Non-competes on the Fed’s Chopping Block
Following recent state legislative trends, as well as encouragement from the Biden Administration, the Federal Trade Commission (FTC) announced on January 5th a proposed rule (Proposed Rule) to ban non-compete agreements between most employers and employees in an effort to bolster both competition and innovation in the workplace. If adopted, the Proposed Rule would apply nationwide. Given the significant implications of this action for employers, legal challenges are expected. In the meantime, a mandated 60-day public comment period is now open through March 5, 2023. If finalized as currently written, however, the Proposed Rule would include the following key elements:
Proposed Rule’s Key Provisions
1. Broad definition of “non-compete”
Under the Proposed Rule, a “non-compete clause” is defined as 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, and includes “de facto” non-compete clauses (contractual terms that have 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 offers two examples of de facto non-compete clauses: (1) a non-disclosure agreement between an employer and 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, and (2) mandated repayment of training costs pursuant to which a worker must repay an 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.
While the Proposed Rule does not expressly address client and customer non-solicitation restrictions, the FTC’s supplementary materials state that “the definition of non-compete clause would generally not include other types of restrictive 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 operating a business after the conclusion of the worker’s employment with the employer.” Under the de facto provision in the definition of “non-compete clause,” however, “such covenants would be considered non-compete clauses where they are so unusually broad in scope that they function as such.” (emphasis added.)
2. Broad definition of “employee”
The term “employee” is defined as including individuals classified as employees, independent contractors, externs, interns, volunteers, apprentices, or sole proprietors who provide a service to a client or customer. Although the definition excludes “franchisees” in the context of a franchisee-franchisor relationship, it does include individuals who work for a franchisee or franchisor.
3. Rescission of existing non-competes
Existing non-compete clauses between employers and employees must be rescinded under the Proposed Rule by virtue of the rule’s requirement that employers not “maintain” non-compete clauses with their employees.
4. Notice requirement
The Proposed Rule will require employers to notify both current and former employees that any existing non-compete clauses between them are no longer in effect and cannot be enforced. Such notice must be made on an individual basis (not in a general communication), provided in writing in an email, text or on paper (not orally), and delivered within 45 days of the rescission. Model notice language is available, but is not mandated, in the Proposed Rule.
The FTC’s ban on non-compete clauses excludes those related to the sale of a business. Specifically, the Proposed Rule carves out non-competes entered into by:
(a) a person who is selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or
(b) 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. (“Substantial” means having at least a 25 percent ownership interest in a business entity).
6. Relationship to state laws
The Proposed Rule would supersede state laws that are inconsistent with its provisions but not state laws that offer broader protections to workers.
7. Comments sought
The FTC is seeking comments on the Proposed Rule, especially those specifically addressing alternatives it considered such as (1) whether, instead of a categorical ban on non-competes, there should be a rebuttable presumption that they are unlawful, (2) whether non-competes should be prohibited only for a subset of workers defined by factors such as job function, occupation, and income level, and (3) whether non-competes should be prohibited for certain categories of workers with a rebuttable presumption of unlawfulness for others.
8. Actions for employers to consider
Employers may want to perform an inventory of their business protection agreements with former and current employees to determine whether they include non-compete and de facto non-compete provisions in the event the Proposed Rule is adopted so that they will be prepared to comply with the rescission and notice requirements. Employers also may want to review their current non-compete clauses and other restrictive covenant provisions, including non-disclosure and non-solicitation provisions and work with legal counsel to assess how compliance with the Proposed Rule, in the event it is adopted as currently written, will affect their business operations. Finally, employers should consider evaluating the business justification, breadth, and necessity of non-competes and other restrictive covenants going forward given the increasing hostility toward such provisions at both the state and federal level.
Outside GC will continue to monitor developments related to the FTC’s Proposed Rule and provide updates as appropriate. In the meantime, please feel free to contact a member of our employment team with any questions you may have.
Lorna Hebert email@example.com (617) 512-8401
Christy Kotowski firstname.lastname@example.org (510) 748-0930
Trish Lantzy email@example.com (804) 683-1737
Margaret Scheele firstname.lastname@example.org (703) 408-4718
Lorna Hebert (New England team) is an employment, labor, higher education, and litigation attorney with nearly 30 years of experience handling a broad range of complex employment and labor matters. Lorna advises clients on a wide range of employment matters, including workplace investigations, dispute resolution, hiring, performance management, discipline, terminations, reorganizations, accommodations, employee benefits, wage and hour issues, discrimination claims, policies and procedures, and training.
Christy Kotowski joined Outside GC’s California team as Senior Counsel in 2019. Based in the San Francisco Bay Area, Christy handles a broad range of complex workplace issues at the federal, state and local levels. Previously, she worked as in-house employment counsel for several large companies, and started her legal career in the Silicon Valley office of Morrison & Foerster, one of California’s oldest and largest law firms.
Patricia Lantzy (Washington D.C. team) is a labor and employment attorney with almost 30 years of experience. Trish works with a wide range of clients, from individual executives and small businesses to the Fortune 500, on employment-related issues across the employee lifecycle, including recruiting, hiring, workplace harmony and leave issues, performance and discipline/discharge, corporate reorganizations and reductions in force.
Margaret Scheele (Washington D.C. team) is an employment law attorney with almost 30 years of experience. Margaret has represented a range of clients in a variety of industries, including aviation, food service, telecommunications, health care, and government contracting. Her practice includes the full range of advice and counseling work that arises within the employment context, including most recently COVID-related matters.
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