FTC Proposes Federal Rule to Ban Employer Non-Compete Clauses

January 13, 2023

On January 5, 2023, the U.S. Federal Trade Commission (“FTC”) proposed a new federal rule at 16 CFR Part 910 to ban employer use of non-compete clauses with a broad class of workers including employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors.  The rule would apply to every employer that hires or contracts with a worker to work for the employer and would supersede any conflicting state law that permits the use of non-compete clauses.  The rule is subject to a public comment period through March 10, 2023, and would require employer compliance within 180 days after the date of publication of any final rule, if published after the close of the comment period.

FTC Chair Lina M. Khan states that the rule is necessary because non-compete clauses block workers from freely switching jobs, deprives them of higher wages and better working conditions, and deprives businesses of a talent pool necessary to build and expand.  Chair Khan further states that the rule would promote greater innovation and healthy competition.

“Non-Compete Clauses”

The proposed rule generally prohibits employer use of “non-compete clauses” with workers.  Section 910.1(b) of the rule defines “non-compete clause” to mean 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.  The term also includes a contractual term that is a de facto non-compete clause because it has the effect of prohibiting the worker from seeking or accepting employment after the conclusion of the worker’s employment with the employer. For example, the rule states that the following types of contractual terms, among others, may be de facto non-compete clauses:

  • 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 the worker’s employment with the employer.
  • A contractual term 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.

The rule does not apply to traditional covenants of confidentiality, non-disclosure, customer non-solicitation, or employee non-solicitation.  However, if one of these types of covenants is written too broadly, it could be considered a de facto non-compete clause prohibited by the rule under the above-described functional test.

Non-Compete Clauses Viewed as “Unfair Methods of Competition”

Although many employers view non-compete clauses as mission-critical to protect against unfair competition by departing employees, the FTC’s current view is that employer use of non-compete clauses is itself an unfair method of competition.  Section 910.2(a) of the proposed rule states:

Unfair methods of competition.  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; or represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause.

The rule would require employers to affirmatively rescind existing non-compete clauses and give workers notice of the rescission.  Section 910.2(b) states:

(1) Rescission requirement.  To comply with paragraph (a) of this section, which states that it is an unfair method of competition for an employer to maintain with a worker a non-compete clause, an employer that entered into a non-compete clause with a worker prior to the compliance date must rescind the non-compete clause no later than the compliance date.

(2) Notice requirement.

(A) An employer that rescinds a non-compete clause pursuant to paragraph (b)(1) of this section must provide notice to the worker that the worker’s non-compete clause is no longer in effect and may not be enforced against the worker. The employer must provide the notice to the worker in an individualized communication. The employer must provide the notice on paper or in a digital format such as, for example, an email or text message. The employer must provide the notice to the worker within 45 days of rescinding the non-compete clause.

(B) The employer must provide the notice to a worker who currently works for the employer. The employer must also provide the notice to a worker who formerly worked for the employer, provided that the employer has the worker’s contact information readily available.

Section 910.2(b)(2)(C) of the rule provides model language that constitutes employer notice to the worker that the worker’s non-compete clause is no longer in effect and may not be enforced against the worker:

A new rule enforced by the Federal Trade Commission makes it unlawful for us to maintain a non-compete clause in your employment contract. As of [DATE 180 DAYS AFTER DATE OF PUBLICATION OF THE FINAL RULE], the non-compete clause in your contract is no longer in effect. This means that once you stop working for [EMPLOYER NAME]:

  • You may seek or accept a job with any company or any person—even if they compete with [EMPLOYER NAME].
  • You may run your own business—even if it competes with [EMPLOYER NAME].
  • You may compete with [EMPLOYER NAME] at any time following your employment with [EMPLOYER NAME].

The FTC’s new rule does not affect any other terms of your employment contract. For more information about the rule, visit https://www.ftc.gov/legal-library/browse/federal-register-notices/non-compete-clause-rulemaking.

Exception for Substantial Owners, Members, and Partners

Section 910.3 of the proposed rule states that it shall 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 defines substantial owner, substantial member, and substantial partner to mean an owner, member, or partner holding at least a 25 percent ownership interest in a business entity.  Non-compete clauses covered by this exception would still remain subject to federal antitrust laws as well as all other applicable laws to the extent otherwise applicable.  The complete text of the proposed rule is available on the FTC’s website at https://www.ftc.gov/system/files/ftc_gov/pdf/p201000noncompetenprm.pdf.

Bottom Line

The FTC’s proposed rule would significantly increase employee mobility presently limited by lawful non-compete clauses.  However, the rule would simultaneously expose employers to significant additional risks of unfair competition by departing employees and their new employers, who will be emboldened by the rule.  Most states recognize that departing employees can, at times, represent a threat of unfair competition to their former employers.  This is especially true when employees are closely affiliated with their former employers’ goodwill with their customers, communities, and the industries they serve.  Accordingly, most states permit narrowly tailored non-compete clauses intended to protect employers against unfair competition beyond the normal competition that a stranger in the industry can provide.  For example, the state of Wisconsin has a longstanding pro-employee legal standard that permits non-compete clauses when employers can show that the clauses are:

  • Reasonably necessary for the employers’ reasonable protection against unfair competition;
  • Reasonable in time;
  • Reasonable in territorial scope;
  • Not harsh or oppressive as to the employees; and
  • Not contrary to public policy.

See Wis. Stat. § 103.465.  When a Wisconsin employee non-compete clause is overly broad in any respect, the entire clause is considered illegal, void, and unenforceable.  Many states have similar legal standards that protect employees against overly broad clauses.

The FTC’s proposed rule would supersede, or take precedence over, state laws by preventing employers from using non-compete clauses that would otherwise be permissible under state law.  The author anticipates substantial industry feedback objecting to the rule during the current 60-day comment period.  If a final rule is published, then the author further expects significant litigation over the FTC’s authority to promulgate such a rule.  This can create confusion and uncertainty among employers and workers alike.

In the interim, employers should consider updating their employment policies and employee handbooks including especially their trade secret protection programs, policies limiting employee access, use, and possession of company facilities, equipment, and other property (including but not limited electronic data), and the like.  In the event the FTC is successful in its current rulemaking plan, then employers will have to rely more heavily on statutory and common law tort restrictions against unfair competition and covenants of confidentiality, non-disclosure, customer non-solicitation, and employee non-solicitation, to the extent otherwise allowed under applicable law.

The author frequently drafts and enforces such policies and covenants and is available to discuss any of the above at 608.283.6746 or [email protected].