FTC Proposes Rule Banning Non-Compete Agreements in Employment Contracts

On January 5, 2023 the Federal Trade Commission (the “FTC”) proposed a rule that will ban non-compete clauses in employment agreements. According to the proposal, approximately 1 in 5 Americans are bound by a non-compete provision in their employment contract. In sum, the FTC is claiming that non-compete agreements stifle competition in the free market, decreases compensation for employees subject to non-compete agreements, and restricts new businesses from being formed. The FTC claims that this proposal will increase employee earnings between $250 billion and $296 billion a year.

This brief article will address the key points of the proposed rule which are: (1) the functional test to determine whether the contractual term is a indeed a non-compete; (2) the proposed rule’s impact on existing non-compete clauses; (3) the proposed rule’s limited exception; and (4) the proposed rule’s relation and impact on existing state law and lastly, speak to what employees and employers can do now to prepare for the upcoming changes.

The Functional Test to Determine Whether a Contractual Clause is a Non-Compete Clause

The Functional Test included in the proposed rule makes it clear what the FTC is looking to ban, which is any clause that has the effect of prohibiting a 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 other words, any clause that is a de-facto non-compete.

While it may seem lazy on the front-end, the FTC may be trying to make this as simple as it possibly can to combat any challenges (trust me, there will be some) and simplify the analysis for any judge, mediator, or arbitrator.

The Proposed Rule’s Impact on Existing Non-Compete Clauses

Under the proposed rule, the employer must rescind the non-compete provision of the agreement and provide proper notice to the employee that the non-compete clause is no longer in effect. Without this requirement, an employee would still be subject to the non-compete, defeating the whole purpose of the rule itself. Additionally, the employer could attempt to circumvent the non-compete by simply amending the operative employment agreement, but retaining the non-compete clause.

The Proposed Rule’s Limited Exception

?Almost every rule, law, or regulation comes with some sort of exception and the FTC’s proposed rule is no different, but it is extremely narrow. The sole exception to the proposed rule is when a non-compete clause is signed by a person selling a business entity or disposing of the one’s interest in a business entity, so long as the person was a substantial partner, owner, or member of a business entity at the time the non-compete was signed.

The Proposed Rule’s Relation and Impact on Existing State Law

Considering this proposed rule will be at the Federal level, this rule will supersede an existing state law that is inconsistent with the proposed rule. Simply put, any statute, law, rule, or regulation that allows non-compete agreements, in any way, will be unlawful.

What Can Employers and Employees Do Now?

Employers

Employers are undoubtedly the most impacted by this proposed rule. Employers alike use non-compete clauses to protect their business model, institutional knowledge, and ensure that anything the employer learns during their time with that employer cannot then be used against the employer if the employee leaves. Unfortunately, such an outlook is anti-competitive on its face which is why the FTC is getting involved.

Moving forward, employers will need to address this proposed rule with any employees subject to a non-compete. While the conversation may be easy, the impact of that conversation can be detrimental if that the employee chooses to go and work for a competitor. Employers should be prepared to increase compensation, provide additional benefits, or take other measures to ensure that employee does not leave, that is if that employee is a valuable asset.

Additionally, employers may be able to use different types of contractual language that may not necessarily bar competition but potentially limit the impact of an employee’s departure on the business.

Employees

???????????????All employees subject to a non-compete clause should monitor the proposed rule because once it goes into effect, the employer must take proper steps to rescind that clause. This will undoubtedly lead to more competition in spaces that tend to rely on non-competes to retain its business practices, such as the tech and healthcare sector, so expect more competition (and opportunities) across the board.