The FTC Proposes Rule to Ban Noncompete Clauses: What’s Next and What to Do

The Proposed Rule

On July 9, 2021, President Biden signed an “Executive Order on Promoting Competition in the American Economy”, which encouraged the Federal Trade Commission (the “FTC”) to “exercise the FTC’s 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.”

In accord with the President’s Executive Order, on January 5, 2023, the FTC proposed a new rule that would ban employers from imposing or enforcing non-competes on their workers as an “unfair method of competition” under Section 5 of the FTC Act. The proposed rule follows FTC settlements last week with three companies and two individuals for allegedly illegal non-compete agreements imposed on workers.‎ Specifically, the proposed rule would make it illegal for an employer: (1) to enter into or attempt to enter into a non-compete with a worker; (2) maintain with a worker a non-compete clause; or (3) represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause. The proposed rule would also require employers to rescind existing non-competes and actively inform workers that they are no longer in effect. The proposed rule would apply to all independent contractors as well as employees and is not limited to lower-wage employees as had been anticipated. It is unclear under the proposed rule whether forfeitures or clawback of compensation would be prohibited as forms of non-competes.

The FTC has recognized certain exceptions to the proposed rule. These include:

• Other types of restrictive covenants such as non-disclosure and customer non-solicitation agreements unless they are so unusually broad in scope that they, in effect, function as non-competes.
• Non-competes entered into outside of the employment relationship, such as in the context of a franchisee-franchisor relationship.
• Non-competes entered in connection with the sale of the business where the party restricted by the non-compete is an owner or partner in the business with at least a 25% ownership interest in the business being sold.

The proposed rule purports to supersede any State statute, regulation, order, or interpretation to the extent that such statute, regulation, order, or interpretation is inconsistent with the proposed rule.

What’s Next

In its Notice of Proposed Rule Making, the FTC has invited the public to submit comments on the rule. Comments are due 60 days after the Federal Register publishes the proposed rule. The FTC will review the comments submitted by the public and make any changes, in a final rule, based on the comments and the FTC’s further analysis of the issue.

Considering the scope of the proposed rule (the FTC estimates that 20% of American workers are subject to non-compete provisions) and the business interests that would be impacted by it, we expect that the FTC will receive a large number of comments on the proposed rule. We expect that many of these comments will suggest narrower versions of the non-compete ban pursuant to which, for example, non-competes would be banned only for certain workers, such as low wage workers, or non-competes would be enforceable only under certain circumstances, such as where they are reasonable in time and geographic scope.

Once a final rule is published, it would go into effect 180 days later. We expect, however, that any final rule banning non-competes will be challenged in court and that those challenging the rule will seek injunctive relief preventing the rule from going into effect. We expect significant legal challenges to any final rule, including, that the FTC lacks statutory authority to promulgate substantive competition rules under the FTC Act, as well as constitutional challenges ‎that the FTC exceeded the scope of its authority under the non-delegation doctrine and the major questions doctrine as the Supreme Court addressed in its June 2022 ruling with respect to rulemaking by the EPA, and that the rule should not preempt well-established state laws that have long governed noncompetes.

Because of the large number of expected comments and likely legal challenges to the rule, we believe that there will be a significant amount of time (perhaps a year or more) before any non-compete ban goes into effect, assuming it survives legal challenge.

What Should Employers Do Now?

We are working with clients and trade associations who are considering providing comments to the proposed rule on the issues of most concern to them. Please contact us for more information about commenting.

Now is also the time to assess the content of your existing policies and agreements with respect to post-employment restrictions to make sure they are not prohibited or overbroad under existing state or foreign law. Orrick is well versed on the law of non-competes with respect to all 50 states as well as the laws of foreign jurisdictions and can assist in a review of substance and the extent of your exiting non-compete agreements.

In addition, to avoid future issues, if you would not share certain confidential information with certain workers absent an enforceable non-compete, you may want to consider other ways to protect confidential information and generally shore-up your NDA’s and other post-employment restrictions on the use of confidential company information. Orrick can assist in such a review.

For further information please reach out to any of the authors of this Alert or to your Orrick relationship partner.