On January 5, 2023, the Federal Trade Commission (FTC) published a new proposed rule that would ban employers’ use of covenants not to compete. The rule comes in the wake of an Executive Order issued by the Biden administration in July 2021, asking FTC to draft rules “to curtail the unfair use of non-compete clauses.” The proposed rule is subject to a 60-day period of public comment. After that, FTC will have the opportunity to consider the comments and issue a Final Rule, which will go into effect 180 days after issuance.
The new proposed rule’s impact would be enormous on employers and employees alike. This note discusses first the scope of the new proposed rule. Then, it discusses the likely effect such a rule would have, were it implemented.
The New Proposed Rule
The proposed rule would prohibit all “employers” from entering into a “non-compete clause” with a worker. Both terms would be defined by the rule. “Employer” encompasses any entity that hires or contracts with a worker. And “non-compete clause” refers to a contractual term that prevents the worker from seeking or accepting employment after the conclusion of their work with the employer. Notably, the definition of “non-compete clause” is likely broad enough to include all covenants not to compete (e.g. non-solicitation, no-contact, non-compete, etc.).
The proposed rule also has a retroactive clause that would apply to existing non-competes. This retroactive clause would make it an “unfair practice” to maintain any pre-existing covenant not to compete. To enact this retroactive clause, the rule contemplates a notice period, in which the employer would alert the employee that his or her covenant not to compete is no longer enforceable.
The proposed rule does not touch on confidential information or trade secrets. Those areas of law (which are governed mostly by state statutes) will continue as normal.
Finally, the proposed rule includes an exception for persons who are selling a business or ownership interest and have executed a non-compete clause in conjunction with the disposition. The exception would permit the enforcement of covenants not to compete against people, who are divesting themselves of the ownership interests. The rationale for this exception is to protect the value of the business for the buyer.
Effect of Banning Covenants Not to Compete
Restrictive covenants are broadly used throughout the United States. From doctors to executives, insurance salespersons to nurses, employees in nearly every industry may be subject to a covenant not to compete. Should the proposed rule become final, such covenants would generally be unenforceable—even those that already exist.
FTC’s Fact Sheet states that non-compete clauses “stifle new business” and “reduce workers’ wages.” It touts the proposed rule as helping workers and consumers. Of course, the economic effect is—as of yet—uncertain.
What is certain is that employers should be prepared to handle this new rule if it becomes final. The new rule will impose some immediate responsibilities on employers, such as the notice requirements, and it will require a review of any employment agreement or existing covenant not to compete.