FTC Proposes New Rule Banning Non-Compete Agreements

January 9, 2023

Last week, the Federal Trade Commission (FTC) published the Non-Compete Clause Rulemaking, a proposed rule that would prohibit the use of non-compete agreements and preempt all state laws that provide less protection to workers. If made final, the proposed rule would effectively ban the use of all non-compete agreements in employment contracts by classifying such agreements as an unfair method of competition.

Key Takeaways

Here are the key takeaways from the proposed rule:

Broad Definition of “Non-Compete Clause”

The proposed 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.” In addition, the proposed rule contains a functional test to determine whether a contractual term constitutes a non-compete clause. Under the test, a contractual term is a “de facto non-compete clause” if it “has 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 provides two examples of de facto non-compete clauses:

  1. A non-disclosure agreement “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”
  2. A contractual term requiring workers to pay for training costs “if the worker’s employment terminates within a specified time period” and the payment “is not reasonably related to the costs the employer incurred for training the worker.”

Broad Definitions of “Employer” and “Worker”

The proposed rule also contains very broad definitions of “employer” and “worker”. “Employer” is defined as a person “that hires or contracts with a worker to work for the person.” The term “worker” includes “a natural person who works, whether paid or unpaid, for an employer.” This definition encompasses employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provides a service to a client or customer. A franchisee is not included in this definition, but a person who works for the franchisee or franchisor is considered a “worker”. Notably, these broad definitions of “employer” and “worker” apply to over 99% of the country’s workforce.

Unfair Methods of Competition Prohibited

The proposed rule provides that it is an unfair method of competition for an employer to enter into or maintain a non-compete clause with a worker or to represent to a worker that the worker is subject to a non-compete clause.

Rescission Requirement

Employers are required to rescind all preexisting non-compete clauses by the proposed rule’s compliance date.

Notice Requirement

Employers are also required to provide notice to workers that their non-compete clauses are no longer effective and enforceable. Specifically, notice must be provided: 1) individually to each worker; 2) in writing, either digitally or on paper; and 3) within 45 days of rescission of the non-compete clause. Employers must provide notice to both current and former workers, as long as the former worker’s contact information is “readily available” to the employer.

Narrow Exception for Sale of Businesses

The proposed rule does not apply to non-compete clauses for the sale of a business where the non-compete clause was entered into by a person who is: 1) selling all of their ownership interest in the business; or 2) selling all or substantially all of a business’s assets and is a substantial owner, member, or partner of the business at the time they entered into the non-compete clause.

The proposed rule does not establish a private right of action for workers. Rather, only the FTC can bring a claim for violations of the proposed rule.

Effective Date

If made final, the proposed rule would become effective 60 days after it becomes final. However, employers would have 180 days after the rule becomes final to comply.

Opposition and Criticism

The FTC has already been scrutinized for the harsh implications the proposed rule would have on employers. Sean Heather, Vice President of the U.S. Chamber of Commerce, called the proposed rule “blatantly unlawful” and emphasized that “Congress has never delegated the FTC anything close to the authority it would need to promulgate such a competition rule.” In her dissent, FTC Commissioner Christine Wilson noted that the proposed rule “represents a radical departure from hundreds of years of legal precedent that employs a fact-specific inquiry into whether a non-compete clause is unreasonable.”

The proposed rule comes nearly 18 months after President Biden signed the Executive Order on Promoting Competition in the American Economy, which directs the FTC to “curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.” The proposed rule also comes just one day after the FTC announced it had reached settlement agreements with three companies after finding that the companies “illegally imposed non-compete restrictions on workers.”

The public is permitted to submit comments on the proposed rule through March 6, 2023. Following the commenting period, the FTC will issue a final rule, which will likely face significant legal challenges. KJK will continue to monitor the status of the proposed rule and provide updates accordingly. For more information or to discuss further, please contact KJK’s Labor and Employment Chair Rob Gilmore (RSG@kjk.com; 216.736.7240) or attorney Hannah Kraus (HJK@kjk.com; 216.736.7243).