On January 5, 2023, the Federal Trade Commission (“FTC”) released a Notice of Proposed Rulemaking that seeks to ban employers from imposing and enforcing existing non-compete clauses. The FTC’s proposed rule would serve, with minor exceptions, as a complete ban on non-compete clauses and drastically change the employer and employee relationship as well as competition in the marketplace as a whole.
OlenderFeldman LLP has prepared this FAQ to address the proposed rule and what it means for those affected.
Q. What is the FTC’s proposed rule?
A. The FTC has proposed a new rule that would make it unlawful for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non-compete clause; or represent to a worker that the worker is subject to a non-compete clause.
Q. How is “Non-Compete Clause” defined?
A. As currently written, 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 determining whether a contractual provision is considered a non-compete clause, it appears that the determination will be decided on how the provision functions. While the proposed rule does not include other restrictive employment covenants within its definition, e.g., non-disclosure agreements (“NDAs”) and non-solicitation agreements, in the event that such contractual provisions are unusually broad in scope and have the effect of preventing a worker from seeking and/or accepting employment, then such provisions would be viewed as a de facto non-compete, and therefore, unenforceable.
Q. How is “Employer” defined?
A. As currently written, the proposed rule defines “employer" as any person, partnership, corporation, association, or other legal entity, that hires or contracts with a worker to work for them.
Q. How is “Worker” defined?
A. As currently written, the proposed rule defines “worker" as a natural person who works, whether paid or unpaid, for an employer. The term “worker” includes, without limitation, an employee, individual classified as an independent contractor, extern, intern, volunteer, apprentice, or sole proprietor who provides a service to a client or customer.
Q. What does the FTC’s proposed rule seek to accomplish?
A. The FTC’s proposed rule seeks to encourage competition, benefit workers, and prohibit anticompetitive harm to the labor, product, and service markets.
Q. Is the FTC’s proposed rule retroactive?
A. Yes. As currently drafted, the proposed rule would require employers to rescind existing non-compete clauses and provide notice to the worker of its rescission. Employers will be required to provide notice to both current and former workers within 45 days of rescinding the non-compete clause.
Q. What exceptions are there to the FTC’s proposed rule?
A. The proposed rule currently includes a limited exception that allows for a non-compete clause in connection with the sale of a business.
In particular, the proposed rule will not prohibit a non-compete clause (as defined by the proposed rule) when it is entered into:
- By a person who is selling a business entity or otherwise disposing of all of the person’s ownership interests in the business entity; or
- By a person who is selling all or substantially all of the business entity’s operating assets.
Note, however, that this exception would only apply when the seller is an owner, member, or partner holding at least a 25% ownership interest in the business entity.
While the exception to the proposed rule is somewhat unclear, it appears that an owner, owning less than 25% of the selling entity, may be subjected to a non-compete clause with the sale of the business, so long as the owner is not a worker as defined in the proposed rule.
Q. Will all non-compete provisions be prohibited?
A. It appears that the proposed rule only applies to non-compete provisions between employers and workers. As currently drafted, the proposed rule will not apply to other types of non-compete clauses, e.g., non-compete clauses between two businesses, where neither party is a “worker” as defined under the proposed rule.
Notwithstanding, if a non-compete clause is not covered by the proposed rule, it is still subjected to federal and state laws.
Q. If passed, when would the FTC’s proposed rule be effective?
A. Currently, the FTC is allowing public comment on the proposed rule. If the FTC’s proposed rule is approved, employers will have 180 days from its date of publication in the Federal Register to rescind existing non-compete provisions.
Q. What effect does the FTC’s proposed rule have on the worker?
A. The proposed rule is only a proposal and does not affect any existing non-compete provision that a worker may be a signatory to. Notwithstanding, the proposed rule is seemingly employee friendly. Indeed, non-compete clauses typically prohibit workers from switching jobs and, as a result, often restrict their ability to earn higher wages and potentially obtain better working opportunities. If the FTC’s proposed rule is implemented, it will invalidate non-compete provisions as indicated above and allow for more labor competition in the marketplace and, in turn, provide the worker with the ability to freely seek employment opportunities and higher paying positions. Persons seeking employment, however, will lose the ability to freely agree to a non-compete provision in exchange for consideration that may otherwise have been offered absent the prohibition.
Q. What effect does the FTC’s proposed rule have on the employer?
A. Although employers will be prohibited from using non-compete provisions, as indicated above, employers can utilize other mechanics of contract to protect valuable investments/confidential information of their business, such as: NDAs, non-solicitation agreements, and confidentiality provisions. However, an employer must be wary of the provisions' scope so as not to create a de facto non-compete provision, which would then be unenforceable.
Additionally, an employer can protect its investment in the worker by contracting for a term of employment. An employer might establish a “term of employment” that requires the worker to pay the employer for training costs if the worker’s employment terminates within a specified time period, so long as the required payment is reasonably related to the costs the employer incurred for training the worker. An employer may also structure compensation in a manner that is contingent on a minimum “term of employment”.
Q. What should employers be doing now?
A. Even if the proposed rule is published and implemented, employers can continue to include confidentiality provisions and other restrictive covenants within their agreements.
In the interim, employers should perform a thorough review of all agreements to identify current non-competes and be prepared to address same should the proposed rule be implemented. Additionally, employers should review said agreements to ensure the enforceability of their other restrictive covenants contained therein.
While the likelihood of the rule being implemented is unknown, if published, employers could face considerable time constraints to comply with the requirements of the rule. Therefore, employers should begin to develop a plan and have one in place before a decision is rendered on the proposed rule.
Further information or guidance concerning the proposed rule can be obtained from ">OlenderFeldman LLP.
