16 Feb Is this the End of Non-Competes?
On January 5, 2023, the Federal Trade Commission (“FTC”) proposed a ban on non-compete clauses in employment contracts, including the elimination of all existing non-competes (the “Proposed Rule”), which, if adopted in its current form, will serve as a complete nullification of non-compete clauses and contractual provisions or employment policies that have a similar effect.
At the present time, non-compete clauses are governed by state law, by either specific statutes or common law. Most states determine the enforceability of non-compete clauses based on the reasonableness of the geographic scope, duration and restrictions of a non-compete. Eight states (or districts) have previously adopted some level of bans or prohibitions on the use of non-competes for workers – California, Washington, D.C., North Dakota, Oklahoma, Illinois, Maryland, Virginia and Washington. This Proposed Rule, if adopted and enacted, would become federal law and applicable in all states and territories.
The Proposed Rule is based on a position by the FTC that non-competes constitute an unfair method of competition, violating Section 5 of the FTC Act., and the FTC’s actions follow through on President Biden’s urging to take action against the unfair use of non-compete clauses and other clauses that may unfairly limit workers’ wages and mobility.
The Proposed Rule has two key components. First, the rule categorizes any and all levels of non-compete agreements with workers to be “unfair methods of competitions,” therefore making it illegal under federal law for an employer to enter into non-competes with any workers, including employees, independent contractors, interns, or volunteers, and from maintaining or representing to such workers that they are subject to covered non-compete clauses.
Second, it requires employers to rescind existing non-competes and to notify current and former employees in writing of the rescission; with the FTC providing a template for such notices which will explain that “the workers non-compete clause is no longer in effect and may not be enforced against the worker.”
The Proposed Rule defines a non-compete clause as an agreement 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, and it also applies a “de facto test” (if a provision is not couched as a non-compete but has the practical effect of prohibiting a worker from seeking or accepting employment with another employer) to determine if a particular clause qualifies as a non-compete clause under the Proposed Rule. Therefore, while the Proposed Rule does not prohibit nondisclosure or nonsolicitation agreements, those terms could fall under the definition of non-compete if the provisions were broad enough to prohibit a worker from working in the same field.
The scope of the Proposed Rule also presumably goes beyond a traditional employer-employee relationship, extending to partnerships and membership agreements among individuals.
However, it is important to note that the Proposed Rule would not apply to agreements between buyers and sellers of a business entity, the sale of an ownership interest in a business entity, or the sale of all of a business entity’s operating assets, where the individual restricted by a non-compete was a substantial owner, member or partner in the business entity being sold.
This Proposed Rule is just that for now, a proposal. It is premature for employers to panic or employees to rejoice. The Proposed Rule is open for public comment for 60 days, and the FTC will likely receive a lot of comments opposing the Proposed Rule and the FTC’s ability to impose it. Employers should consider submitting comments to the FTC as the more viewpoints provided to the FTC, the more it will need to analyze the application of a final rule and what that should cover. Also, the final rule will be reviewed by the federal courts under the Administrative Procedures Act and it is likely that someone will attempt to litigate the jurisdiction of the FTC to set such a rule. The Proposed Rule faces numerous and significant challenges and it is far from certain that it will ever become effective.
While the ultimate decision is unknown, and the Proposed Rule may eventually be struck down, employers should consider reviewing their policies regarding non-competes. Employers with non-compete clauses or other restrictive clauses should consider a review their policies and practices, and, decide what risk profile is appropriate for them. Additionally, employers should consider exploring alternatives to non-competes that help companies protect their competitive information and relationships, such as non-disclosure or customer non-solicitation agreements.
ABOUT THE AUTHOR: Bradley W. Rapp is a Shareholder at Rapp & Krock, PC in the Corporate Law and Business Transactions group and routinely advises businesses concerning non-compete agreements.
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