The Notice would ban all existing and future non-compete agreements with workers, with a narrow exception in connection with the sale of a business by any individual holding at least a 25% interest in such business.
January 9, 2023
Thanks to Pillsbury Winthrop Shaw Pittman LLP
- The FTC has published a proposed rule for a nationwide ban on non-compete agreements with workers, including non-employees who perform work for employers.
- The proposed rule includes an exception for owners of at least 25% of a business in connection with the sale of such business, but the FTC is soliciting comments on whether the final rule should include additional exceptions.
- Any final rule is likely to include additional changes and face legal challenges to the FTC’s authority.
Citing its interest in promoting competition and opening up “better employment opportunities” for workers, the Biden Administration is moving forward with a proposal to prohibit a feature of many U.S. employment relationships valued by employers and of significant importance in M&A transactions; non-competition agreements. Rather than looking to Congress to enact legislation to achieve this goal, the Administration is relying on the authority of the U.S. Federal Trade Commission (FTC) to enforce and engage in rulemaking under existing antitrust laws.
In July 2021, President Biden signed an Executive Order directed at promoting competition in which he encouraged the Chair of the FTC “to exercise the FTC’s statutory rulemaking authority, under the Federal Trade Commission Act, to curtail the use of non-compete clauses and other clauses or agreement that may unfairly limit worker mobility.” The FTC was listening. In November 2022, the FTC releases a policy statement to reinvigorate Section 5 of the Federal Trade Commission Act (FTC Act), which bans unfair methods of competition. Then, on January 4, 2023, the FTC announced that it found that three firms had engaged in unfair competition by using illegal non-compete agreements with their workers.
The very next day, on January 5, 2023, the FTC released a Notice of Proposed Rulemaking (NPRM) proposing to ban all non-competes entered into between employers and workers. If ultimately adopted, the rule will apply both prospectively and retroactively, including with respect to the estimated 30 million Americans who are currently subject to non-compete agreements. This proposed rule has implications for companies across the entire country – even companies operating solely in jurisdictions like California that already ban non-competes – and for the merger and acquisition process. The proposed rule contains only a single, narrow exception for non-competes in the sale of business context: a person selling a business entity, or otherwise disposing of all of their ownership interest in the business entity, may be bound by a non-compete only if they own 25% or more of such business. This narrow exception is far more restrictive than even California’s sale of business exception. The proposed rule also applies beyond the employment context, covering workers who fall outside the traditional definition of “employees.”
The FTC voted 3-1 to publish the NPRM, with Commissioner Christine S. Wilson voting no and issuing a dissenting statement attacking the rule as a departure from “hundreds of years of legal precedent” and arguing that the rule “will trigger numerous and likely successful legal challenges regarding the Commission’s authority.”: The FTC seeks public comment on several topics, including whether the rule should impose a categorical ban on non-compete clauses or a rebuttable presumption of unlawfulness, and whether certain categories of workers should be exempted from or treated differently under the rule, such as senior executives or higher wage workers. Comments are due within 60 days of the rule’s publication in the Federal Register.
The rule proposes an effective date of 60 days, and a compliance date of 180 days, after publication of a final rule in the Federal Register.
According to the FTC, researchers have found that use of non-competes has negatively affected competition in labor markets, resulting in reduced wages for all workers across the labor force, both those with and those without non-competes. The FTC estimates that the proposed rule could increase workers’ earnings across industries and job levels by $250 billion to $296 billion per year. The FTC further asserts that researchers have found that non-competes have negatively affected competition in product and services markets and innovation.The FTC, therefore, pursuant to Sections 5 and 6(g) of the FTC Act, deems employers’ use of non-competes an unlawful “unfair method of competition.” Specifically, the proposed rule provides that it is an unfair method of competition for an employer to enter into or attempt to enter into a non-compete clause with a worker, to maintain with a worker a non-compete clause, or, under certain circumstances, to represent to a worker that the worker is subject to a non-compete clause. In addition, the FTC intends for this to be the governing law of the United States. The proposed rule contains an express preemption provision noting that the “Rule shall supersede any state statute, regulation, order, or interpretation to the extent that such statute, regulation, order, or interpretation is inconsistent with the Rule.”
Significantly, the proposed rule applies to “workers,” broadly defined to include any “natural person who works, whether paid or unpaid, for an employer,” even if not a statutory employee. The term “worker” includes “without limitation, an employee, individual classified as an independent contractor, extern, intern, volunteer, apprentice or sole proprietor who provides a service to a client or customer.”
The proposed rule focuses only on non-competes governing work restrictions post-employment and only on those between employers and workers and not, for example, on non-competition agreements between businesses. The Department of Justice, however, already takes the position that business-to-business agreements not to poach each other’s workers may be considered unlawful under the Sherman Act.
The proposed rule prohibits non-competes and their functional equivalents. The Preamble to the proposed rule states that the definition of non-compete clause “would generally not include other types of restrictive employment covenants – such as non-disclosure agreements (NDAs) and client or customer non-solicitation agreements – because these covenants generally do not prevent a worker from seeking or accepting employment with a person or operating a business after the conclusion for the worker’s employment with the employer.” The Preamble cautions, however, that “such covenants would be considered non-compete clauses where they are so unusually broad in scope that they function as such.”
In addition to prohibiting employers from entering into non-compete clauses with workers, the proposed rule would require employers to rescind existing non-competes and provide notice to applicable workers that their non-compete clause is no longer in force and effect. The proposed rule includes model language that satisfies this notice requirement and establishes a safe harbor whereby an employer can satisfy the rule’s requirement to rescind existing non-competes by simply providing relevant workers with a notice in compliance with the notice requirement.
As noted above, the proposed rule includes a limited exception for non-competes between the seller and buyer of a business where the party restricted by the non-compete is an owner, member, or partner holding at least a 25% ownership interest in a business entity. This exception is likely to send shockwaves through the private equity world and will have a profound impact on mergers and acquisitions if the rule takes effect.
The proposed rule unfortunately leaves many questions unanswered. For example, it is not clear if:
- A partner in a partnership, such as a worker who holds profits interests in an LLC taxed as a partnership and receives income reported on a K-1, would be deemed a covered “worker.”
- A distinction can be made between a post-employment non-compete and a non-compete that has a fixed time-based duration applicable regardless of employment status.
- Companies could still impose restrictions on competitive acts in exchange for the grant of equity or deferred compensation to an employee, and, if such employee engages in competitive acts, whether companies would be able to claw back such grants.
Commenters should request that the final rule address these more nuanced issues.
The Proposed Rule’s Uncertain Future
The substance of this proposed rule is likely to change given the FTC itself is soliciting input on the several key matters, including whether non-competes for senior level or high-wage employees should remain viable. Moreover, as Commissioner Wilson notes in her Dissenting Statement, the rule is likely to trigger numerous legal challenges. Indeed, the U.S. Chamber of Commerce almost immediately issued a statement questioning the authority of the FTC to promulgate such a rule: “Today’s actions by the Federal Trade Commission to outright ban non-compete clauses in all employer contracts is blatantly unlawful. Since the agency’s creation over 100 years ago, Congress has never delegated the FTC anything close to the authority it would need to promulgate such a competition rule. The chamber is confident that this unlawful action will not stand.”
Commissioner Wilson highlights three likely arguments in response to the proposed rule in her Dissenting Statement: (i) the FTC lacks the authority to engage in “unfair methods of competition” rulemaking under the FTC Act; (ii) under the major questions doctrine, the rule is a major question requiring clear Congressional authorization to impose a regulation banning non-competes and such authorization does not exist; and (iii) under the non-delegation doctrine, Congress cannot delegate its legislative power to the FTC.
These legal challenges could take months, if not years, to reach an ultimate resolution, leaving employers in a difficult position with how to manage non-competes.
Employers Must Ensure Current Compliance with Applicable State Law
Non-competes are not only under attack by the FTC; they are increasingly under attack and disfavored by legislatures across the country. While waiting for a final answer on the applicable federal non-compete law, employers must ensure that they are compliant with the increasingly varied non-compete state laws across the country.
California, North Dakota and Oklahoma, for example, each have general prohibitions of non-competes (and California and North Dakota also prohibit non-solicits of customers and Oklahoma permits only non-solicits of an employee’s established customers).
An increasing number of states permit non-competes only for exempt employees or employees making more than a statutory minimum. As of the date of this Alert, these states include Colorado, Illinois, Maine, Maryland, Massachusetts, Nevada, New Hampshire, Oregon, Rhode Island, Washington, and Virginia as well as the District of Columbia. Some of the statutory minimums are quite high. For example, as of the date of this Alert, employees must make at least $150,000 to have a non-compete in the District of Columbia, $101,250 in Colorado, and $116,593.18 in Washington.
An increasing number of states also have laws prohibiting forum selection and choice of law clauses designating any jurisdiction other than their own state. Such laws are currently in place in California, Colorado, Massachusetts, and Washington.
In addition, an increasing number of states have enacted laws prohibiting employers from enforcing non-competes without pay during the restricted period, such as Massachusetts and Oregon.
Next Steps for Employers
In this current climate of remote work and employees working across the country, employers are well advised to work with their employment counsel to ensure that their current restrictive covenant agreements comply with all potentially applicable state laws.
In addition, in preparation for the possibility of a nationwide ban on non-competes, employers should work with their employment and intellectual property counsel to ensure that their existing agreements independently offer sufficiently robust protection of their confidential, proprietary and trade secret information.