The US Federal Trade Commission (“FTC”) is following through on its commitment to more closely police competition issues in labor markets. As we reported previously, President Biden tasked the agency with focusing on labor-related competition issues, including the impact of post-employment non-compete agreements. On January 5, 2023, the FTC announced a proposed rule that would institute a near-total ban on such clauses, with a limited exception for certain non-competes executed in M&A transactions.
The proposal closely follows the FTC’s announcement of consent agreements in which three companies agreed to cease the use of post-employment non-competes in light of the FTC’s allegations that they constituted “unfair methods of competition” in violation of Section 5 of the FTC Act. The enforcement actions and the proposed rulemaking are the FTC’s first attempt at implementing a more expansive use of its Section 5 authority. These actions foreshadow likely increased FTC enforcement in both the labor context and in other areas of business conduct traditionally viewed as outside the FTC’s purview.
It will take time for the proposed non-compete rule to be finalized and implemented, and the FTC is likely to face legal challenges to its authority to implement such a rule, if it is adopted. However, if it were to go into effect, it could have significant implications given the ubiquitous use of non-competes in the employment context in certain states and in the M&A context. The rule would, among other things:
- supersede any “inconsistent” state laws regulating non-competes, replacing state-specific employment laws and policies with a single federal rule;
- eliminate the existing and long-standing “reasonableness” assessment of non-competes under antitrust law that allows for business justifications in certain circumstances, such as preserving the goodwill of a business being transferred or protecting trade secrets; and
- potentially undercut the value of certain acquisitions where a significant driver lies in the transfer and retention of key talent, particularly acquisitions in the tech space.
The Proposed Non-Compete Rule
The proposed non-compete rule 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.” This definition excludes other types of restrictive covenant clauses (such as confidentiality and customer and employee non-solicit clauses), provided that those clauses are not “de facto” non-compete clauses, drafted in a manner that would prevent the individual from obtaining new employment. The term “worker” is broadly drafted by the FTC to include not just senior executives and other employees, but also independent contractors, externs, interns, volunteers, apprentices, and sole proprietors.
In addition to banning employers from entering into new post-employment non-compete clauses, the proposed rule would also make it illegal to maintain them and would require all employers to notify their workers, prior to the proposed non-compete rule’s compliance date, that they are rescinding all of their existing clauses. It also would prevent employers from representing to workers that they are subject to post-employment non-competes.
The rule’s ban on post-employment non-compete clauses is almost categorical. Unlike many state non-compete limitations, it includes no exceptions for high earners, senior executives, or workers with highly specialized skills. The FTC’s rationale for a sweeping ban is that non-compete clauses are so harmful to workers and the market that there should be no exceptions, except for a limited sale-of-business exception. The exception would allow an acquiring employer to agree to a post-employment non-compete clause with a worker who holds at least a 25% ownership interest in an acquired business. We note that in California, which, among US states, has taken the lead on restricting non-compete clauses, the sale-of-business exception is commonly relied upon to enforce non-compete clauses against founders, executives, or other employees who hold significantly less than a 25% ownership interest in an acquired business.
What Happens Next?
For the next 60 days, the FTC is seeking public comment on the proposed non-compete rule and has specifically asked for comments on whether certain classes of employees should be treated differently. Given the potential widespread reach and impact of the proposed non-compete rule, we expect many industry groups and employers will submit comments to the FTC. For example, the FTC is seeking comments as to whether there should be a rebuttable presumption that would allow employers to enter into enforceable post-employment non-compete agreements with certain senior executives. The FTC will then address the comments it receives, including potentially revising its current proposal. If adopted, the proposed non-compete rule will go into effect 60 days after the final version is published in the Federal Register, and employers will need to comply with the rule 180 days after the effective date.
The proposed non-compete rule, if adopted as proposed, would supersede and preempt any state law governing non-compete clauses, excluding state laws that provide for even greater worker protections. Considering that employment contracts in the United States have historically been governed by state law, we expect that the proposed non-compete rule will be challenged in US federal court by employers as exceeding the FTC’s authority. In her dissenting statement opposing the rule, Commissioner Christine Wilson explained several legal bases on which she believes the FTC’s entry into this space could be challenged, including that the FTC lacks the authority to engage in competition rulemaking.
We likewise do not expect the proposed non-compete rule to go into effect without serious administrative law challenges. It therefore is likely premature for employers to begin taking any proactive steps in response to this announcement. Employers are well-advised though to continue to monitor developments relating to the proposed non-compete rule to be able to swiftly respond to employees and other key stakeholders. The Freshfields team will continue to monitor developments and is available to advise on comment letters to be submitted during the public comment period.