On Thursday, January 5, 2023, the Federal Trade Commission (FTC) made headlines with its announcement that it is proposing a new rule that would ban employers from using noncompete clauses (the “rule”).

The rule, as drafted, would prohibit employers throughout the United States from relying on or enforcing covenants to not compete. It is retroactive, further requiring the rescission of any such restrictive covenants currently in existence by an undetermined compliance date (which will be at least 240 days from now, at the earliest). The rule also specifies that the federal regulations would supersede any contradictory state law.

The announcement, while stunning to many, is a development that we anticipated and questioned halfway through 2022 and saw coming by the end of the year.

News of the rule came directly on the heels of the FTC’s announcement on January 4, 2023, that it had entered into consent agreements with three companies and two individuals that “prohibit the companies and, where applicable, their individual owners from enforcing, threatening to enforce, or imposing noncompetes against any relevant employees,” among other things. As the FTC acknowledged in the press release announcing these agreements, “these actions mark the first time that the agency has sued to halt unlawful noncompete restrictions.” 

What the Rule Says

Definitions

The FTC’s proposal would create “rules concerning unfair methods of competition” under a new subchapter J, Part 910, addressing noncompete clauses. The proposed Part 910 definitions section provides a straightforward explanation that a “non-compete clause” is “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 definition goes further by also providing that it encompasses any “contractual term that is a de facto non-compete clause” and sets forth a functional test for whether a contractual term is a “non-compete clause.”

While it is clear that the rule would not apply to (1) customer or co-worker non-solicits (unless they could somehow be construed as “de facto non-compete clauses”), (2) reasonable advance notice of resignation requirements (i.e., clauses that require an employee to give notice some time before their resignation, during which time they remain an employee and owe their employer a duty of loyalty), or (3) routine confidentiality agreements, it is less clear where the line will be drawn for “de facto non-compete clauses.” For example, while the FTC provides as an example of a “de facto non-compete clause” 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,” there is no explanation of what would be too broad or effectively preclude employment. Similarly, another example that the FTC provides of a “de facto non-compete clause” is “[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.” But it is unclear what “reasonably related” means. It is also unclear whether the rule would ban more traditional forfeiture-for-competition clauses that are excepted from various states’ definitions of noncompetes, or whether the rule would have any purported effect on such clauses when they are included in employee benefit plans governed by ERISA (e.g., certain stock option plans).

Substantive Regulations

Noncompetes Banned:Under the rule, all post-employment noncompete clauses would constitute an unfair method of competition and would thus become unlawful. The rule would require employers to rescind any existing noncompete clauses and to notify employees who had been subject to such clauses of the rescission, in writing, within 45 days of the rescission. Model language for such notices is included in the rule. Importantly, the specific date by which employers would be required to rescind existing noncompete clauses is yet undetermined, but, as mentioned above, would be no earlier than 240 days from now.

Limited Exception:The rule specifies that it would not apply to a noncompete agreement with a person who is selling or otherwise transferring ownership of a business entity or its operating assets, if the restrictions apply to the seller or a substantial partner in the business entity at the time the noncompete agreement is entered.

Preemption: The rule specifies that it would preempt any inconsistent state or local law, noting that state and local laws are not “inconsistent” with the rule if they afford workers any protection that “is greater than the protection provided under this Part 910.” Notably, the rule makes no mention of its purported effect on forfeiture-for-competition provisions included in benefit plans governed by ERISA.

About the Federal Rulemaking Process

The FTC’s decision to submit the Notice of Proposed Rulemaking (the “notice”) for publication in the Federal Register is just the first step in the rulemaking process, and it is far from certain that the rule will be adopted as drafted. Once the notice is formally published, a 60-day comment period will commence, during which interested parties will be able to submit concerns and remarks about the rule via the federal government’s online portal.

The four FTC commissioners voted 3–1 to advance the proposed regulations. FTC Chairperson Lina Khan voted in favor and issued a statement about the decision, and was joined by Commissioners Rebecca Kelly Slaughter and Alvaro Bedoya, who also issued an additional joint statement. Dissenting Commissioner Christine Wilson likewise issued an extensive statement, urging affected parties to participate in the open comment period.

What Employers Should Do Now

Whether or not the rule is adopted remains to be seen, but it seems clear that the current administration appears determined to promulgate regulations limiting traditional noncompetes. That being said, there are serious questions about the FTC’s authority to regulate noncompetes under Section 5 of the Federal Trade Commission Act, especially following the Supreme Court’s 2022 decision in West Virginia v. Environmental Protection Agency, which applied the “major questions doctrine” to strike down an environmental regulation on the basis that the EPA did not have “clear congressional authority” to issue a rule concerning an issue of “great political significance” that would affect “a significant portion of the American economy.”

Accordingly, once finalized, we expect that the rule will be challenged in court on various jurisdictional and substantive grounds.

In the meantime, in addition to providing comments during the comment period, employers should focus more on compliance with state noncompete laws, which have been evolving substantially over the past few years. As we have previously reported, many now include income thresholds and notice requirements, among other due process-type protections. Employers may also consider transitioning away from noncompetes and focusing instead on strong non-solicits, “advance notice of resignation” requirements, and confidentiality covenants.

Once the comment period officially commences, individuals and organizations can submit their commentary via the federal website, regulations.gov. In the meantime, employers should keep a number of facts in mind:

• If adopted, the final version of the rule will not become effective for at least 240 days: The comment period will last at least 60 days, and could be extended, followed by a mandatory 180-day notice period after the final version of the rule addressing comments received is issued.
• It is likely that the rule, as drafted, will give rise to legal challenges. However, any litigation to enjoin the rule would most likely be filed after the final version of the rule is issued, but before it takes effect, during the 180-day notice period.
• The rule would not prohibit all restrictive covenants in employment or other business agreements. For example, the rule does not restrict customer or coworker non-solicits, reasonable “advance notice of resignation” requirements (i.e., clauses that require an employee to give notice of their resignation, during which time they remain an employee and owe their employer a duty of loyalty), or routine confidentiality agreements.
• The rule, as drafted, will not apply to noncompetes entered into in a “sale of business” context.

For now, employers should stay the course and not make any immediate changes in their noncompete practices while they continue to monitor developments in this area.