Proposed U.S. Ban on Non-Compete Clauses: What Are the Implications?

Proposed U.S. Ban on Non-Compete Clauses: What Are the Implications?

On January 5, 2023, the Federal Trade Commission (FTC) announced a proposed regulation that, if adopted, could potentially invalidate and largely prohibit the use of employee non-competes in the U.S. Currently, some estimate that non-compete agreements bar about 30 million American workers from freely quitting their jobs and going to work for rival companies or starting their own businesses. The FTC has called this practice exploitative and wants to ban it using its rulemaking power.

While non-compete agreements and clauses are often instituted to protect intellectual property and sensitive company information (more about this below), they can also restrict low-wage workers such as food service workers or essential workers like primary care physicians from seeking a similar job, within a reasonable distance from their old job.

Key features of the proposed regulation include:

  • The ban would prohibit employee non-competes in almost all circumstances.
  • The ban is both prospective and retroactive. Employers with preexisting non-competes would be required to rescind those agreements and inform both current and former employees that their restrictive covenants are no longer in effect.
  • Inconsistent state laws are preempted by the regulation.

While any such rule is likely to be challenged in court, employers should be prepared to pay close attention to their restrictive covenants throughout 2023. Understanding who and what you are restricting can help keep your covenants intact if any kind of ban is enacted.  

In particular, employers may be able to achieve most of their objectives by having confidentiality agreements that prohibit employees from taking or using things like customer lists and contact information or other truly proprietary material to a new employer (especially a competitor).  Also, non-solicitation agreements that prohibit a former employee from affirmatively soliciting other employees to leave and join a competitor may also survive this new rule.  As a matter of practice, we have historically preferred confidentiality and non-solicitation agreements because they are based upon preventing misappropriation of assets, as opposed to preventing a person from working where they choose.  In our experience it is easier to enforce confidentiality agreements and non-solicitation agreements than non-compete agreements, unless the person at issue gave the non-compete covenant in connection with the sale of their business. Be mindful that confidentiality agreements and non-solicitation agreements cannot be so broad in scope that they function as de facto non-compete clauses.

What Is the FTC Proposing?

Ban on Non-Competes and De Facto Non-Competes

The proposed regulation would ban not only employee non-compete agreements but also other agreements so broad as to “effectively preclude[] the worker from working in the same field.” The regulation also covers similar agreements with independent contractors, interns, and volunteers.

Rescission of Preexisting Agreements

The proposed rule would also require companies to rescind preexisting non-compete agreements within six months of the effective date of the new rule. Within 45 days of rescinding an employee non-compete, the employer would be reasonably obligated to notify both current and former employees of the rescission. 

Preemption of Inconsistent State Laws

Companies should note that the proposed regulation purports to preempt inconsistent state laws. This means that, as currently proposed by the FTC, even where an employer’s non-compete contracts are valid and enforceable under state law, the new FTC regulation would invalidate the contract anyway. However, any state laws that afford workers greater protection than is provided under the FTC’s regulation would remain in force.

Are There Any Exceptions to This Proposed Rule?

Sale of a Business or Business Unit

The FTC has proposed a single, narrow exception to the prohibition on employee non-competes: The ban would not apply to employee non-competes made in connection with the sale of a business or a business unit. However, the party so restricted must own 25% or more of the business or business unit being sold. 

Businesses Outside the Scope of the FTC Act

The FTC’s notice of proposed rulemaking also explains that some businesses may be out of the scope of the regulation’s coverage because they are outside of the scope of the FTC Act.  For instance, because certain banks, non-profits, common carriers, and others are exempt from the FTC Act, these entities would theoretically be exempt from the proposed ban on non-competes. However, even though non-profit institutions generally fall outside the scope of the FTC Act, the scope of this exemption is unsettled and can be difficult to parse. For instance, non-profits sometimes have for-profit parents and subsidiaries that the FTC Act would cover.

Limitation to Post-Employment Restrictions 

Finally, the FTC notes that the proposed regulation applies only to post-employment restrictive covenants between employer and employee. This means that restraints enacted while the employee is still employed—i.e., restrictions on what the worker may do during their active employment—would not be affected by the proposed regulation. Thus, an employer would remain able, within reason, to prohibit current employees from working part-time for a competitor. 

For instance, a taxi company would be within its rights to prevent its drivers from engaging in an off-hours “side gig” driving for a rideshare company during the course of their employment. However, the taxi company would be unable to prevent its drivers from going to work for that same rideshare company immediately after the termination of their employment.

Can the FTC Do This?

The FTC does not have unfettered or unlimited rulemaking power and has never tried anything of this magnitude before. We anticipate litigation will be brought, and these cases may raise challenges to the scope of the FTC’s rulemaking authority.

The FTC has the authority to promulgate “substantive rules” about what constitutes unfair methods of competition, according to a seminal 1973 case that set the precedent for its rulemaking authority. However, the facts of that case concerned a narrow rule about the posting of octane ratings on gasoline pumps. The rule at stake here is a broad, nationwide rule that would preempt competition laws in virtually every state and regulate billions of dollars in human capital. 

Next Steps for Businesses

First, companies can take advantage of the FTC’s 60-day comment period and add their voices to the administrative process. If your firm has thoughts on how the proposed regulation can be modified to suit the circumstances of your industry, speak up!

Next, look for opportunities to recruit talent. Regardless of your industry, top talent may be on the market without the added complexities of negotiating a garden leave or buyout package. While you may have some concerns about your own workforce, if you are looking to deepen your bench, this regulation and environment could be a fantastic growth opportunity for you.

Finally, review your own restrictive covenants. Are they fair? Do they stand up to your state’s law? Could they be enforced if you had to take one to court today? Be sure to pressure-test your existing agreements to see if they will need to be updated if the FTC makes drastic changes in the near future.