FTC Announces Proposed Rule Banning Non-Competes
On January 8, 2023, the Federal Trade Commission (“FTC”) published a proposed rule that would prohibit employers from utilizing non-compete clauses in the employment context and beyond.[i] The public may submit comments on the proposed rule for a period of sixty (60) days. The comment period for the proposed rule will close on March 10, 2023.[ii] For companies interested in submitting comments, the Koley Jessen Employment, Labor, and Benefits Department is happy to offer support and guidance in doing so.[iii] After the comment period has closed, the FTC will issue a final rule which will have an effective date of one hundred eighty (180) days after its publication. As discussed in more detail below, the proposed rule will likely face legal challenges after the final rule is published.
Categorical Ban on Non-Compete Clauses in the Employment Context
As noted above, the proposed rule categorically bans an employer’s use of non-compete clauses with its workers, which include any employee, independent contractor, volunteer, or any other person, whether paid or unpaid, who works for such employer. The proposed rule would not only prohibit the use of non-compete clauses going forward, but would also require employers to rescind any non-compete clause within 180 days of the publication of the final rule.
The term “non-compete clause” is broadly defined as 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 workers’ employment with the employer.[iv] Although the FTC has stated that the proposed rule does not prohibit the use of non-disclosure agreements or client non-solicitation agreements, the liberal definition and the functional test within the proposed rule prohibits any contract term that is sufficiently broad so as to “function” as a non-compete. In other words, there is a possibility that a broad customer-based restriction might be deemed to “function” as a non-compete and, as such, be prohibited under this proposed rule.
Non-Compete Clauses in the Sale of Business Context
The proposed rule contains a limited exception for the use of non-compete clauses in the sale of business with “substantial owners,” which the proposed rule defines as “an owner, member, or partner holding at least 25 percent ownership interest in a business entity.”[v] Thus, under the proposed rule, if a business is owned by five (5) separate individuals who each hold a twenty percent (20%) interest, a non-compete clause in a purchase agreement would be unenforceable as applied to any of the owners. However, if a business is owned by four separate individuals who each hold a twenty-five percent (25%) interest, a non-compete clause would be enforceable.
In the explanatory comments accompanying the proposed rule, the FTC states that its intent in setting the twenty-five percent (25%) threshold is to prevent the use of non-compete clauses in situations “where a worker with a small amount of company stock sells stock back to the company as part of a stock redemption agreement when the worker’s employment ends.”[vi] Despite the FTC’s apparent intent in setting the threshold of wanting to prevent employers from using the sale of business exception to circumvent the ban on employment non-competes, the twenty-five percent (25%) threshold set by the FTC would invalidate non-competes in many bona fide M&A transactions.
Impact on State Laws
The proposed rule states that it would supersede any state law, including, but not limited to statute or judicial decision, that is inconsistent with the rule. As drafted, the proposed rule would supersede the non-compete laws of most every state to some extent. As mentioned above, the broad definition of “non-compete clause” could be used to ban customer-based restrictions, such as those currently enforceable under Nebraska law. Specifically, under current Nebraska case law, a customer-based restriction that prohibits an employee from working for, accepting business from, or being employed by customers is enforceable as long as it is limited to those customers with whom the employee did business and had personal contact. It is unclear whether a court would determine that these restrictions “prevent[ ] the worker from seeking or accepting employment with a person . . . .”[vii]
Anticipated Legal Challenges
The proposed rule represents a considerable expansion in the FTC’s regulatory activity. As such, legal challenges to any final rule published by the FTC seem inevitable. In fact, FTC Commissioner Christine S. Wilson issued a dissent from the notice of the proposed rulemaking stating that the proposed rule is “vulnerable to meritorious legal challenges” and “will lead to protracted litigation in which the [FTC] is unlikely to prevail.”[viii] Commissioner Wilson notes that the challenges are likely to center around the FTC’s authority to engage in this type of rulemaking.[ix] Typically, this type of action requires direct Congressional authorization.[x]
It is always difficult to predict with any certainty whether any regulatory action will survive legal challenges. With that said, Commissioner Wilson’s dissent makes a compelling case against the validity of the proposed rule as it is currently drafted and her dissent is consistent with the views of other commentators and stakeholders that have voiced doubts about the long-term viability of the proposed rule. Therefore, to the extent any final rule resembles the current proposal, there is a chance that the rule could be enjoined before it becomes effective.
The Koley Jessen Employment, Labor, and Benefits Department will continue to monitor the developments on the proposed rule and will provide additional guidance as needed. Employers with questions are welcome to contact a member of our Department with any questions they may have about this proposed rule.
[i] Non-Compete Clause Rulemaking, Federal Trade Commission (Jan. 5, 2023), https://www.ftc.gov/legal-library/browse/federal-register-notices/non-compete-clause-rulemaking
[ii] Comments may be submitted at https://www.regulations.gov/document/FTC-2023-0007-0001.
[iii] Businesses are encouraged to submit comments. As of 1:30 pm (CT) on January 10, 2023, approximately 130 comments had been submitted. A review of the comments indicate that there will be significant support for the proposed rule from employee and labor groups.
[iv] Notice of Proposed Rulemaking, Federal Trade Commission (Jan. 5, 2023) at 211, https://www.ftc.gov/system/files/ftc_gov/pdf/p201000noncompetenprm.pdf.
[viii] Dissenting Statement of Commissioner Christine S. Wilson, Federal Trade Commission (Jan. 5, 2023), at 1-2, https://www.ftc.gov/system/files/ftc_gov/pdf/p201000noncompetewilsondissent.pdf.
[x] West Virginia v. EPA, 297 U.S. ___, 142 S. Ct. 2587, 2609 (2022) (concluding that EPA did not have statutory authority to promulgate regulation at issue and further noting that the Court “presume[s] that ‘Congress intends to make major policy decisions itself, not leave those decisions to agencies.’”)