On January 5, 2023, the U.S. Federal Trade Commission (FTC) proposed a new rule which would prohibit the imposition of non-compete agreements in the employment context. The FTC’s view is that non-compete agreements are “exploitative” and can substantially harm workers, including in particular by preventing workers from obtaining better employment opportunities to the tune of an estimated $300 billion per year in additional wages. President Biden also spoke to the issue of non-competes in 2021 speech, noting that it is not only “high-paid executives or scientists who hold secret formulas for Coca-Cola” being subjected to non-competes, but also “construction workers, hotel workers, [and] disproportionately women and women of color.”
The proposed rule would make it illegal for any employer to: (i) enter into or attempt to enter into a non-compete with a worker; (ii) maintain a non-compete with a worker (i.e., enforce an existing non-competition agreement), or (iii) represent to a worker, under certain circumstances, that the worker is subject to a noncompete. In fact, employers would be obligated to affirmatively advise employees that any existing non-competes are no longer effective.
As required by federal law, the FTC’s proposed rule is now undergoing a 60-day comment period. Employers are objecting to the proposed rule, arguing that non-competes are an appropriate tool – which are already limited in use by state law – to protect an employer’s trade secrets and competitive advantages. As proposed, the new rule would “preempt” state law, thereby preventing any state from adopting legislation to permit non-competes in contravention of the FTC rule. If adopted, the rule would become effective one hundred eighty (180) days following its publication in the Federal Register.
It is important to note that the FTC-proposed restriction would not eliminate all restrictive covenants and similar commitments made by employees. In particular, it would not impact the availability or enforceability of other employment-related restrictive limitations, such as non-disclosure agreements and non-solicitation agreements. In addition, the proposed rule contains a limited exception for non-competes in the context of the sale of a business. It is customary for sellers to agree not to compete with the buyer of their business for a stated period of time – often for five years following the sale. This restriction is critical to the buyer as it cannot be in a position of buying a business only to allow the seller to immediately thereafter open a competing business. That said, the FTC seeks to impose limitations on this exception as well. The current proposed rule would only allow a seller of more than a twenty-five percent (25%) ownership in the selling business to be subject to a non-compete, thereby rendering non-competes unenforceable against owners who would hold only a minority stake in the selling business.
The proposed prohibition would apply employees as well as to individuals who are engaged as “independent contractors”. It is unclear, however, if the prohibition would apply also to entities that are engaged as independent contractors and if it would also extend to individuals who are employees or independent contractors of such entities. Hopefully, this would be clarified in a future version of the proposed rule.
Notwithstanding the uncertainty regarding the FTC’s proposed rule becoming law, as well as what changes, if any, may be made during the rule-making process, business owners should begin planning for the possibility of this rule becoming law. It will have implications with respect to the re-drafting of employment agreements and the ability of buyers to protect a new business following an acquisition from its owners. Advance planning will enable business owners to mitigate the legal and operational effects of the proposed rule.
