On January 5, 2023, the Federal Trade Commission (“FTC”) issued a notice of proposed rulemaking that, if implemented, would prevent employers from entering into non-compete clauses with workers, and require employers to rescind existing non-compete clauses. This action comes one day after the FTC obtained its first-ever consent agreements against three companies for imposing non-compete restraints on workers, on the theory that it was in violation of Section 5 of the FTC Act, which generally prohibits “unfair methods of competition.”
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Proposed Rule
At present, the enforceability of non-competition provisions is a matter of state law, and the states vary in their views of such provisions.
Under the proposed national rule, it would be an “unfair method of competition for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non-compete clause; or 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.” A non-compete clause is defined in the proposed rule 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,” and includes a “contractual term that is a de facto non-compete clause because 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 prohibition would extend not only to employees, but also to other work arrangements, including independent contractors, interns, externs, volunteers or a “sole proprietor who provides a service to a client or customer.”
The proposed rule would also require “an employer that entered into a [pre-existing] non-compete clause with a worker” to “rescind the non-compete clause” no later than 180 days after the final rule is published. To rescind existing non-compete clauses, employers would be required to “provide notice to the worker that the worker’s non-compete clause is no longer in effect and may not be enforced against the worker.” That communication would have to be “individualized” and “on paper or in a digital format such as, for example, an email or text message.” Such notice must be delivered “within 45 days of rescinding the non-compete clause.” This requirement applies both to existing and former workers, to the extent “the worker’s contact information [is] readily available.”
The proposed rule contains a narrow sale-of-business exception, which is applicable only to “a person who is selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or by a person who is selling all or substantially all of a business entity’s operating assets, when the person restricted by the non-compete clause is a substantial owner of, or substantial member or substantial partner in, the business entity at the time the person enters into the non-compete clause.” As noted below, the FTC is specifically seeking comments from the public on whether senior executives and high-wage earners also should be excluded from the proposed ban.
If it were adopted, the proposed rule would likely face prompt legal challenge. As FTC Commissioner Noah Phillips explained in 2020, the FTC has never before issued a competition rule that relies solely on the FTC Act’s general prohibition of “unfair methods of competition.” Commission Phillips at the time noted “the traditional commitment of the issue to the states” and lack of historical precedent, and also raised concerns about whether Congress had appropriately delegated to the FTC the authority to issue a rule banning non-compete agreements. The Supreme Court has recently applied similar reasoning to the Commissioner’s final point in its January 2022 decision striking down a Department of Labor rule that required most employers to mandate COVID vaccination, writing, “Administrative agencies are creatures of statute. They accordingly possess only the authority that Congress has provided.” NFIB v. OSHA, 142 S. Ct. 661, 665 (2022). Challenges to the proposed rule may also arise under the “major questions doctrine,” which, as articulated by the Supreme Court in June 2022, considers whether agencies are “asserting highly consequential power beyond what Congress could reasonably be understood to have granted.” West Virginia v. EPA, 142 S. Ct. 2587, 2609 (2022). “Under that doctrine’s terms, administrative agencies must be able to point to clear congressional authorization when they claim the power to make decisions of vast economic and political significance.” Id. at 2616 (Gorsuch, J., concurring). Additionally, under the Congressional Review Act, Congress is entitled to a 60-day period to review the rule, and during that period could pass a joint resolution disapproving the rule, which would require either approval by the President or, if the President vetoed, an override of the veto by a supermajority of Congress.
The FTC Commissioners voted 3-1 along partisan lines to issue the proposed rule, with the sole Republican commissioner, Christine Wilson, voting no. In her dissenting statement, Commissioner Wilson explained that the proposed rule “represents a radical departure from hundreds of years of legal precedent that employs a fact-specific inquiry into whether a non-compete clause is unreasonable in duration and scope, given the business justification for the restriction.” Commissioner Wilson noted her expectation that the “Commission’s competition rulemaking authority itself certainly will be challenged,” including under the “major questions doctrine” addressed in West Virginia v. EPA, as the “Commission lacks clear Congressional authorization to undertake this initiative.” Commission Wilson concluded that the “proposed rule will lead to protracted litigation in which the Commission is unlikely to prevail.”
Once the proposed rule is published in the Federal Register, the public will have 60 days to submit comments. The FTC stated that, in particular, it is seeking comments on (i) whether franchisees should be covered by the rule; (ii) whether senior executives should be exempted from the rule, or subject to a rebuttable presumption rather than a ban; and (iii) whether low- and high-wage workers should be treated differently under the rule.
Recent FTC Enforcement Actions
On January 4, 2022—one day prior to the issuance of the proposed rule—the FTC announced that it had, for first time, filed complaints and obtained consent agreements against three companies to “forc[e] them to drop noncompete restrictions that they imposed on thousands of workers.” The complaints, which are based on Section 5 of the FTC Act, are against companies that employ low-wage security guards and glass container manufacturing workers. Under the consent agreements, the companies agreed to cease and desist from entering into or enforcing non-compete agreements with their workers.
Commissioner Wilson dissented from both consent agreements, noting (among other things) that, in her view, the FTC should not “condemn conduct summarily as an unfair method of competition based on little more than the assignment of adjectives” and that she has “seen no evidence of anticompetitive effects that would give [her] reason to believe that respondents have violated Section 5 of the FTC Act.” Commissioner Wilson’s dissents are available here and here.
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The FTC’s proposed rule follows President Biden’s July 2021 executive order urging the FTC to ban or limit non-compete agreements. Our memorandum on that order is available here.
The proposed rule is the latest development in a string of recent actions seeking to regulate employment-related agreements at a federal level. Our blog post about the “Speak Out Act,” which makes non-disclosure or non-disparagement agreements signed before a dispute arose unenforceable in certain contexts with respect to claims of sexual assault or sexual harassment, is available here. Our memorandum on related legislation that prohibits mandatory arbitration of sexual assault and sexual harassment claims is available here.