The FTC’s Proposed Ban on Non-Compete Clauses

Posted on by MBELR

By Alexander Johnson

On January 5, 2023, the Federal Trade Commission (“FTC”) released a proposed rule that would prohibit the use of non-compete clauses in employment and independent contractor agreements. As written, this rule would render existing non-compete clauses unenforceable and prohibit most employers from attempting to use such clauses in employment agreements. The proposed rule has generated substantial feedback and controversy – it has received over 20,000 public comments at the time of this post.1 This move by the FTC, and anticipated legal challenges in response to it, may represent a significant change in the relationship between businesses and their workers, and for employment and administrative law in general. 

What are Non-compete Clauses?

Non-compete clauses are a standard form of restrictive covenants used in employment agreements in the U.S. As defined in the proposed rule, they are “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.”.2 Non-compete clauses are broadly used in employment agreements within the U.S. There are an estimated 30 million Americans, or 18% of the workforce, who are subject to a non-compete.3

The general policy goal of non-compete clauses and similar restrictive covenants is to prohibit former employees from disclosing confidential information and trade secrets to an employer’s competitors. 

However, there has been significant backlash against their usage. In a statement, FTC Chair Lina Khan stated that “[n]oncompetes block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand.”4 Najah Farley, a senior staff attorney at the National Employment Law Project (“NELP”), states that the rule would create “more competition between companies for workers.”5 The FTC estimates the proposed rule could increase workers’ earnings across industries and job levels by $250 billion to $296 billion per year, and would close racial and gender wage gaps by 3.6 to 9.1 percent.6

Enforcement of Non-compete Clauses under State Law

Enforceability of non-compete clauses varies significantly under state law. Generally, states limit their enforceability by a standard of reasonableness. In Michigan, for example, non-compete clauses and other restrictive covenants must be reasonably limited to be enforceable. The non-compete must be reasonably limited in (1) geographic scope, (2) duration, and (3) to the scope of employment that is covered.7 The restrictions must also be narrowly construed according to the specific context of the former employer’s particular business interests, and the knowledge and function the former employee had.8 Some states have been more dismissive toward the use of non-compete clauses, however. In California, non-compete clauses are per se unenforceable unless the employer qualifies for a statutory exemption.9) If the non-compete is entered in connection with (1) a company acquisition,10), (2) a partnership exit or dissolution,11), or (3) an LLC member’s exit or dissolution,12), then the non-compete is enforceable. Other states that have effectively banned the use of non-compete clauses include Connecticut, Illinois, Maine, Maryland, Massachusetts, New Hampshire, Oregon, and Washington.13

The FTC’s Proposed Rule

On July 9, 2021, President Biden issued an executive order aimed at promoting competition in the U.S. economy.14 In Section 5(g) of the Order, the President encouraged the FTC to “exercise [their] statutory rulemaking authority under the Federal Trade Commission Act to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.” Pursuant to this Order, the FTC voted 3-1 to publish a Notice of Proposed Rulemaking (“NPRM”), the first step in the rulemaking process.15

As stated, the proposed rule functionally bans the use of non-compete clauses for most employment agreements. This is accomplished by the FTC finding the use of such a restrictive covenant as an “unfair method of competition”, which may be regulated through rulemaking under Section 5 of the Federal Trade Commission Act.16

The proposed rule also bans “de facto” non-compete clauses that have “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.”17 A “functional test” would be used to determine whether a clause is, in reality, a de facto non-compete clause. However, it is unclear what factors would be used in this test. Under § 910.1(b)(2), the proposed rule gives two examples of what the FTC considers to be de facto non-compete clauses:

i. A non-disclosure agreement between an employer and a worker that is written so broadly that it effectively precludes the worker from working in the same field after the conclusion of the worker’s employment with the employer.

ii. A contractual term between an employer and a worker that requires the worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specified time period, where the required payment is not reasonably related to the costs the employer incurred for training the worker.

18 The proposed rule also requires businesses using non-compete clauses to rescind them within 180 days of a publicized final rule, and provide individual notice to existing and former employees that their non-compete is rescinded and unenforceable against them.19 Other standard forms of restrictive covenants, such as non-solicitation and confidentiality clauses, are not included within the proposed rule. An exception exists for non-competes entered into in connection with a sale of business.20 The proposed rule would supersede inconsistent state statutes, provided the state statute does not provide greater protection than the rule.21

Rationale, Reactions to the Proposed Rule

The majority of Commissioners offered rationale on this shift in policy, claiming that non-compete clauses reduce competition in labor markets and suppress wages and job mobility.22 The majority state that federal action is appropriate given the interstate harm caused by non-competes.23

Commissioner Christine Wilson, the lone Republican on the Commission, voted against publishing the NPRM. Commissioner Wilson centered most of her argument on claims that the FTC lacked the authority to issue such a rule, stating it is “vulnerable to meritorious challenges that (1) the Commission lacks authority to engage in ‘unfair methods of competition’ rulemaking, (2) the major questions doctrine addressed in West Virginia v. EPA applies, and the Commission lacks clear Congressional authorization to undertake this initiative; and (3) assuming the agency does possess the authority to engage in this rulemaking, it is an impermissible delegation of legislative authority under the non-delegation doctrine, particularly because the Commission has replaced the consumer welfare standard with one of multiple goals.”24

In response to Commissioner Wilson, the majority of the Commissioners stated the “rulemaking authority we are exercising today is firmly rooted in the text and structure of the FTC Act and supported both by judicial precedent interpreting the scope of the law as well as further statutory language…”25) On the major questions doctrine question raised by Commissioner Wilson, the majority stated they are “operating under clear statutory authority. Identifying and addressing unfair methods of competition is central to the mandate that Congress gave the Commission in the text of our authorizing statute.”26

Conclusion

Legal challenges against the FTC’s authority will almost certainly raise major questions and non-delegation challenges to strike the proposed rule down, if enacted. Sean Heather, a senior vice president of the U.S. Chamber of Commerce, a business lobbying group, claims the rule exceeds statutory authority and stated the organization intends to file suit against the rule’s issuance.27

The Supreme Court decision in West Virginia v. EPA applied the major questions doctrine to strike down a regulation, stating the EPA did not have “clear congressional authority” to promulgate rules concerning an issue of “great political significance” affecting “a significant portion of the American economy.”28 The ruling signaled to commentators that the Court would generally be more restrictive against agency authority in the future; it is presumed this proposed rule would face a similar challenge.29

Following the FTC’s lead, on February 1, 2023, a bipartisan group of senators introduced the Workforce Mobility Act of 2023, which would also generally ban the use of non-compete clauses.30 The bill is in committee, and has not been voted on as of this post. 

Public comments on the proposed rule may be submitted until April 19, 2023.31 The legal profession and the organizations they advise will need to pay close attention to this potential sea change in employment law, and plan to update their employment agreements accordingly. 

  1. Fed. Trade Comm’n, Non-Compete Clause Rule, Regulations.gov (Jan. 9, 2023). https://www.regulations.gov/document/FTC-2023-0007-0001. ↩

  2. See Non-Compete Clause Rule, 88 Fed. Reg. 3482, 3535 (Jan. 19, 2023) (to be codified at 16 C.F.R. pt. 910). ↩

  3. FTC Proposes Rule to Ban Noncompete Clauses, Which Hurt Workers and Harm Competition, Fed. Trade Comm’n (Jan. 5, 2023), https://www.ftc.gov/news-events/news/press-releases/2023/01/ftc-proposes-rule-ban-noncompete-clauses-which-hurt-workers-harm-competition. ↩

  4. Jessica Dickler, Proposed ban on noncompete clauses could affect ‘every business in the country,’ says attorney — what that means for you, CNBC (Jan. 11, 2023, 3:10 PM), https://www.cnbc.com/2023/01/11/what-the-proposed-ban-on-noncompete-clauses-means-for-you.html ↩

  5. Id. ↩

  6. Fact Sheet: FTC Proposes Rule to Ban Noncompete Clauses, Which Hurt Workers and Harm Competition, Fed. Trade Comm’n (last visited Mar. 31, 2023), https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete_nprm_fact_sheet.pdf ↩

  7. See Mich. Comp. Laws. § 445.774a(1); see also Robert Half Int’l, Inc. v. Van Steenis, 784 F. Supp. 1263, 1271 (E.D. Mich. 1991). ↩

  8. Mich. Comp. Laws. § 445.774a(1); see also Whirlpool Corp. v. Burns, 457 F. Supp. 2d 806, 812 (W.D. Mich. 2006). ↩

  9. Cal. Bus. & Prof. Code § 16600 (West 2023 ↩

  10. Cal. Bus. & Prof. Code § 16601 (West 2023 ↩

  11. Cal. Bus. & Prof. Code § 16602 (West 2023 ↩

  12. Cal. Bus. & Prof. Code § 16602.5 (West 2023 ↩

  13. Testimony of Najah Farley, In Support of Proposed B23-494, Ban on Non-Compete Agreements Amendment Act of 2019, Nat’l Emp. L. Project (Dec. 6, 2019), https://s27147.pcdn.co/wp-content/uploads/NELP-Testimony-DC-Council-Non-Compete-bill.pdf. ↩

  14. Exec. Order No. 14,036, 3 C.F.R. 609 (Jul. 9, 2021. ↩

  15. A Guide to the Rulemaking Process, Off. Fed. Reg., https://www.federalregister.gov/uploads/2011/01/the_rulemaking_process.pdf. ↩

  16. See Non-Compete Clause Rule, 88 Fed. Reg. 3482, 3535 (Jan. 19, 2023) (to be codified at 16 C.F.R. pt. 910); see also 15 U.S.C. § 45(a)(1). ↩

  17. Non-Compete Clause Rule, 88 Fed. Reg. 3482, 3535 (Jan. 19, 2023) (to be codified at 16 C.F.R. pt. 910). ↩

  18. Id. ↩

  19. Id. ↩

  20. Id. ↩

  21. Id. ↩

  22. U.S. Fed. Trade Comm’n, Statement of Chair Lina M. Khan Joined By Commissioner Rebecca Kelly Slaughter and Commissioner Alvaro M. Bedoya Regarding the Notice of Proposed Rulemaking to Restrict Employers’ Use of Noncompete Clauses (Jan. 5, 2023), https://www.ftc.gov/system/files/ftc_gov/pdf/statement-of-chair-lina-m-khan-joined-by-commrs-slaughter-and-bedoya-on-noncompete-nprm.pdf. ↩

  23. Id. ↩

  24. U.S. Fed. Trade Comm’n, Dissenting Statement of Commissioner Christine S. Wilson Regarding the Notice of Proposed Rulemaking for the Non-Compete Clause Rule (Jan. 5, 2023), https://www.ftc.gov/system/files/ftc_gov/pdf/p201000noncompetewilsondissent.pdf. ↩

  25. U.S. Fed. Trade Comm’n, Statement of Chair Lina M. Khan Joined By Commissioner Rebecca Kelly Slaughter and Commissioner Alvaro M. Bedoya Regarding the Notice of Proposed Rulemaking to Restrict Employers’ Use of Noncompete Clauses (Jan. 5, 2023 ↩

  26. Id. ↩

  27. The FTC’s Noncompete Rulemaking is Blatantly Unlawful, U.S. Chamber of Com. (Jan. 5, 2023), https://www.uschamber.com/finance/antitrust/the-ftcs-noncompete-rulemaking-is-blatantly-unlawful. ↩

  28. West Virginia v. Env’t Prot. Agency, 142 S. Ct. 2587, 2608-10 (2022). ↩

  29. Shay Dvoretzky, Emily J. Kennedy, Elizabeth A. Malone, West Virginia v. EPA: Implications for Climate Change and Beyond, Skadden (Sep. 21, 2022), https://www.skadden.com/insights/publications/2022/09/quarterly-insights/west-virginia-v-epa. ↩

  30. S. 220, 118th Cong. (1st Sess. 2023). ↩

  31. Fed. Trade Comm’n, Non-Compete Clause Rule, Regulations.gov (Jan. 9, 2023). https://www.regulations.gov/document/FTC-2023-0007-0001. ↩

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