On January 5, 2023, the Federal Trade Commission (FTC) issued a Notice of Proposed Rulemaking that would effectively ban Noncompetition Agreements, or “noncompete clauses” across the United States. Such a rule, if adopted, would have a significant impact on employers who require certain employees to sign such agreements as a condition of employment, particularly those high-level employees who have access to a company’s trade secrets or “proprietary” information. 

A noncompete clause is a contract term that basically prohibits an employee from working in a similar position at a competing employer, usually within a certain geographic area for a limited period of time after the employee’s employment ends. 

Justification for the Ban
According to the FTC, this proposed rule banning noncompete clauses is necessary because “noncompete clauses prevent workers from leaving jobs and decrease competition for workers, they lower wages for both workers who are subject to them as well as workers who are not” and “also prevent new businesses from forming, stifling entrepreneurship, and prevent novel innovation, which would otherwise occur when workers are able to broadly share their ideas.” The FTC estimates that its proposed rule would increase American workers’ earnings between $250 billion to $296 billion per year. 

While the FTC’s justification for this proposed rule has been hotly debated and contested by numerous pro-business groups and associations representing employers, what is certainly true is that in recent years noncompete clauses have been more heavily scrutinized and criticized by state governments and state and federal regulators. Much of this scrutiny resulted from certain large employers imposing noncompete clauses against lower-level employees who do not have access to the companies’ highly sensitive confidential information or its “trade secrets.” 

In one of the most noteworthy examples of this trend, in 2016, Jimmy John’s, the national submarine sandwich franchise, was sued by multiple states, including Illinois and New York, for its imposition of noncompete clauses on front-line workers who made its sandwiches. These noncompete clauses prevented those workers from taking jobs with competitors for a period of time. Jimmy John’s agreed to settle these lawsuits, rescind its noncompete clauses for its “low-wage” workers and pay hundreds of thousands of dollars in fines. The Jimmy John’s settlement led many other companies to reconsider how they use noncompete clauses, and what classes of employees they would ask to sign them. 

Confronting the Challenges

Most significantly, FTC’s proposed rule goes beyond just targeting employers who “overuse” noncompete clauses, it bans them for all employees, and even would require employers to rescind existing noncompete agreements. In addition, the rule “shall supersede any state statute, regulation, order, or interpretation to the extent that such statute, regulation, order, or interpretation is inconsistent” with the rule. 

Accordingly, if the FTC’s rule is adopted, employers will have to think long and hard about how they can implement alternative protections that would prevent or “disincentivize” departing employees from harming their business if they choose to go to a competing business. These could include a variety of clauses, such as the use of confidentiality, nonsolicitation and forfeiture clauses, and bringing claims under a variety of under-used state and federal trade secret statutes, such as the Federal Defend Trade Secrets Act. Employers should consult counsel to determine the best way to proceed in drafting and/or revising their employment agreements that address these issues, and in general. 

There is little doubt that the FTC’s proposed rule banning noncompetes will be legally challenged by employer groups, or possibly by individual companies. The grounds for the challenge will likely include  (1)  that the FTC does not have the authority to adopt such a rule; (2)that the rule infringes on a state’s right to regulate contracts; (3)that the rule “impairs” existing contracts and (4) the rule infringes on the right of parties to freely enter into such agreements. 

Stay tuned, this battle will be interesting. But employers should not be complacent in the hopes that such challenges to the rule will be successful. Employers should act now to address their noncompete agreements.