U.S. Federal Trade Commission proposes ban on employee non-compete agreements

Introduction

On Thursday, January 5, in a 3-1 party line vote, the Federal Trade Commission (FTC) issued a notice of proposed rulemaking that targets employers’ use of non-compete clauses and agreements. As proposed, the rule would ban the use of non-competes in most settings and require employers to rescind existing non-competes. The move has drawn intense criticism from the FTC’s lone Republican, Commissioner Christine Wilson, as well as from business groups and allies.

The proposed rule is now out for an initial public comment period of 60 days. During the rulemaking process, the agency may alter the substance of the rule in response to comments, and the FTC’s public statements have indicated that it is eager for public comments to help the agency understand the practical implications of the rule. If the proposed rule is adopted by a majority vote of the Commissioners, it is expected to face substantial legal challenges on a number of fronts.

Proposed Rule

Invoking the FTC’s statutory powers under Sections 5 and 6(g) of the Federal Trade Commission Act, the FTC’s majority voted out a proposed rule designating non-compete clauses as unfair methods of competition. This move has long been telegraphed as part of the FTC’s renewed efforts to combat unfair methods of competition under Section 5.

The substance of the proposed rule, which applies to all businesses and activities under the FTC’s jurisdiction (this does not include certain industries such as banking and non-profits), is relatively straightforward:

• Employers would be banned from utilizing or attempting to utilize non-compete provisions in employment agreements.
• Employers would have to notify current and past workers subject to existing non-compete agreements that the employer disavows existing non-competes and will not seek to enforce them.
• There is one exception: where someone with a substantial (ie at least 25%) ownership interest in a business is selling or disposing of their ownership interest.
• So-called “de facto” non-competes would also be banned, eg other contract clauses such as non-disclosure provisions written so broadly that the worker is precluded from working in the same field.

All indications are that the FTC considers this very much a proposal rather than a “done deal”. Public statements by commissioners and FTC staff show that they are very interested in public comments to help formulate the rule and frame its scope. For instance, the FTC’s Director of the Office of Policy Planning, Elizabeth Wilkins, acknowledged that the 25% ownership interest threshold might be arbitrary and inappropriate in some circumstances.

The proposed rule marks a major shift in the legal treatment of non-competes by federal regulators. Currently, limits on the use of non-compete agreements are governed by state law. Most states (with California  being a notable exception) allow non-competes if they are not overly broad. The proposed rule would “supersede any State statute, regulation, order, or interpretation to the extent that such statute, regulation, order, or interpretation is inconsistent with [the proposed rule].”

Rationale

The proposal comes after years of increasing scrutiny by state and federal law makers and regulators of employers’ use of non-compete agreements. They argue that such provisions restrict worker mobility, suppress workers’ wages, and depress innovation. According to statistics cited by the FTC, approximately 30 million, or one in five, American workers are bound by a non-compete clause. The FTC has stated that scrapping these non-compete provisions would increase the earnings of American workers by between USD250 billion and USD296bn per year.

In a press release announcing the proposed rule, the FTC’s majority also claimed that non-compete clauses hinder innovation and business dynamism. The majority points to an inability of new businesses to hire vital workers because the experienced talent pool is bound by non-competes.

The FTC’s majority has additionally voiced concern about worker awareness of non-compete unenforceability, maintaining that the wage suppressing effect can be the same if workers wrongly believe they are bound by an agreement that is actually unenforceable.

Along with recent agency enforcement actions targeting specific non-compete agreements, the proposed rule is part of a broader initiative to “promote fair competition in labor markets.”

Criticism

The proposed rule has already received strident criticism from Commissioner Wilson in dissent, as well as from business and industry groups and publications. This criticism focuses both on the substance of the proposed rule and the FTC’s legal authority to issue it.

According  to Commissioner Wilson, the substance of the proposed rule is a radical departure from the current approach of the FTC. She notes that under the current approach, non-compete clauses are subject to a fact-intensive inquiry to determine their competitive effects and business justifications. Commissioner Wilson argues that the purposed change is  unjustified given the FTC’s limited experience with employee non-competes and the narrow and conflicting evidence that supports the anticompetitive effects of non-compete clauses. She also argues that suspension of non-competes across all industry sectors may lead to negative unintended consequences. Finally, Commissioner Wilson maintains that the FTC lacks the rulemaking authority to issue such a rule, and that had Congress delegated such authority, such a grant would be unconstitutional.

Outlook

Like all rules produced by U.S. federal agencies, the FTC’s proposed non-compete rule must go through a lengthy rulemaking process. The proposed rule is out for initial public comment for a period of 60 days. The FTC is seeking comments on, for example, whether the rule should apply to senior executives and whether low wage workers should be treated differently from high wage workers.

Following the initial public comment period, the proposed rule can and likely will be reworked, and there is no set deadline for when the rule will be finalized. Once finalized, employers would have 180 days to comply with the rule, subject to any legal challenges delaying its implementation.

Like all agency rules, the FTC’s proposed rule is subject to legal challenge in court. This is widely anticipated given the significant commercial impact of the rule. In addition to the standard legal challenges to agency rulemaking, we anticipate additional legal challenges to the rule and the agency’s statutory authority based on the major questions doctrine, the non-delegation doctrine, and the use of the correct statutory rulemaking procedure  by the FTC.

Conclusion

In sum, the FTC’s proposed rule banning non-competes is a significant step in the agency’s bid to target these types of agreements. However, the final rule may be significantly revised in response to public comments received by the FTC during the public comment period. We therefore advise all interested parties to submit comments on the proposal in order to help to shape its parameters and scope. Lawsuits targeting any final rule curtailing the use of non-competes and the FTC’s process for producing such a rule should be anticipated.