Non-competes Under Attack by FTC
To ring in the 2023 new year, the Federal Trade Commission (“FTC”) has taken multiple actions targeting the use of non-compete agreements, all of which are consistent with President Biden’s July 2021 Executive Order on competition in the labor market. The FTC has proposed both a rule banning the use of non-compete agreements with employees and independent contractors, and it also took legal action under its existing authority against three companies for their use of non-competes.
The FTC’s proposed rule would ban employers from entering into, maintaining, or enforcing non-compete clauses with their workers, including employees, independent contractors and unpaid workers. The FTC’s notice does not mince words about its effect, as the agency states its intention to “categorically ban employers from using non-compete clauses.”
The rule defines a non-compete clause 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.” Though the rule does not target non-solicitation or non-disclosure clauses, it proposes a functional test to determine whether a clause meets the definition, meaning that a non-disclosure or non-solicitation covenant that effectively bars an employee from seeking employment in their chosen industry could be considered a non-compete. Non-compete clauses that require the employee to pay liquidated damages to the employer in the event of competition are also prohibited.
The rule would apply retroactively and require employers to rescind any existing non-compete contracts within 180 days after publication of the final rule. Employers would also be required to provide individualized notice to the employees within 45 days of rescinding the non-compete clause. Importantly, the rule would not apply in the context of a sale of a business or ownership interest of at least 25%.
The FTC also brought an enforcement action against three different companies to invalidate their respective worker non-compete agreements pursuant to its broad authority under Section 5 of the FTC Act. In the respective legal actions, the FTC ordered the companies to cease enforcing their agreements and to notify all employees they were no longer bound by the agreements. This comes on the heels of the FTC’s major policy announcement that the agency would vigorously enforce Section 5’s prohibition on unfair methods of competition and that this enforcement effort would cover areas that may otherwise not be within the purview of other antitrust laws, such as the Sherman and Clayton Acts.
If ultimately published as a final rule, employers can anticipate the non-compete ban will face immediate legal challenge on numerous grounds, as noted in FTC Commissioner Wilson’s lone dissent to the proposed rule. Given the importance of non-compete agreements to many employers’ efforts to protect their competitive information and relationships, employers should carefully monitor these developments. Now is the time to re-evaluate strategies for protecting competitive information by focusing on other avenues available by contract or under law that do not rely on non-competes. This includes careful examination and identification of protectable information (trade secrets), the measures in place to keep such information secret, and employees’ access to such information.