Proposed FTC Rule Could Ban Most Non-Compete Agreements

Employee restrictive covenants — particularly non-compete agreements — have been debated (and litigated) for many years. Several state legislatures have been working to narrow the scope of restrictive covenants and the circumstances under which they can be enforced. Five states and the District of Columbia have already passed legislation designed to limit the use of non-compete agreements. At least 18 more states have proposed or pending legislation on their agenda. Some states have banned or plan to ban almost all non-compete agreements. Other states prohibit non-compete agreements unless the individual earns above a certain salary level.

At the federal level, efforts by Congress to restrict the use of non-compete agreements have not been successful. A proposed amendment to the Fair Labor Standards Act (FLSA), introduced in July 2021, would have banned the use of non-compete agreements with employees who are non-exempt under the FLSA. The legislation was referred to the Senate Committee on Health, Education, Labor, and Pensions, and further action has yet to be taken.

President Biden’s 2021 Executive Order on Promoting Competition in the American Economy charged the Federal Trade Commission (FTC) to “curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.” The FTC has recently taken action to fulfill that directive.

In early January 2023, the FTC proposed a rule that effectively bans all non-compete clauses in employee agreements. There is a small carve-out that preserves the ability to use non-compete agreements associated with selling a business. The proposed rule characterizes non-compete clauses as an “unfair method of competition” and not only prohibits their use in the future but also requires employers to rescind existing non-compete agreements and notify current and former employees.

If enacted, this federal rule would preempt and supersede any state statute or regulation inconsistent with the final rule’s provisions unless the state law provides greater worker protections.

Interested parties can submit comments about the proposed rule until March 10, 2023. The FTC may make changes to the rule following the public comment period. The FTC will indicate a compliance period

when the new rule is finally published.

However, litigation is possible as soon as the rule is published, challenging the FTC’s authority to enact such a broad, national rule. The argument for overreach is a strong one. The FTC cites Section 5 of the FTC Act — which prohibits unfair methods of competition and unfair practices affecting commerce — to support its rulemaking authority. However, the agency’s authority under Section 5 is not unlimited. Banks, federal credit unions, air carriers, common carriers, meatpackers, poultry dealers, and nonprofits are exempt.

Recommendations for employers

For now, even though employers in many states can continue to use non-compete agreements, it is clear that these agreements are under increased legal scrutiny. Now would be a good time for employers to review these agreements and evaluate their enforceability. Courts routinely decline to enforce non-compete agreements if they find them unnecessarily broad. In doing this review, ask:

• What business interests need protection? Trade secrets, specialized training, or other commercially sensitive information are examples of legitimate business interests requiring protection.
• Which employees need to sign? It’s best only to use non-compete agreements with employees whose departure and subsequent employment by a competitor would pose a risk to the business. Courts have routinely invalidated non-compete agreements signed by fast-food workers, manufacturing employees, and other similar types of workers because their departure from the company did not threaten any legitimate business interest.
• What are the current state regulations? Restrictions on non-compete agreements vary from state to state. For a multi-state employer, a general non-compete agreement may be enforceable in one state but unenforceable in another state.

Given the strong possibility of this new federal regulation taking effect soon, employers should also consider whether they can protect their business interests with other types of agreements. Even if non-compete agreements are outlawed entirely later this year, employers can still include legally effective language in their employment contracts, including provisions protecting confidential information and prohibiting a former employee from soliciting customers with whom that former employee had contact, to protect their business interests.

If you need assistance with evaluating and restructuring your employment contracts in light of this pending rule — or have any questions regarding the regulatory investigation and resolution process at the FTC — don’t hesitate to contact us.

About the Authors: Steven L. Winer and Lindsay E. Nadeau

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