On January 5, 2023, the Federal Trade Commission (FTC) voted 3-1 to propose the Noncompete Clause Rule (the rule), which would ban essentially all noncompete clauses that employers impose on their employees and other workers.1
The rule will be open for public comment for 60 days after its upcoming publication in the Federal Register. Some employers will support the rule in its current formulation because it would give them more freedom to hire talent in order to grow their businesses. Others will oppose the rule as denying businesses an effective tool to protect their trade secrets and good will. While any ultimate prohibition is likely to be more limited than initially proposed, employers who use covenants not to compete should review them to ensure that they are drafted and applied narrowly as needed to protect actual trade secrets and confidential information. In addition to the FTC’s proposed rule, courts have applied stricter scrutiny to covenants not to compete in recent years, refusing to enforce them without compelling proof of the legitimate business interest that would be harmed if the worker at issue is permitted to compete.
The FTC’s notice of proposed rulemaking (NPRM) comes just one day after the FTC announced three new settlements against companies for their use of employee noncompete clauses.2 In these settlements, the FTC banned Prudential Security, Owens-Illinois Glass, Inc. (O-I Glass), and Ardagh Group, S.A. (Ardagh) from using noncompete clauses against their workers in a range of positions from “low-wage security guards to manufacturing workers to engineers.”3
Both the proposed Noncompete Clause Rule and the enforcement actions against noncompete clauses highlight the current FTC’s goals to promote competition in labor markets and to deploy its expanded interpretation of Section 5 of the FTC Act, which bans “unfair methods of competition.”
The Noncompete Clause Rule
If enacted in its current form, the rule would ban companies from enforcing nearly all noncompete clauses against their employees. According to the FTC, the use of noncompete agreements “suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses.”4
Specifically, the rule would make it illegal for employers to: i) enter into or attempt to enter into a noncompete clause with employees and independent contractors; ii) maintain a noncompete clause with a worker that was executed prior to the rule’s effective date; and iii) represent to a worker, under certain circumstances, that the worker is subject to a noncompete clause.
The rule’s current scope is broad. It would apply to anyone who works, whether paid or unpaid, for an employer, including employees, independent contractors, externs, interns, volunteers, and apprentices.5 As written, it would cover nearly all post-employment noncompete clauses, with one exception for noncompete clauses entered into as part of the sale of business (or all or substantially all of its interests).6 However, even noncompete agreements in such context will only be permitted where the party restricted by the noncompete clause is an owner, member, or partner holding at least a 25 percent ownership interest in the business entity that is (or whose interests are) being sold. The rule also would ban provisions that are functionally equivalent to noncompete clauses (i.e., overly broad confidentiality provisions and customer nonsolicitation provisions), regardless of the form those provisions take.
While the FTC is proposing a ban on noncompete clauses, it also is seeking public comment on alternative formulations:
- whether the rule should be a categorical ban or a rebuttable presumption of illegality;7
- whether different categories of workers should be subject to different rules (such as varying rules by job category or earnings level);8
- whether noncompete clauses for “senior executives” should be subject to different rules, and if so, how “senior executive” should be defined;9
- whether franchisees should be covered by the rule; and10
- whether the FTC should instead consider disclosure requirements or reporting requirements related to noncompete clauses.11
However, not all of the FTC commissioners agree with the proposed rule. Commissioner Christine Wilson wrote a forceful dissent to the NPRM, as well as a separate dissent to the enforcement actions described below. Commissioner Wilson stated that the FTC’s proposed expansion of Section 5 authority to prosecute noncompete clauses as “unfair methods of competition” conflicts with legal precedent.12 She further noted that, prior to the three enforcement actions announced one day before the NPRM, the FTC had never pursued any enforcement action against noncompete agreements, and therefore lacked any substantive experience on the topic.13 Without this prior experience, Commissioner Wilson argues, the FTC also has no prior evidence to conclude that noncompete agreements harm competition in labor markets.14
The proposed rule is a departure from current legal treatment of noncompete agreements. Presently, noncompete agreements are subject to federal antitrust laws15, as well as state contract and employment laws that govern restrictive covenants. While a few states, like California, only permit noncompete agreements in very limited circumstances, most states allow noncompetes as long as they are reasonable in scope and duration.16
Wilson Sonsini’s antitrust and competition team is available to support companies interested in submitting public comments. To learn more, please contact your Wilson Sonsini attorney or any of the members listed below.
Noncompete Enforcement Actions
One day prior to the proposed rule announcement, the FTC filed lawsuits and reached settlements against three companies and two individuals, forcing them to revoke noncompete provisions they had enforced against thousands of employees.17 These challenges are particularly notable because they are the FTC’s first attempt at using its expanded authority under Section 5 of the FTC Act to target noncompete agreements that it sees as anticompetitive.
- Prudential Security, Inc., and Prudential Command Inc. are two affiliated Michigan-based companies who, along with their owners, were sued by the FTC for their allegedly unfair noncompete agreements for employee security guards.18 The FTC alleged that these companies “exploited their superior bargaining power against low-wage security guards” by requiring the guards to sign noncompete agreements that prohibited them from working for competing businesses within a 100-mile radius of their Prudential job site for two years after leaving Prudential. Violation of this agreement would require the guards to pay Prudential $100,000 in penalties, even though Prudential’s security guards typically earned hourly wages at or near minimum wage.19
- O-I Glass and Ardagh, two glass food container manufacturing companies, were also sued by the FTC for their use of employee noncompete clauses. According to the FTC, O-I Glass imposed noncompete agreements on employees in a variety of positions for over a decade. The restrictions typically required employees to “avoid working for, owning, or being involved in any other way with any business in the United States selling similar products and/or services” without O-I’s prior consent, typically for a period of one year.20 Similarly, according to the FTC, Ardagh imposed noncompete clauses which “typically banned workers, for two years after leaving Ardagh, from directly or indirectly performing ‘the same or substantially similar services’ to those the worker performed for Ardagh to any business in the United States, Canada, or Mexico that is ‘involved with or that supports the sale, design, development, manufacture, or production of glass containers’ in competition with Ardagh.”21
As part of these settlements, the FTC banned Prudential, O-I Glass, and Ardagh from imposing or enforcing noncompete clauses on current and future employees, required the companies to notify affected employees of the FTC order, and required the companies advertising to employees for the next 10 years that employees are free to seek or accept a job with any other company or to compete against the companies following their employment.
Wilson Sonsini’s Takeaways
The rule and noncompete enforcement actions were brought under the FTC’s expansive interpretation of Section 5 of the FTC Act. In November 2022, the FTC announced a “reinvigoration” of Section 5, which gave the agency the independence to decide whether conduct is an “unfair method of competition,” regardless of whether it violated other antitrust statutes.22 The rule, and the FTC’s expansive interpretation of Section 5 generally, will likely face legal challenges. But in the meantime, the FTC will deploy its Section 5 authority to aggressively challenge business conduct it regards as anticompetitive.
If enacted as originally proposed, the rule will have far reaching consequences. Employers will be able to hire talent without the specter of costly noncompete litigation, but will not be able to protect their trade secrets through contractual restrictions on competitive employment. Employers will instead need to rely on other measures to protect their interests, especially with regard to R&D-oriented employees and others who have access to highly sensitive competitive information. For example, employers will likely consider strengthening their confidentiality, intellectual property assignment, and nonsolicitation agreements, and taking steps to tighten worker access to trade secrets and ensure return of confidential materials and information upon employee exit. We also would expect to see a spike in litigation against workers for claims such as conversion, misappropriation of trade secrets, breach of fiduciary duty, and related claims.
With the assistance of Wilson Sonsini’s employment and trade secret litigation group, employers should conduct a careful review of their restrictive covenants and other contractual provisions and policies relating to the protection of their trade secrets to ensure that they are properly drafted to withstand challenge to the extent possible, and to enact a plan for protecting business interests in the event that the rule is enacted as proposed.
Input from affected businesses before the rule is finalized is vital to shaping the contours of the rule. Wilson Sonsini’s antitrust and competition practice is here to assist with the public comment process. Even if the rule is not enacted or enacted in more limited form, it is clear that the FTC intends to aggressively challenge the use of noncompete clauses using all of the tools at its disposal. It will likely bring more Section 5 enforcement actions against individual companies for their use of noncompete clauses. Indeed, when announcing the recent enforcement actions, Bureau of Competition Deputy Director Rahul Rao said that the FTC “will continue to investigate, and where appropriate challenge, noncompete restrictions and other restrictive contractual terms that harm workers and competition.”23 Accordingly, companies using or considering employee noncompete clauses should engage outside antitrust counsel to assess the possible increased risk of FTC enforcement.
[1] FTC, Press Release, FTC Proposes Rule to Ban Noncompete Clauses, Which Hurt Workers and Harm Competition, (January 5, 2023), https://www.ftc.gov/news-events/news/press-releases/2023/01/ftc-proposes-rule-ban-noncompete-clauses-which-hurt-workers-harm-competition.
[2] FTC, Press Release, FTC Cracks Down on Companies That Impose Harmful Noncompete Restrictions on Thousands of Workers, (January 5, 2023), https://www.ftc.gov/news-events/news/press-releases/2023/01/ftc-cracks-down-companies-impose-harmful-noncompete-restrictions-thousands-workers?utm_source=govdelivery.
[3] Id. at ¶ 2.
[4] Press Release, FTC Proposes Rule to Ban Noncompete Clauses, (2023) at ¶ 1.
[5] Noncompete Clause Notice of Proposed Rulemaking, Federal Trade Commission, 16 CFR Part 910, at p. 5, available at https://www.ftc.gov/system/files/ftc_gov/pdf/p201000noncompetenprm.pdf [hereinafter “Noncompete Clause NPRM”].
[6] Id. at 105.
[7] Id. at 139-43.
[8] Id. at 143-47.
[9] Id. at 150-52.
[10] Id. at 152-53.
[11] Id. at 154-56.
[12] See Dissenting Statement of Commissioner Christine S. Wilson, Regarding the Notice of Proposed Rulemaking for the Non-Compete Clause Rule, (January 5, 2023), at page 5, FN 21, https://www.ftc.gov/system/files/ftc_gov/pdf/p201000noncompetewilsondissent.pdf. Specifically, Commissioner Wilson refers to O’Regan v. Arbitration Forums, Inc., 121 F.3d 1060, 1065-66 (7th Cir. 1997) (“[T]o apply antitrust laws to restrictive employment covenants, there must be some attempted enforcement of an arguably overbroad portion of the covenant in order for there to be a federal antitrust violation.”), and Lektro–Vend Corp. v. Vendo Co., 660 F.2d 255, 267 (7th Cir.1981) (“[A] section 1 violation requires proof that the defendant knowingly enforced the arguably overbroad section of the ancillary noncompetition covenant”).
[13] Id. at 5.
[14] Id.
[15] Statement of Interest, Beck v. Pickert Medical Grp., No. CV21-02092, Nev. Second Judicial District Court (Feb. 25, 2022). Available at. https://www.justice.gov/atr/case-document/file/1477091/download.
[16] Chris Marr for Bloomberg Law, Employee Noncompete Clause Limits Adopted by Three More States, (June 2021), available at https://news.bloomberglaw.com/daily-labor-report/employee-noncompete-clause-limits-adopted-by-three-more-states.
[17] Press Release, FTC Cracks Down on Companies that Impose Harmful Noncompete Restrictions, (2023) at ¶ 1.
[18] Id. at ¶ 7.
[19] Id. at ¶ 8, 11.
[20] Id.
[21] Id. at ¶ 15.
[22] Statement of Chair Lina M. Khan, Commissioner Rebecca Kelly Slaughter, and Commissioner Alvaro M. Bedoya, On the Adoption of the Statement of Enforcement Policy Regarding Unfair Methods of Competition Under Section 5 of the FTC Act, (November 10, 2022), https://www.ftc.gov/system/files/ftc_gov/pdf/Section5PolicyStmtKhanSlaughterBedoyaStmt.pdf.
[23] Press Release, FTC Cracks Down on Companies that Impose Harmful Noncompete Restrictions, (2023) at ¶ 4.
