New FTC Rule Proposes Sweeping Ban on Noncompete Clauses for Workers

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A noncompete clause is a contractual term between an employer and a worker that blocks the worker from working for a competing employer, or starting a competing business, typically within a certain geographic area and period of time after the worker’s employment ends. While many jurisdictions have enacted legislation designed to curtail overly restrictive noncompete clauses and increase worker mobility, the FTC’s new proposed rule is the most significant and far-reaching – an outright ban with few exceptions. If enacted, this rule will impact employers of all types and sizes across a wide range of industries and will require nearly all employers to assess, and potentially modify, the ways in which they protect their confidential information.

The Proposed New Rule

The proposed rule would: 1) ban noncompete clauses as an unfair method of competition; 2) ban employers from entering into, or attempting to enter into, noncompete agreements with their workers; and 3) require employers to rescind existing noncompete clauses within 180 days of adoption of the final rule and to actively inform their workers that such contracts and clauses are no longer in effect. Below are some of the key features of the rule:

• Broad Scope: The proposed ban contains no exceptions based on entity (corporation, nonprofit, small business, etc.), position (all employees, contractors, interns, etc.), salary (unlike some state legislation, no distinction based on overtime exempt v. nonexempt), or industry.

• Broad Definition: Prohibited clauses would include not only overt noncompete clauses but also other contractual terms that amount to a “de facto.” The rule does not define this term but provided examples of de facto noncompetes include (1) a non-disclosure agreement “written so broadly that it effectively precludes the worker from working in the same field after the conclusion of the worker’s employment with the employer,” and (2) any contractual term requiring the worker to pay the employer or a third-party for training or other costs if the worker’s employment terminates within a specified time period and the required payment is not reasonably related to actual costs incurred for training.

• Uncertainty on Non-Solicitation: While the proposed rule is silent as to client non-solicitation provisions, the FTC notice states that “the definition of noncompete clause would generally not include . . . client or customer non-solicitation agreements” because these agreements do not generally prevent workers from competing with their employer. However, the notice cautions that non-solicits could function as “de facto.”

• Affirmative Rescission of Existing Noncompetes: Under the rule, employers must proactively provide written notice to current and former employees (unless the former’s contact information is not readily available) subject to noncompetes that the noncompete provision is rescinded.

• Limited Exceptions: The proposed rule would carve out an exception for noncompete clauses entered into by a person (a) selling a business or all of his or her ownership interest in the business or (b) selling all or substantially all of a business’s assets, where such person is a “substantial” owner, member or partner in the business at the time he or she enters into the noncompete. Franchisees and franchisors may also be exempt, though individuals who work for franchisees and franchisors are included.

• Supersedes State Law: The proposed rule would supersede all state statutes, regulations and other authority inconsistent with the rule, unless the state law provides greater protection for the worker, though it is hard to imagine a more sweeping ban.

When May The Rule Take Effect?

Currently, the FTC is inviting public comment on a number of topics, including: (1) whether franchisees should be covered by the rule; (2) whether senior executives should be exempted from the rule or subject to a rebuttable presumption rather than a ban; and (3) whether low- and high-wage workers should be treated differently under the rule. Comments must be submitted within 60 days of the date that the proposed rule is published in the Federal Register. The FTC will review the comments it receives and may make changes in a final rule, based on the comments and on the FTC’s further analysis of this issue. The rule could be finalized by the end of the year, and legal challenges to the final rule are expected to follow.

Proposed New Rule Is Part Of A Larger Trend Toward Federal Regulation Of The Employment Relationship.

On January 9, 2021, President Biden issued an Executive Order on Promoting Competition in the American Economy. A press release issued by the White House announced that the Executive Order would “[m]ake it easier to change jobs and help raise wages by banning or limiting non-compete agreements and unnecessary, cumbersome occupational licensing requirements that impede economic mobility.”

On January 4, 2023, a day prior to publishing the proposed new rule, the FTC issued a press release announcing a crackdown on non-compete restrictions and that, in connection with this effort, it had taken legal action against and subsequently entered into proposed consent orders with three companies and two individuals, “forcing them to drop noncompete restrictions that they imposed on thousands of workers,” including hourly workers, engineers, “quality assurance” employees, and other salaried employees in certain positions. In its complaints, the FTC said the restrictions constituted an unfair method of competition under Section 5 of the FTC Act. The FTC should publish the consent agreement packages in the Federal Register soon for public viewing.

Impact On Employers

In addition to efforts during the rule-making process to ameliorate the sweeping effects, it is anticipated that there will be legal challenges brought to enjoin and overturn the rule, so it would be premature for any employer currently utilizing noncompete clauses to immediately cease doing so. That said, there are steps that employers should consider to be prepared for the change that are also useful regardless of the enforceability of the rule for keeping confidential information and intellectual property suitably protected. These include:

• Review agreements and policies relating to confidentiality and non-solicitation to ensure they appropriately protect confidential information and trade secrets in the event noncompete provisions are no longer available and to also assess if they would qualify as a “de facto.”
• Coordinate with IT and security professionals to make sure that electronic systems have proper controls and sensitive data is restricted to those that need that information.
• Concerned parties may submit comments directly to the FTC. Comments should identify specific and concrete concerns and the particular impact on your business, including costs and potential adverse effects.
• Continue to monitor the progress of the FTC’s proposed rule, including through our future client alerts. If adopted, employers will have a limited window in which to notify workers that their noncompete clauses are rescinded.

For more information and analysis of this important topic, please join us for a webinar on January 17, from 12:00 – 1:00 p.m. EST. This complimentary program will qualify for 1 hour of PA CLE substantive credit. Register here.

Co-authors Jonathan Krause, Litigation Chair and Teri Sherman, partner are members of the Labor & Employment practice group at Klehr Harrison.