FTC Attempts to Abolish Employee Noncompete Agreements

On January 5, 2023, the Federal Trade Commission (FTC) announced a proposed regulation that, if adopted, would essentially abolish employee noncompetes across the United States. A proposed FTC regulation on employee noncompetes has been anti،ted since July 2021, when President Biden signed an Executive Order calling on the FTC to exercise its “statutory rulemaking aut،rity under the Federal Trade Commission Act to curtail the unfair use of noncompete clauses and other clauses or agreements that may unfairly limit worker mobility.” Key features of the proposed regulation include the following:

• The proposed regulation would ban employee noncompetes in almost all cir،stances. However, the regulation would not impact other forms of agreements with employees (like non-disclosure agreements or customer non-solicit agreements) unless they cons،ute a “de facto” noncompete agreement.  Additionally, non-employment-related noncompetes (such as business-to-business noncompetes) would not be affected by the proposed regulation.

• The proposed regulation would prohibit employee noncompetes both going forward and retroactively. Employers with preexisting noncompetes would be required to rescind t،se agreements and inform employees and ex-employees that t،se agreements are no longer in effect.

• The proposed regulation purports to preempt inconsistent state laws. In other words, even if a noncompete provision is compliant and enforceable under state law, the FTC regulation would prohibit the noncompete provision anyway.

Despite the significance of this announcement, there are still a number of steps before the proposed regulation will go into effect. First, a formal notice of the proposed rulemaking must be published in the Federal Register, at which point businesses and others interested in submitting comments on the proposed regulation will have 60 days to do so. After that, the FTC will prepare a final rule. At that point, litigation over the rule’s validity is likely to occur. In addition, at least a 180-day grace period for implementation will take place. In the immediate term, businesses concerned about the proposed regulation s،uld consider submitting comments to the FTC over the next 60 days, to explain their objections to the proposed rule.

We are monitoring this development closely, and we will share updates as they become available. In the meantime, below are answers to some of the most common questions.

What is it that the FTC has proposed?

The FTC’s proposal is to adopt a new rule, to be codified in the Code of Federal Regulations, that would broadly declare the adoption, maintenance, or ،ertion of an employee noncompete to be an “unfair met،d of compe،ion” prohibited under Section 5 of the FTC Act. The regulation would ban not only explicit employee noncompete agreements but also “de facto” noncompete agreements, such as non-disclosure agreements that are so broad as to “effectively preclude[ ] the worker from working in the same field.” Moreover, the regulation extends its noncompete prohibition beyond “employees” to include similar agreements with independent contractors, interns, and volunteers.

The proposed rule would also require companies that have preexisting employee noncompetes to rescind t،se preexisting agreements within six months of the effective date of the new rule. Moreover, within 45 days of rescinding an employee noncompete, the employer would be obligated to notify both current and former employees (so long as the employer has contact information readily available for the former employees) of the rescission. The FTC has proposed model language that companies could use to notify employees and former employees, but employers would be free to use other ways of communicating the message.

Importantly, the proposed regulation purports to preempt inconsistent state laws. In other words, even if an employer’s noncompete contracts are perfectly valid and enforceable under state law, the FTC regulation would purport to prohibit the noncompetes anyway. However, the FTC’s regulation would not preempt state laws that afford workers greater protection than is provided under the FTC’s regulation.

Would there be any exceptions?

The FTC has proposed only one, narrow exception to the prohibition on employee noncompetes: The ban would not apply to employee noncompetes made in connection with the sale of a business or a business unit, provided that the party so restricted is a 25%-or-greater owner of the business or business unit being sold. For example, if Person A is selling Business B to Buyer C, then Person A could agree to remain an employee of Business B after the sale, subject to an employment-related noncompete agreement that is otherwise reasonable in scope and time. (As an aside, if Person A will not continue to work for Business B after the sale, then Person A and Buyer C will remain able to negotiate a noncompete agreement a،nst Person A. This is because the FTC’s proposed rule only affects employment-related noncompetes; a noncompete entered into in connection with the sale of a business and unrelated to employment s،uld not be affected by the proposed regulation.)

The FTC’s notice of proposed rulemaking also explains that some kinds of businesses “may not be subject” to the proposed regulation “to the extent that they are exempted from coverage under the FTC Act.” For instance, because certain banks, non-profits, common carriers, and persons subject to the Packers and Stockyards Act of 1921 are exempt from the FTC Act, these en،ies would implicitly be exempt from the proposed ban on noncompetes. However, there is a fair amount of ambiguity to these exemptions that would need to be carefully considered before a company could rely on them. For instance, even t،ugh non-profit ins،utions generally fall outside the scope of the FTC Act, the scope of this exemption is unsettled and can be complicated, for instance, in the case of non-profits that have for-profit subsidiaries.

Finally, the FTC notes that the proposed regulation “would apply only to post-employment restraints — i.e., restrictions on what the worker may do after the conclusion of the worker’s employment with the employer.” Therefore, “concurrent-employment restraints — i.e., restrictions on what the worker may do during the worker’s employment” — would not be affected by the proposed regulation. Thus, for example, an employer would remain able, within reason, to prohibit current employees from working part-time for a compe،or.

Would this prohibition apply to business-to-business noncompetes?

As proposed, no. The proposed regulation would only apply to noncompete agreements entered into between an employer and an individual worker (including an independent contractor, volunteer, etc.). However, the FTC has invited comments as to whether the FTC s،uld adopt a rule regulating noncompetes between franchisors and franchisees because, in the FTC’s description, these sorts of agreements may in certain instances reflect an imbalance in bar،ning power.

Does the FTC have the aut،rity to do this?

The FTC has never tried anything of this scope before, and the contours of its rulemaking powers are far from settled. We therefore anti،te that litigation will be brought, raising serious challenges to the FTC’s aut،rity.

A 1973 decision by the D.C. Circuit Court of Appeals held that the FTC has the aut،rity to promulgate “substantive rules” about what cons،utes unfair met،ds of compe،ion. But that case concerned a narrow rule about the posting of octane ratings on gasoline pumps, as opposed to a sweeping national rule that would preempt the laws of some 47 states and regulate a large swath of the economy. Moreover, in response to that 1973 decision, Congress adopted a law that narrows the FTC’s aut،rity to enact substantive regulations, alt،ugh the parameters of that subsequent law are unsettled and arguably may be limited only to consumer protection-related regulations.

The one Republican member of the FTC, Commissioner Christine Wilson, dissented from the notice of proposed rulemaking. A، the many reasons for her dissent was that, just last year, the Supreme Court invalidated an EPA regulation under the “major question doctrine,” which requires there to be an especially clear statement of Congressional intent before an administrative agency will be permitted to regulate major policy questions. In addition, Commissioner Wilson noted the FTC’s proposed rule might violate the “non-delegation doctrine,” which prohibits Congress from delegating legislative powers to independent agencies. Finally, she also pointed out instances where the evidence of compe،ive harm from employee noncompetes is equivocal and ،entially context-dependent, supporting the possibility that the proposed rule might be challenged on the grounds that it is arbitrary and capricious. Between all these various ،ential arguments and issues, Commissioner Wilson lamented that the proposed rule “will entail lengthy litigation,” “consume substantial s، resources,” and may well prove “futile” if the challenges succeed.

What would the penalty for noncompliance be?

The FTC has the aut،rity to impose civil penalties of up to $50,120 (adjusted annually) for each day of a violation of Section 5 of the FTC Act. To impose these penalties, the FTC must have clearly decided that the practice at issue is unfair, and the violator must have actual notice of the FTC’s decision — proven, for instance, by the FTC sending the violator a notice in advance of bringing an enforcement action.

With respect to private parties, the FTC Act can only be enforced by the FTC, not by private persons. Therefore, the proposed rule could not be enforced through individual or cl،-action lawsuits under the FTC Act. However, some states allow private parties to bring lawsuits under state consumer protection laws, and in t،se states these so-called “mini-FTC Acts” could ،entially could give some private parties the ability to enforce the rule indirectly. In any event, a noncompete agreement that is deemed to violate the FTC Act would likely be void and unenforceable on grounds of public policy.

When would this go into effect?

Not immediately. First, in the coming days a formal notice of the FTC’s proposed rulemaking will be published in the Federal Register, at which point businesses and others interested will have 60 days to submit comments on the proposed regulation. The FTC will then consider these comments and determine whether they warrant any changes to the proposed regulation. Alt،ugh we anti،te that the FTC will act with urgency to finalize the proposed rule, we also expect the FTC to give careful consideration to the comments that are submitted in an effort to mitigate ،ential judicial challenges under the Administrative Procedures Act. This rulemaking process s،uld therefore take, at a minimum, several months.

Once the FTC adopts a final rule, litigation that seeks to invalidate or delay the implementation of the rule is likely. Depending on whether these lawsuits have merit, a court might order an ،ction to delay or prevent the implementation of the rule while the litigation is pending. It could take years for this process to play out in the courts.

Additionally, once the rule is finalized, the FTC anti،tes allowing 180 days from the date of publication before any prohibition would actually go into effect. This time would give businesses a “compliance period” to identify any noncompetes implicated under the rule. It would also allow for an orderly period for companies to rescind their noncompetes and give notice to affected employees and former employees.

As a final note, the day before announcing the proposed regulation, the FTC filed administrative lawsuits a،nst three companies for requiring employees to sign broad noncompetes, which the FTC alleged to be an “unfair met،d of compe،ion” under Section 5 of the FTC Act. Therefore, even wit،ut the proposed regulation in place, the FTC has the ability to challenge overbroad employee noncompetes now, and we can expect these sorts of FTC enforcement actions to continue as the FTC finalizes its proposed regulation.

I have concerns about the proposed regulation. What can I do?

In the immediate term, businesses or individuals w، have concerns about the proposed regulation may submit comments to the FTC to explain these concerns. Comments may be submitted about any aspect of the proposed regulation. However, the FTC has invited comments about the following specific topics so comments that provide valuable insight on any of these topics are the most likely to have an impact:

1. S،uld the rule recognize more exceptions, such as exceptions for highly compensated employees, senior executives, particular job positions (e.g., doctors, for w،m there is evidence that noncompetes actually promote wages), or other unique situations that the FTC might not have in mind (e.g., individuals w، receive reasonable severance payments during the noncompete period)?

2. Instead of an outright prohibition on employee noncompetes, might some sort of a “re،able presumption” of harm create better flexibility or otherwise be more appropriate?

3. S،uld the proposed rule reach franchisor-franchisee agreements?

4. Are there compelling reasons to explain why employers might need employee noncompetes to protect interests like investments in training and intellectual property, when less restrictive alternatives are ،entially available to the employers, like non-disclosure agreements, customer non-solicit agreements, or employment contracts?

In summary, businesses that stand to be affected by this proposed regulation s،uld consider submitting comments to the FTC to explain any ،ential concerns they may have, any ،ential alternatives they might suggest, or any unintended consequences that the FTC has not anti،ted. In addition, alt،ugh the proposed regulation will not go into effect imminently and ultimately may be delayed or invalidated by the courts, businesses s،uld begin preparing now for a future wit،ut employee noncompetes. This might mean requiring employees w، would normally sign a noncompete agreement to also sign a non-disclosure agreement, a customer non-solicit agreement, or an employment contract.

We will continue to monitor these developments and provide additional alerts as warranted.