On January 5, 2023, the U.S. Federal Trade Commission (FTC) voted 3–1 along party lines to propose a new federal antitrust rule that would ban most noncompete clauses in employment contracts as unfair methods of competition. The proposed rule, if adopted in its current form, would broadly prohibit employers from entering into noncompete agreements with employees and, in many circumstances, independent contractors.1 It follows on the heels of consent orders prohibiting noncompete agreements that the Commission announced on January 4.2
While the FTC has clearly established authority to issue consumer-protection rules specifying “unfair or deceptive acts of practices” (UDAP),3 it is uncertain whether the FTC may issue antitrust rules specifying “unfair methods of competition” (UMC).4 Indeed, the FTC’s proposed competition rule against noncompetes is a replay of a tumultuous period in the agency’s history. Before 1975, when the Federal Trade Commission Act was amended to establish UDAP rulemaking authority, the FTC relied on an aggressive interpretation of its own powers to support rulemaking.5 Now the FTC has revived the same theory to support UMC rulemaking. President Joe Biden has urged the FTC to revive the aggressive posture it took during the 1970s, and Chair Lina Khan has signaled that other UMC rules are likely to follow.6
The Proposed Rule Would Broadly Ban Noncompetes
The proposed rule declares that it is an “unfair method of competition” for an employer to enter into or attempt to enter into a noncompete agreement and bans such agreements, with only limited exceptions. Noncompete agreements are defined as agreements including “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.”7
This definition includes conventional noncompete agreements as well as “de facto” noncompete agreements that satisfy a test included in the proposed rule. The test is satisfied if the contractual term at issue explicitly prohibits or otherwise has 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.”8
The proposed rule could implicate other common employment-contract terms such as certain nondisclosure clauses, nonsolicitation clauses, and nonrecruitment clauses, all of which the FTC might characterize as de facto noncompete clauses. Indeed, the FTC provides two examples of what it believes are “de facto” noncompete clauses: (1) nondisclosure agreements written so broadly as to effectively precludes the worker from working in the same field after the conclusion of the worker’s employment with the employer, and (2) agreements to repay training costs if the employee’s employment terminates within a specified time period and the required payment is not reasonably related to the costs the employer incurred in training the worker.
Beyond its forward-looking ban, the proposed rule contains a rescission requirement that would require employers to void all currently existing noncompete agreements within 180 days of publication of the final rule and notify employees.
The Proposed Rule Applies to all Types of Workers, With an Exception for Acquisitions
The proposed rule defines the term “worker” broadly. In addition to employees, it includes independent contractors, externs, interns, volunteers, apprentices, sole proprietors who provide a service to a client or customer, and gig economy workers. There are no carveouts for specific professions, like doctors, engineers, or other highly skilled positions. The proposed rule similarly does not include any carveouts based on salary, leadership roles, or employer investment in the employee’s education. The FTC has sought comment on alternatives that would narrow the rule, such as exempting senior executives from the ban.9
The only exception in the proposed rule is for agreements related to the sale of businesses. The proposed rule would not apply to noncompete clauses between a seller who is also a substantial owner, partner, or member of the to-be-sold business entity or operating assets at the time the person enters into the noncompete clause. To qualify as “substantial owner, substantial member, and substantial partner,” the person (subject to the noncompete clause) must be “an owner, member, or partner holding at least 25 percent ownership interest in a business entity.”10
Impact on State Noncompete Laws
The proposed rule supersedes all inconsistent state laws. A state law is deemed inconsistent if it provides less protection to workers than the proposed rule. It would be deemed consistent if it provides greater worker protections than the proposed rule.
Existing state law regarding noncompetes is derived from both statute and state common law. State courts applying common law to determine the enforceability of noncompete clauses typically use a reasonableness inquiry that weighs the hardships caused to either side, the necessity of the noncompete, and the likely injury to the public. State statutes run the gamut, from permitting noncompete agreements so long as they further certain reasonable interests (like confidential information and goodwill) to limiting permission to certain professions or income levels to complete bans. The majority of states statutorily permit noncompetes for workers in certain occupations, most commonly physicians. The FTC’s proposed rule would ban these state laws because they offer less protection than the FTC’s proposed rule.
Comment Period Will Last Only 60 Days
Under Section 6(g) of the FTC Act, the Commission “may make rules and regulations for the purposes of carrying out the provisions of this subchapter.”11 The FTC asserts that this provision authorizes rulemaking for “unfair methods of competition” under the general notice-and-comment rulemaking procedures set forth in the Administrative Procedure Act.12 These procedures are far less rigorous than the Section 18 procedures that govern the FTC’s rules targeting “unfair or deceptive acts or practices.” Notably, whereas Section 18 gives interested parties multiple opportunities to participate in the rulemaking process (including an in-person evidentiary hearing),13 the FTC has indicated that it will give interested parties only one guaranteed opportunity to make arguments or present evidence here.
Comments will be due 60 days after the FTC publishes its proposed rule in the Federal Register, likely in mid-March. In her dissent, Commissioner Christine Wilson noted that this will be the sole opportunity for public comment.
Litigation Against the Rulemaking Is Expected
Employers are unlikely to agree with the FTC’s far-reaching view of its own rulemaking powers, meaning that affected businesses are likely to challenge any final rule issued by the FTC, subjecting it to a years-long legal limbo.
Aggrieved parties are likely to challenge the FTC’s rulemaking authority under Section 6(g) of the FTC Act. Affected businesses will argue that Section 6(g) authorizes only procedural rules, not substantive and binding regulations.14 The FTC majority notes its disagreement with that position, citing the D.C. Circuit’s 50-year-old decision in National Petroleum Refiners Association v. FTC.15 The continued validity of that decision is debatable, particularly given the Supreme Court’s intervening development of the “major questions doctrine.” That doctrine requires an agency to identify a “clear congressional authorization” before it issues a rule with “vast economic and political significance,” as these plainly would.16
It will take some time before any rule is in effect, if at all, but the FTC has other tools to challenge noncompetes. Several commentators who support the FTC’s efforts to challenge noncompetes have urged the FTC to use its enforcement tools rather than rulemaking.17 The FTC has already begun to use its Section 5 authority to do just that, announcing on January 4 that three companies agreed to cease use of noncompete restrictions in employment contracts that the FTC concluded violated Section 5 of the FTC Act as unfair methods of competition. Although the companies at issue in that announcement settled, other companies may choose to litigate instead and could raise numerous defenses, such as a lack of net anticompetitive effect or lack of authority.
Key Takeaways for Employers
- The proposed rule broadly covers employees and independent contractors and covers many types of agreements such as nondisclosures and nonsolicitation agreements.
- Companies should be prepared to enact immediate compliance measures when the rule goes into effect and build the systems necessary to give the affirmative notice required under the proposed rule.
- Companies that wish to shape or challenge the FTC rules should file comments by the upcoming deadline (or coordinate with others that plan to do so).
- Employees may challenge any employment agreement that resembles a “de facto” noncompete in light of the FTC’s current enforcement actions and proposed rule.
- The FTC’s January 4, 2023, enforcement actions may be a harbinger of more noncompete enforcement actions and additional rulemakings.
For additional information on this topic please view this related Sidley Update.
1 Non-Compete Clause Rulemaking, Fed. Trade Comm’n (Jan. 5, 2023).
3 15 U.S.C. § 57a(a)(1)(B).
4 Id. § 45 (granting FTC power to enforce general prohibition on “unfair methods of competition”).
5 See Magnuson–Moss Warranty — Federal Trade Commission Improvement Act § 202, Pub. L. No. 93-637, 88 Stat. 2183, 2193 (1975).
6 https://www.whitehouse.gov/briefing-room/speeches-remarks/2021/07/09/remarks-by-president-biden-at-signing-of-an-executive-order-promoting-competition-in-the-american-economy/ (“Forty years ago, we chose the wrong path, in my view, following the misguided philosophy of people like Robert Bork, and pulled back on enforcing laws to promote competition…. I believe the experiment failed”); Rohit Chopra & Lina M. Khan, The Case For “Unfair Methods of Competition” Rulemaking, 87 U.Chi. L. Rev. 357 (2020). See generally J. Howard Beales III & Timothy J. Muris, Back to the Future: How Not to Write a Regulation, AEI (June 2022), https://www.aei.org/wp-content/uploads/2022/05/Back-to-the-Future-How-Not-to-Write-a-Regulation.pdf?x91208.
7 Notice of Proposed Rulemaking at 4.
8 Id. at 214.
9 NPRM at 143–52.
10 Id. at 106. The proposed rule would also not apply to franchisees in the context of a franchisee-franchisor relationship. The FTC believes that relationship is more closely analogous to the relationship between two businesses than the relationship between an employer and a worker. Nevertheless, the proposed rule would apply to any workers employed by that franchisee or franchisor.
11 15 U.S.C. § 46(g).
12 https://www.ftc.gov/about-ftc/mission/enforcement-authority.
13 See 15 U.S.C. 57a(b)–(c). One of Chair Khan’s first steps was to change the procedures for using Section 18 to make it easier to promulgate such rules. See FTC, Revisions to Rules of Practice, 86 Fed. Reg. 38542 (Jul. 22, 2021).
14 See Thomas W. Merrill & Kathryn Tongue Watts, Agency Rules with the Force of Law: The Original Convention, 116 Harv. L. Rev. 467, 549–57 (2002).
15 482 F.2d 672 (D.C. Cir. 1973).
16 West Virginia v. EPA, 142 S. Ct. 2587, 2605, 2609 (2022).
17 See, e.g., Richard J. Pierce Jr., Can the Federal Trade Commission Use Rulemaking to Change Antitrust Law? at *16.
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