The Federal Trade Commission Proposes New Rule to Ban Employers From Enforcing Non-Compete Agreements

On Jan. 5, the Federal Trade Commission (FTC) proposed a new rule that would ban employers from enforcing non-compete agreements on their workers. Non-competes prohibit employees from leaving their employment and competing against the employer by working for a business competitor and/or in a specific geographic area for a specific time period.

Employers often want these agreements for critical employees, such as managers or salespeople, who are provided business training and access to customers, tactics, pricing, etc. that employers are concerned will be used against them by the employee in future employment. If this sweeping proposed rule goes into effect, it will significantly impact many industries where these agreements are a common practice and would supersede any inconsistent state law that has permitted such agreements.

In its announcement, the FTC described non-compete agreements as “a widespread and often exploited practice that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses.”

As justification for the rule, the FTC has made a preliminary finding that non-compete agreements constitute an unfair method of competition that violates Section 5 of the Federal Trade Commission Act. The FTC estimated that its new proposed rule would affect 30 million Americans and increase wages by nearly $300 billion per year.

The FTC’s proposed new rule would make it illegal for an employer to:

• • Enter or attempt to enter into a non-compete with a worker, including employees and independent contractors;
  • Maintain a non-compete with a worker; or
  • Represent to a worker, under certain circumstances, that the worker is subject to a non-compete.
    
    

The proposed rule also would require employers to rescind any existing non-competes and inform workers, including former workers, that they are no longer in effect and will not be enforced. The proposed rule includes model language of the notice for employers, but different language may be used provided it satisfies the notice requirement.

The proposed rule does not specifically prohibit non-solicitation clauses. These narrower agreements only prohibit employees from soliciting their former co-employees to leave their employment or the customers of their former employer.

However, the proposed rule includes a “functional test” to determine if a contractual term is a prohibited non-compete clause. This test defines a term as a de facto non-compete clause if “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.” 

The proposed rule includes the example of a “non-disclosure agreement” that is “written so broadly that it effectively precludes the worker from working in the same field.” This broad definition could be argued, in certain cases, to encompass non-solicitation agreements and even common “confidentiality” agreements.

The proposed rule does exempt from the ban non-compete agreements entered by a person who is selling a business or selling all or substantially all the business’s assets. The exception only applies if a person restricted by the agreement is “a substantial owner of, or substantial member or substantial partner in” the business entity.

The FTC has opened a 60-day comment period before final implementation of the rule. If it goes into effect, the rule would be effective 180 days after publication.

Employers with existing non-compete agreements should follow progress of this proposed rule closely and consult with legal counsel about the enforceability of their current agreements. Employers also should carefully consider whether to enter any new non-competes before there is a decision on the proposed rule. Employers should also prepare for possible implementation of the rule, specifically the rescission notice requirement, and consider with counsel alternatives to their existing agreements that might protect their business interests.

It will not be a surprise if there is litigation filed to stop or alter the FTC’s proposed rule.  We will monitor the comment period and any litigation on the proposed rule, and provide additional updates on this subject as may be warranted.

Please reach out to Michael E. Turner or any member of Phelps’ Labor and Employment team with questions or for advice and guidance.