FTC Proposes Rule to Ban Non-Compete Agreements
The Federal Trade Commission (FTC) last week proposed a new rule that would impose a near-complete ban on non compete agreements or clauses. The FTC intends for this prohibition to extend to all workers and would require employers to rescind existing noncompete agreements or clauses within 180 days of the publication of the final rule.
The proposed rule grew out of President Biden’s July 9, 2021, executive order on promoting competition in the economy and scrutinizing anticompetitive workplace practices. The day before the proposed rule was released, the FTC announced enforcement actions against three companies and two individuals for illegally imposing non-compete restrictions on workers, claiming for the first time that their non-competes were unfair methods of competition.
The proposed rule represents a significant expansion of the FTC’s regulatory reach, and ILMA and many other business groups doubt that the commission has this authority. Any final rule can expect to face legal challenges.
“ILMA members need not scramble at this time,” said ILMA CEO Holly Alfano. “However, members may need to explain to employees that non-compete agreements are still in effect and remain subject to state law.”
What's in the Proposed Rule?
The proposed rule would make it an unfair method of competition under the FTC Act for
an employer to:
- Enter or attempt to enter into new non-compete clauses.
- Maintain pre-existing non-compete clauses.
- Represent to workers, under certain circumstances, that the worker is subject to a non-compete.
The FTC broadly defines 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.” The rule includes a functional test that prohibits such restrictions if they are so broad as to have the effect of preventing the worker from seeking or accepting other employment.
The prohibitions would not include other common contractual restrictions, such as nondisclosure or confidentiality agreements, or agreements for repaying training costs, providing for workers who move to a competing company to forfeit deferred compensation or benefits, or restricting a worker from soliciting customers or other workers. However, the FTC warns that these types of agreements could be deemed non-competes if they are written so broadly that they meet the functional test.
The definition of a worker in the proposed rule includes interns, volunteers, apprentices, independent contractors and gig economy workers, but not a franchisee in the context of a franchisee-franchisor relationship.
Existing Non-Compete Clauses
The proposed rule would require employers to rescind all existing non-compete agreements within 180 days after publication of the final rule and provide notice to current and former employees. Employers that use the FTC’s model notice language would have a safe harbor from enforcement.
Sale of Business Exception
The proposed rule includes an exception for non-competes with someone who is selling a business or ownership interest in a business, or selling all or substantially all of a business’s operating assets. However, the exception only applies to a “substantial owner, substantial member or substantial partner” who holds at least 25% ownership. This carve-out is consistent with most state-based restrictive covenant laws.
Preemption of State Law
The proposed rule expressly preempts any state statute, regulation, order or interpretation that is inconsistent with the rule. The FTC intends for the rule to be a “regulatory floor, not a ceiling.”
Key Takeaways for ILMA Members
If finalized as proposed, this rule will drastically change the way employers, including ILMA members, use post-employment, non-compete restrictions. The FTC intends for its prohibition to apply to virtually every worker—including independent contractors and unpaid workers—and employer in the country.
The commission’s use of the functional test to determine a non-compete clause raises red flags for ILMA’s General Counsel, Jeff Leiter. “Non-disclosure agreements, as opposed to non-competes, are broadly written by Association members to protect trade secrets and confidential information, and they historically have been subject to lighter judicial scrutiny than true non-competes where employers show that they have taken reasonable steps to protect the confidentiality of that information,” Leiter said. “Under the proposed rule, employers may have to tailor existing agreements to comply with the rule while still leaving them broad enough to show the employer is taking reasonable measures to protect its valuable, confidential information.”
Leiter also questions the extent to which the definition of a non-compete clause and functional test will cover other types of restrictive covenants used by employers, especially employee and customer non-solicitation agreements. For example, could a non-solicitation clause that prevents the worker from “accepting” business from a former customer be deemed a de facto non-compete clause?
ILMA intends to submit comments on the proposed rule. Members with any questions or concerns should contact Holly Alfano at halfano@ilma.org or 571-206-8803.