On January 5, 2023, the FTC announced a proposed rule that would ban virtually all non-compete clauses, with extremely limited exceptions.   The FTC’s reasoning for proposing this rule is that non-compete agreements suppress wages, hamper innovation, and block entrepreneurs from starting new businesses. The FTC estimates that the new proposed rule could increase wages by nearly U.S. $300 billion per year and expand career opportunities for about 30 million Americans.

The FTC decided to actively address this issue in response to a July 2021 executive order issued by President Joe Biden entitled, “Promoting Competition in the American Economy.” This executive order steered the FTC to exercise its “statutory rulemaking authority under the Federal Trade Commission Act to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”

The FTC’s proposed rule would make it illegal for an employer to: (i) enter into or attempt to enter into a noncompete with a worker; (ii) maintain a noncompete with a worker; or (iii) represent to a worker, under certain circumstances, that the worker is subject to a noncompete.

The proposed rule would apply to employees and independent contractors and anyone who works for an employer, whether paid or unpaid. It would also require employers to rescind existing noncompete agreements and actively inform workers that they are no longer in effect.

The proposed rule would generally not apply to other types of employment restrictions, like non-disclosure agreements. However, other types of employment restrictions could be subject to the rule if they are so broad in scope that they function as noncompete agreements.

For purposes of this proposed rule, the FTC views 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.”  Clause titles would not be the focus of whether a clause is a non-compete provision; instead, the FTC would utilize a functionality test to determine if a clause is a noncompete agreement.   

The functionality test would entail an analysis to see if a contractual clause 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 an existing employer.  The FTC used the example of 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.

The proposed rule would not apply to a non-compete clause entered into in a sale-of-business context. This includes agreements between a person selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or someone who is selling all or substantially all of a business entity’s operating assets. This exception only applies when the person restricted by the non-compete clause is a substantial owner of, or a substantial member or substantial partner in, the business entity at the time the person enters into the non-compete clause.  The FTC currently views a “substantial owner” as an owner who has a 25% ownership interest in a business entity.  This ownership percentage interest may change though in the final rule.

The proposed rule states that it supersedes any inconsistent state statute, regulation, order, or interpretation. However, the FTC does provide that state statutes, regulations, orders, or interpretations that afford greater protection to workers would be allowed. For example, a state law prohibiting non-competes and non-solicitation provisions would be permissible; a state law allowing non-competes would not.

Since this rule was proposed back in early January of this year, various groups have questioned whether the FTC has the authority to even try and implement a federal rule that would supersede state authority on this subject.  For right now though, we are in the midst of a 60-day notice and comment period during which the public can provide input concerning the proposed rule. The FTC may extend the time period past the current due date of March 20, 2023 though.  After the comment period closes, the FTC could move to finalize the rule or adopt alternatives. 

If the FTC decides to enact this rule as it is presently stated, then the rule still would not become effective until 60 days after publication of the final rule in the Federal Register.  The Federal Register contains rules and regulations which are regulatory documents having general applicability and legal effect.  In addition, there would be a 180-day compliance period (running from the date of publication) during which employers would be allowed to work towards compliance.

As a business owner, it would be prudent to: (i) ask whether the non-compete clause(s) your company uses are necessary to protect your legitimate interests or they can be revised to still accomplish the business goals; (ii) review your business trade secrets and trade secret policies you have in place or should have in place to help protect the trade secrets in conjunction with the perceived need to have non-competitive clauses.  Now would be the time to consider revising those policies and procedures in the event this proposed rule does become a final rule to then better protect your business trade secrets; and (iii) even consider submitting a responsive comment to the FTC during the review period to let the regulators know how you feel about this proposed rule.  Regardless of what happens though, Hollister Legal Services, PLLC is here to provide feedback and advice if you would like to have further discussions on this topic.