On January 5, 2023, the Federal Trade Commission (FTC) sent shockwaves across businesses throughout the U.S. when it issued a sweeping Notice of Proposed Rulemaking (NPRM) that would ban employers from requiring employees to sign noncompete agreements or otherwise impose policies or contracts preventing employees from seeking or accepting work with other employers (the Proposed Rule).
If passed, the Proposed Rule would pre-empt existing state law and make it illegal for an employer to (1) enter into, or attempt to enter into, a noncompete agreement with a worker; (2) maintain a noncompete agreement with a worker; or (3) suggest to a worker that the worker is subject to a noncompete. It would also require employers to rescind any existing noncompetes within 180 days of publication of the final rule and actively inform affected workers, including former workers, that their noncompetes are no longer in effect within 45 days of rescinding the noncompete clause.
Noncompete agreements are commonly issued by employers to prohibit workers from engaging in competitive activities both during and for a certain period of time following their employment or engagement. Historically, the FTC has not regulated noncompete agreements. Rather, noncompete agreements are currently governed on a state-by-state basis through state restrictive covenant statutes or common law. Except a handful of states that outright prohibit noncompete agreements, including California, North Dakota, and Oklahoma, most states currently permit enforcement of noncompete clauses, provided they are reasonable in geographic scope, duration, and the nature of the prohibited activities.
The scope of the Proposed Rule is broad, as the definition of “Worker” would apply to anyone who works for an employer, including independent contractors, interns, and even senior-level executives. The term Worker also presumably extends to individuals who are bound by noncompete clauses within LLC membership and partnership agreements. Further, according to the Proposed Rule, the term noncompete clause is broadly defined as any “contractual term that is a de facto non-compete clause because it has the effect of prohibiting 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.” Under this definition, the Proposed Rule recognizes that a de facto non-compete clause may include “[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.” Thus, there will likely be some dispute as to whether non-disclosure provisions and other common restrictive covenant provisions, such as non-solicitation provisions, are impacted by the rule.
The only exception to the Proposed Rule’s ban on noncompete agreements are those entered into by a person who is selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or by a person who is selling all or substantially all of a business entity’s operating assets, when the restricted person is a substantial owner, substantial member, or substantial partner in the business entity at the time the person enters into the non-compete clause. However, even that exception is narrow, as “[s]ubstantial owner, substantial member, and substantial partner” is defined as “an owner, member, or partner holding at least 25 percent ownership interest in a business entity.”
In support of the rule, FTC Chair Lina M. Khan issued a statement in which she emphasized, “[t]he freedom to change jobs is core to economic liberty and to a competitive thriving economy,” as “[n]oncompetes 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.” Advocates of the rule further argue that noncompete agreements contribute to wage stagnation because one of the most effective ways to secure higher pay is by switching companies.
However, noncompete agreements are also valuable tools that allow employers to facilitate retention, promote workers, protect trade secrets, prevent unfair competition, and invest in training in a tight labor market. In a statement dissenting from the Commission’s decision, FTC Commissioner Christine S. Wilson noted that the rule “represents a radical departure from hundreds of years of legal precedent.” Opponents of the rule, including Sean Heather, U.S. Chamber Vice President for International Regulatory Affairs, note that “when appropriately used, noncompete agreements are an important tool in fostering innovation and preserving competition.” Ironically, while the FTC states that the Proposed Rule will allow employees to bring “innovative ideas” to new employers and thus promote fair competition, without a noncompete or similar agreement in place to protect those ideas from competitors, employers will be much less likely to invest in such innovation.
The Commission voted 3-1 to publish the Proposed Rule, which is the first step in the FTC’s rulemaking process. Comments on the proposed rule are due within 60 days of the FTC’s January 5, 2023 publication date. Once the comment period closes, the FTC will likely make changes to the preliminary version of the Proposed Rule before publishing a final rule. After initial publication of the final rule in the Federal Register, it will take effect after 60 days, with the compliance deadline coming 180 days thereafter. However, we anticipate legal challenges to the proposed final rule, which could delay its effective date for several months or even years.
For now, employers should consider doing the following:
- Continue to comply with applicable state law in issuing and enforcing noncompete agreements while also monitoring the FTC’s rulemaking process. Employers who rely heavily on noncompetes are also encouraged to voice their concerns via the public commenting process.
- Reevaluate their noncompete agreements and ensure they are implementing and enforcing them appropriately. For example, employers should limit the use of noncompetes to key employees – something a growing number of employers are already doing to stay competitive in the current market – and ensure they are narrowly tailored to protect legitimate business interests, such as protecting confidential information, rather than to prohibit competition.
- Strengthen use of other restrictive covenants, such as non-solicitation and non-disclosure provisions, to ensure their business interests are protected in case the Proposed Rule goes into effect.
- Finally, employers should ensure they are taking steps to protect their confidential and trade secrets, as trade secret remedies, which should be unaffected by the Proposed Rule, will likely be more widely relied upon as an alternative way to prevent unfair competition.
MMM continues to monitor developments related to the Proposed Rule. For questions about the Proposed Rule, noncompete agreements, or other restrictive covenant agreements in general, please contact the MMM Employment Team.