Advisory: FTC Proposes Banning Non-Competes

CLEVELAND, OH, January 16, 2023 – FTC v. Non-Competition Agreements

Non-competition agreements (“Non-Competes”) have long been the subject of passionate business disputes, ruined personal and professional relationships, litigation, and judicial scrutiny. Often considered to represent a “restraint on trade,” Non-Competes have nevertheless been generally upheld so long as the agreement was (a) narrowly drafted to protect a very specific interest or need of the drafting employer; (b) reasonable as to scope, length of restriction and geography; and, (c) where use was limited to certain key employees.

Still, Non-Competes and, to some extent, non-solicitation agreements, have always triggered disputes and judicial scrutiny and, more recently, legislative activism. In 2017, California passed a law prohibiting a choice of venue clause in Non-Competes when the employee both lived and worked in California. The California law also provides for attorney fees for employees seeking to enforce that law.

Since then, California and several states have issued outright bans on the use of Non-Competes. Many more states adopted legislation that limits the use of Non-Competes to only highly-compensated employees.

Notwithstanding the growing tide of states barring or restricting Non-Competes, or perhaps because of it, the Federal Trade Commission (“FTC”) recently released a proposed rule banning the use of Non-Competes. Period. The FTC’s announcement has sounded alarms for those organizations who rely on restrictive covenants to protect their investments in intellectual property and talent. And, the proposed rule does not differentiate between employees and contractors.

In defending its actions, the FTC reasoned that the restrictions inherent in Non-Competes significantly restrict workers’ potential earnings, jeopardize their job opportunities, and limit their mobility.

The Proposed Rule’s Rules

• The rule bans Non-Compete arrangements 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 “functional” standard laid out by the FTC provides that: any “de facto” Non-Compete clause that has the effect of prohibiting the worker from seeking or accepting new employment is prohibited. This includes any agreement that precludes the worker from working in the same field.
• The rule applies to any “employer” who hires or contracts with a worker to work for that employer.
  • A “worker” is a natural person who works for an employer, including a person classified as an independent contractor.
• The only exception to the rule involves the sale of a business or substantially all business assets. In that limited situation, a Non-Compete can be used by the buyer to prevent the seller from competing.
• The FTC proposed rule MAY apply to other types of restrictive covenants, including Non-Disclosure Agreements (“NDAs”) and Non-Solicitation Agreements if provisions of those agreements prevent workers from obtaining employment.
• The proposed rule would have uniform application in all 50 states and would make illegal any state law that is less restrictive than the proposed FTC rule.

What’s Next?
The rule now enters a 60 day period for public commentary and will most certainly generate challenges. It is not clear how the FTC has any standing to regulate employment relationships or whether the proposed rule falls within Section 45 of the FTC Act (15 USC Section 45(a)) which gives the FTC power to bar “unfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce,” which is the section upon which the FTC currently relies as its authority for the proposed rule.

If the rule passes in its current form, Non-Compete agreements will become illegal within 180 days. This would have retroactive effect and would immediately make all existing Non-Competes unenforceable.

For now, employers should “read the tea leaves” and ensure that any use of restrictive agreements are narrowly drafted and selectively utilized to protect only essential business concerns.

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