Background

On January 5, 2023, the U.S. Federal Trade Commission (FTC) issued a proposed rule to prohibit the use of non-compete agreements in the employment context and preempt all state laws allowing for such restrictions. The proposed rule comes in the wake of President Biden’s July 2021 Executive Order directing the FTC to explore potential methods to limit “the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.” The proposed rule would effectively eliminate employee non-competes, including the retroactive invalidation of existing non-compete agreements.

The keyword, at this stage, however, is “proposed.” The FTC’s publication is merely a proposed rule and has no immediate impact on existing non-competes. Moreover, if made final, it will likely be subject to significant legal challenges with respect to the FTC’s authority to implement such a sweeping change to the business landscape.

Prohibitions

In its current form, the FTC’s proposed rule would prohibit employers from:

• Entering into (or even attempting to enter into) a non-compete agreement with a worker;
• Maintaining an existing non-compete agreement with a worker; or
• Representing to a worker that a non-compete agreement exists where the employer has no good-faith basis to believe that the worker is subject to an enforceable non-compete.

One important caveat: the rule would not prohibit non-compete agreements between buyers and sellers of a business or those included in franchisee-franchisor agreements.

Application

The FTC broadly defines “worker” to include any paid or unpaid workers, including employees, independent contractors, externs, volunteers, apprentices, or sole proprietors who provide services to clients or customers.

The FTC also defines the “non-compete clause” broadly, extending the rule to 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 with the employer.” The proposal further encompasses “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 with a person or operating a business after the conclusion of the worker’s employment with the employer.”

The FTC provides the following examples of potential 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.

What about preexisting non-compete clauses?

The proposed rule would invalidate all preexisting employee non-compete agreements. Furthermore, it would require employers to actively rescind the non-compete portions of such agreements and inform workers in writing that the non-compete provision is no longer in effect and will not be enforced.

What does this proposed rule mean for businesses TODAY?

Right now, nothing. Employers need to remain informed about the status of the proposed rule, but there is no reason to raise the alarm yet. The proposed rule is nothing more than a proposal. It is not enforceable, and, in fact, it is likely to undergo changes during the rulemaking process, as well as judicial challenges from employers and groups representing the interests of businesses nationwide.