The Death of Non-Compete Agreements?

On January 5, 2023, the Federal Trade Commission (FTC) announced its proposed rule to eliminate non-compete agreements on the basis that they unduly suppress employee wages and stifle innovation and business dynamism. Whether this is a good idea or not depends upon whether you use non-competes to protect your business or whether the existence of non-competes stands in the way of you hiring quality employees. For most businesses, the proposed regulation will be a mixed bag as they want to protect their existing workforce and confidential information while at the same time have the freedom to hire desperately needed talent who are locked up by non-compete agreements.

No matter where your business stands on the issue, the announced regulation should not be the cause for either immediate celebration or immediate panic. To paraphrase Monty Python non-competes are “Not dead yet!” The announcement is just the first step in the rule-making process with public comment open for 60 days after the publication of the proposed rule. Based on the comments received, the FTC will then issue a final rule. As with most regulations, the final rule will likely be challenged in court on numerous grounds including whether the FTC has the power to even issue such a rule. Because of its significant impact on the law in the vast majority of states that allow enforcement of non-compete agreements, a court will likely issue an injunction to preclude enforcement of the rule pending completion of the litigation. As a result, it is highly likely that the rule will not impact non-compete agreements for a year or more.

The Proposed Rule

The proposed rule is relatively simple: All non-competes between employers and workers are prohibited except against an individual selling a substantial interest in a business, which is defined as at least a 25% interest. Starting with this simple prohibition, the rule provides many additional details:

• The prohibition on non-compete agreements does not apply during the term of employment so employers can preclude current employees from competing with them.
• The rule prohibits entering or attempting to enter into a non-compete clause with a worker or representing to a worker that the worker is subject to a non-compete clause if there is no good faith basis to believe that the worker is subject to an enforceable non-compete clause.
• The form of the non-compete clause is irrelevant and is prohibited whether in a handbook, policy, or contract.
• Functional equivalents of non-compete agreements are also prohibited. Examples include the requirement that employees pay damages if they compete or confidentiality agreements that are so broad as to preclude competitive employment.
• The term “worker” includes an employee, individual classified as an independent contractor, extern, intern, volunteer, apprentice, or sole proprietor who provides a service to a client or customer.
• The rule will have an effective date of 60 days after final publication in the Federal Register with a Compliance date of 180 days thereafter.
• Employers will be required to notify both existing and former employees by the Compliance date that all non-compete obligations have been rescinded.
• The rule specifically supersedes all state laws to the contrary.
• The rule does not impact non-solicitation agreements or confidentiality and non-disclosure agreements as long as they are not the functional equivalent of a non-compete agreement.
• The rule does not impact agreements for the repayment of training expenses upon departure from employment as long as the required payment is reasonably related to the costs the employer incurred for training the worker.

Alternatives and Next Steps

The FTC recognizes that the proposed rule is a significant change to the existing legal landscape. While it asserts that businesses can protect their legitimate competitive interests through the use of appropriate confidentiality and non-disclosure agreements, it has invited comments on each element of the proposed rule and has even suggested some alternatives such as creating classes of workers who are and who are not subject to the rule based on a worker’s job functions (enforceable against senior management but not others), earnings (enforceable only against workers making more than a defined amount) or some other factor or combination of factors or, instead of a categorical ban on non-compete agreements, provide that there is a rebuttable presumption that such agreements are unlawful unless the employer can meet a certain evidentiary burden to be articulated in the rule.

The proposed rule is already getting fierce opposition with the U.S. Chamber of Commerce calling it “blatantly unlawful.” Employers that wish to comment on the proposed rule can file their comments at https://www.regulations.gov with the subject line “Non-Compete Clause Rulemaking, Matter No. P201200 or can file paper comments with the Federal Trade Commission, Office of the Secretary, 600 Pennsylvania Avenue, NW, Suite CC-5610 (Annex C), Washington, DC 20580.

If adopted in its present form the rule will require employers to not only abandon their use of non-competes but to revisit their handbooks, confidentiality, and non-disclosure agreements to make sure they are not the functional equivalents of non-compete agreements. While we believe that the proposed rule will undergo a fair amount of change before its final publication the Rhoades McKee Human Resource and Employment Law Team will carefully monitor developments relating to the rule as they emerge so that appropriate steps can be taken by employers to comply with the final rule.