[The following was prepared as a Gibson Dunn client alert by Rachel Brass, Svetlana Gans, Kristen Limarzi, Ilissa Samplin, Katherine V. A. Smith, Stephen Weissman, Chris Wilson, Jamie France, and Connor Leydecker. It is reprinted with permission here.]
On Jan. 5, 2023, the Federal Trade Commission (FTC) issued a Notice of Proposed Rulemaking (NPRM) to prohibit employers from entering non-compete clauses with workers. The proposed rule would extend to all workers, whether paid or unpaid, and would require companies to rescind existing non-compete agreements within 180 days of publication of the final rule. The FTC will soon publish the NPRM in the Federal Register, triggering a 60-day public comment period. The rule could be finalized by the end of the year; court challenges to the final rule are likely to follow.
The rule proposal follows recent FTC settlements with three companies and two individuals for allegedly illegal non-compete agreements imposed on workers—the first time the FTC has claimed that non-compete agreements constitute unfair methods of competition (UMC) under Section 5 of the FTC Act.
The Proposed Rule Would Broadly Ban Non-Compete Agreements
The proposed rule provides:
(a) 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 proposed rule broadly defines non-compete agreements 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.” It proposes a functional test to determine if a clause is a non-compete provision: to qualify, the provision would 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 proposed rule identifies two types of agreements that would constitute impermissible “non-competes”:
- A nondisclosure 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; and
- 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.
While the proposed rule would not expressly prohibit nondisclosure and intellectual-property agreements with employees, those agreements could be deemed impermissible non-competes if, pursuant to the provision excerpted above, they are deemed to be written “so broadly” that they “effectively preclude[ ] the worker from working in the same field.” Further, the term “worker” would be defined as “a natural person who works, whether paid or unpaid, for an employer,” but would not include a franchisee in a franchisee/franchisor relationship.
Rescission Requirement, Safe Harbors, and Federal Preemption
The proposed rule would require employers to rescind all existing non-compete provisions within 180 days of publication of the final rule, and to provide current and former employees notice of the rescission. If employers comply with these two requirements, the rule would provide a safe harbor from enforcement. Further, the proposed rule would exempt from its scope certain non-competes entered in connection with the sale of businesses. This exception also applies under California law, recognizing the need to protect the goodwill of a business.
The proposed rule would preempt all state and local rules inconsistent with its provisions, but not preempt State laws or regulations that provide greater protections. As a practical matter, the proposed rule would override existing non-compete requirements and practices in the vast majority of states.
Concerned Parties Should Submit Public Comments
A 60-day public comment period will begin once the FTC publishes the NPRM in the Federal Register. After the notice-and-comment period concludes, the FTC will consider the comments and then publish a final version of the rule. Enforcement may begin 180 days after publication of the final rule (although, as discussed below, the final rule is likely to be challenged in court).
The final rule’s terms will depend in part on the FTC’s response to comments submitted by interested parties during this notice-and-comment period, including legal and practical objections raised to the rule. Thus, concerned parties are advised to submit robust comments thoroughly explaining their concerns, including potential costs and adverse effects.
Legal Challenges to the Rule Are Likely Once It Is Finalized
The proposed rule represents a significant expansion of the FTC’s regulatory reach in two respects: First, the Commission had not previously held non-compete agreements to be unfair methods of competition under the Federal Trade Commission Act, until its recently announced settlements. Second, substantial doubt exists that the FTC possesses rulemaking authority in this area. As Gibson Dunn partners have explained and Commissioner Christine S. Wilson notes in her statement dissenting to the Notice of Proposed Rulemaking, any final rule is likely subject to several potentially significant legal challenges. Commissioner Wilson notes three concerns:
- Congress did not intend to grant authority to promulgate substantive competition rules under the FTC Act provisions on which the FTC purports to rely to promulgate the proposed rule.
- The rule may exceed the limits imposed by the Supreme Court’s major questions doctrine.
- The rule may exceed the limits imposed by the Supreme Court’s nondelegation doctrine.
This new proposed rule is part of a larger trend toward more vigorous federal regulation of the employment relationship, including by the FTC, National Labor Relations Board, and the U.S. Department of Labor (DOL), as we have noted in previous client alerts addressing the FTC’s approach to no-poach and nonsolicit agreements, the DOL’s rulemaking on who qualifies as an independent contractor under the Fair Labor Standards Act (FLSA), and the FTC’s broader vision of its authority to address unfair methods of competition under Section 5.