In a broad and sweeping exercise of regulatory power, on January 5, 2023, the Federal Trade Commission (FTC) released a Notice of Proposed Rulemaking (NPRM) to prohibit employers from utilizing non-compete clauses. The proposed rule would categorically ban employers from using non-compete clauses with workers at any level within an organization. The issuance of this NPRM commences the 60-day period for which any individual or entity can submit comments to the FTC about the proposed rules. A non-compete clause is a contractual term between an employer and a worker that typically blocks the worker from working for a competing employer, or starting a competing business, within a certain geographic area and period of time after the worker’s employment ends.

In the FTC’s view, non-compete clauses are unlawful as an unfair method of competition. Currently three states — California, North Dakota and Oklahoma — prohibit the enforcement of non-compete agreements. The FTC’s proposed rule, if adopted, would be nationwide in scope and would apply to almost all private employers, regardless of size or location. Some entities, however, may not be subject to the rule to the extent that they are exempted from coverage under the FTC Act. These entities include certain banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers, and persons subject to the Packers and Stockyards Act of 1921, as well as an entity that is not “organized to carry on business for its own profit or that of its members.”

The proposed rule would define the term “non-compete clause” as including any 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. The proposed rule would, among other things, provide that it is 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.
• Under certain circumstances, to represent to a worker that the worker is subject to a non-compete clause.

In addition to prohibiting employers from attempting to impose non-compete restrictions upon workers going forward, the proposed rule also would require employers to rescind existing non-compete clauses with workers and actively and individually inform them that the clauses are no longer in effect. Under the proposed rule, employers also would be barred from entering into non-compete clauses with independent contractors.

However, the rule would not apply to a non-compete clause that is entered into by 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. The rule also would not apply to a franchisee in the context of a franchisee-franchisor relationship.

The proposed rule appears not to affect other types of restrictive employment covenants — such as non-disclosure agreements (NDAs) and client or customer non-solicitation agreements — because these covenants generally do not prevent a worker from seeking or accepting employment with a person or company, or operating a business after the conclusion of the worker’s employment with the employer. The rule may, however, prohibit clauses prohibiting non-solicitation of former co-workers.

Under the proposed definition of “non-compete clause,” covenants would be considered non-compete clauses where they are so broad in scope that they function as such. For example, a non-disclosure agreement between an employer and a worker that is written so broadly that it effectively precludes the worker from working in the same field after the conclusion of their employment would be barred. A covenant between an employer and a worker that requires the worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specified time period, where the required payment is not reasonably related to the costs the employer incurred for training the worker, would be prohibited.

After the 60-day comment period ends, the FTC will likely adopt a final rule with compliance mandated 180 days thereafter. During this 180-day compliance period, the FTC expects that an employer would assess whether to implement replacements for existing non-compete clauses, such as NDAs; draft those covenants; and then negotiate and enter into those covenants with the relevant workers. At the end of the 180-day period, an employer would be prohibited from entering into new non-compete clauses, required to rescind existing non-compete clauses with workers and actively and individually inform their employees that the clauses are no longer in effect.

The FTC is specifically seeking public comment on these topics:

• Whether franchisees should be covered by the rule.
• Whether senior executives should be exempted from the rule, or subject to a rebuttable presumption rather than a ban.
• Whether low- and high-wage workers should be treated differently under the rule.
• Whether “no-poach” agreements, in which employers agree not to solicit or hire one another’s workers, and wage-fixing agreements, in which employers agree to limit wages or salaries (or other terms of compensation) should be barred.

Once a rule is finalized, it is expected that there will be multiple challenges to the FTC’s authority to promulgate this ban on non-compete agreements, which may lead to the ban being enjoined for a period. Ultimately, the issue may go to the U.S. Supreme Court, which in recent years has shown less deference to rules issued by federal agencies that are not clearly supported by express statutory language. In the meantime, however, employers who use non-competes with their employees are advised to consider submitting comments to the FTC either individually or through their respective trade associations.

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