After slowly chipping away at the use of non-compete agreements through enforcement actions, on January 5, 2023, the Federal Trade Commission (“FTC”) published a proposed rule that, if adopted, would establish a nationwide ban on almost all non-compete clauses in workers’ contracts. Non-compete clauses are contractual terms between an employer and worker that, within limits, prohibit the worker from working for a competitor after the worker’s employment ends.
No federal law currently exists governing the use or enforceability of non-compete clauses. Instead, non-compete clauses are governed by state law, creating various standards across the country. Some states have outlawed non-compete clauses altogether, while others have imposed categorical restrictions. Most states, including New Jersey and New York, account for the purpose, duration, and geographic scope when deciding whether such clauses are enforceable.
The proposed FTC rule would eliminate the state-by-state approach in favor of a nationwide prohibition on non-compete clauses. But the rule would not just prohibit employers from entering into such agreements. Instead, within 180 days from the adoption of the final rule, employers would have to rescind any such agreements still in effect and notify impacted employees that they are no longer subject to a non-compete clause.
The rule’s language is intentionally broad in its scope, banning both explicit non-compete clauses and “de facto non-compete clauses” — contractual terms that have the effect of prohibiting workers from “seeking or accepting employment with a person or operating a business after the conclusion of the” workers’ employment with the employer. However, it would not categorically ban other types of restrictive employment covenants, such as non-disclosure or non-solicitation agreements.
To avoid any questions about the classification of impacted workers, the FTC’s rule makes clear that the prohibition is not limited to employees. Instead, employers would be prohibited from entering into non-compete clauses with independent contractors, externs, interns, volunteers, apprentices, or sole proprietors who provide services to clients or customers.
The proposed rule includes two narrow exceptions under which non-compete clauses could be utilized. The first is in relationships between franchisors and franchisees. That exception, however, would not apply to the employees of either the franchisors or franchisees. Second, non-compete clauses could still be used in connection with business sales to restrict individuals who owned at least 25% of the business’s equity.
If adopted, the FTC’s proposed ban on non-compete clauses would be the next in a long line of recent and significant changes to federal employment laws and regulations. But the FTC’s rule is anything but final at this point. The proposed rule is likely to receive extensive commentary, and the FTC’s commentary that accompanied the proposed rule already signaled potential middle grounds on an otherwise complete prohibition. Such options include differentiating between workers based on (1) job function or occupation, (2) earnings, (3) or some combination of the two. Even if the FTC adopts the proposed rule, a long line of legal battles will likely follow.
While many questions remain about the future of the FTC’s proposed ban on non-compete clauses, impacted employers can take preemptive steps to evaluate the impact of this proposed rule on their businesses. O’Toole Scrivo, LLC will continue to monitor as the FTC’s rule moves through the rulemaking process.
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