit comments to the FTC.  The FTC has published several less restrictive alternatives to the categorical ban on non-compete clauses, including a ban on noncompetition agreements for employees below a certain wage threshold.  The FTC also seeks feedback regarding whether it “should adopt different standards for non-compete clauses with senior executives.”

Please contact us with any questions on this topic.