Insights - February 9, 2023

Federal Trade Commission Proposes Noncompete Ban in Employer Contracts

By Travis J. Foels and Michael J. Gore, LL.M.

On January 5, 2023, the Federal Trade Commission (FTC) proposed a rule that, if adopted, would prevent employers across the United States from entering into noncompete agreements with workers. It would also require employers to rescind noncompete agreements already in place and to actively inform current and former workers that noncompete clauses are no longer in effect. If adopted, the proposed rule would supersede any state statute, regulation, order, or interpretation that conflicts with it.

FTC's justification for the proposed ban on noncompete agreements

The proposed rule is based on the FTC’s belief that noncompete agreements constitute an unfair method of competition and violate Section 5 of the Federal Trade Commission Act, which generally prohibits “unfair or deceptive acts or practices in or affecting commerce.” Specifically, the FTC stated that noncompete clauses depress wages as workers are prevented from leaving their jobs, resulting in an overall decrease in competition. The FTC estimates that the proposed rule would increase American workers’ earnings by $250 billion to $296 billion per year.

The FTC also deemed noncompete agreements to be an unfair method of competition because they prevent new businesses from forming and prevent novel innovation which would otherwise occur when workers are able to freely share ideas. In a press release, FTC Chair Lina M. Khan stated “[t]he freedom to change jobs is core to economic liberty and to a competitive, thriving economy . . . [b]y ending this practice, the FTC’s proposed rule would promote greater dynamism, innovation, and healthy competition.”

What does the FTC's proposed rule prohibit?

Noncompete clauses are defined in the proposed rule 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.” The proposed rule includes a “functional test” for whether a contractual term is a noncompete clause, whereby a contractual term is considered a de facto noncompete 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 would generally not apply to other types of employment restrictions. Due to the broad scope of the FTC’s proposed “functional test,” however, other contractual terms such as nonsolicitation and nondisclosure clauses may also be considered unlawful if they hinder a worker’s ability to accept employment or operate a business.

Who would be affected by the FTC's proposed rule?

If adopted, the proposed rule would apply to all employers in the U.S. and virtually all workers, whether paid or unpaid, including employees, independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide a service to a client or customer. There is a limited exception for persons selling or otherwise disposing of their ownership interest in a business entity, or selling substantially all of a business entity’s operating assets, when the person restricted by the noncompete owned at least 25% of the business being sold at the time they entered into the noncompete clause.

What's next?

The FTC has asked for public comment on the proposed rule through March 10, 2023. After that, the FTC may make changes based on comments and further analysis of this issue before publishing a final version of the rule. Employers would then have 180 days from the date of publication to come into compliance with the rule’s requirements.

As currently written, the proposed rule will almost certainly be subject to legal challenges regarding whether the FTC has the authority to engage in such broad rulemaking. The enforceability of noncompetes has historically been left to the individual states. Forty-seven U.S. states currently permit noncompetes, including Florida, which allows noncompetes that are reasonable in time and geographic scope and supported by a legitimate business interest. In a statement by Sean Heather, U.S. Chamber Senior Vice President for International Regulatory Affairs and Antitrust, Heather called the FTC’s outright ban on noncompete clauses “blatantly unlawful.” He noted that “[s]ince the agency’s creation over 100 years ago, Congress has never delegated the FTC anything close to the authority it would need to promulgate such a competition rule.” According to Heather, “[t]he Chamber is confident that this unlawful action will not stand.”

What should employers do while the FTC considers the noncompete rule?

As of right now, employers should monitor the progress of the proposed rule and reach out to legal counsel immediately, if and when, it becomes final.

The full text of the FTC's proposed rule can be found here.

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