FTC's Proposed Ban On Non-Competition Clauses ' What Employers Need To Know And What They Should Be Doing Now

• Published date: 08 June 2023
• Subject Matter: Corporate/Commercial Law, Employment and HR, Compliance, Corporate and Company Law, Contract of Employment, Employee Benefits & Compensation, Franchising
• Law Firm: Faruki
• Author: Ms Melinda K. Burton

As we noted in an August 2022 blog updating the current landscape on non-competition clauses, , "[i]n 2021, [] President [Biden] issued an executive order encouraging the [Federal Trade Commission ("FTC")] to 'consider working...to curtail the unfair use of non-compete clauses and other clauses that may unfairly limit worker mobility.'" The FTC apparently did as it was ordered, and on January 5, 2023, it published a proposed rule that would ban non-competition clauses in virtually all contracts for employment, including those involving independent contractors, and regardless of whether the worker is paid or unpaid. According to the FTC, the use of non-competes must be banned because it is a "widespread and often exploitative practice that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses."

The decision to announce the Notice of Proposed Rule Making ("NPRM"), however, was not unanimous. Commissioner Christine Wilson dissented, stating that "the proposed Non-Compete Clause Rule represents a radical departure from hundreds of years of legal precedent that employs a fact-specific inquiry into whether a non-compete clause is unreasonable in duration and scope, given the business justification for the restriction. The Commission undertakes this radical departure despite what appears at this time to be a lack of clear evidence to support the proposed rule."¹ Commissioner Wilson further admonished:

"Despite the importance of context and the need for fact-specific inquiries, the Commission instead applies the approach of the newly issued Section 5 Policy Statement² to propose a near-complete ban on the use of non-compete clauses. Pursuant to this approach, the Commission invokes nefarious-sounding adjectives - here, 'exploitive and coercive' - and replaces the evaluation of actual or likely competitive effects with an unsubstantiated conclusion about the 'tendency' for the conduct to generate negative consequences by 'affecting consumers, workers or other market participants.'

Using the approach of the Section 5 Policy Statement that enables the majority summarily to condemn conduct it finds distasteful, the Commission today proposes a rule that prohibits conduct that 47 state legislatures have chosen to allow. Similarly, the Commission's proposed rule bans conduct that courts have found to be legal, a concern the Commission dismisses with a claim that the Section 5 prohibition on 'unfair methods of competition' extends beyond the antitrust laws. But the majority's conclusions and today's proposed rule forbid conduct previously found lawful under Section 5 of the FTC Act. Specifically, applying FTC Act Section 5, the Seventh Circuit found that '[r]estrictive [non-compete] clauses . . . are legal unless they are unreasonable as to time or geographic scope[.]'³ In other words, the Seventh Circuit found that a fact-specific inquiry is required under Section 5.

The NPRM announced today conflicts not only with the Seventh Circuit's holding, but also with several hundred years of precedent. With all due respect to the majority, I am dubious that three unelected technocrats have somehow hit upon the right way to think about non-competes, and that all the preceding legal minds to examine this issue have gotten it wrong. The current rulemaking record does not convince me otherwise." Dissent, p. 3.

Given this backdrop, employers and business owners should understand that while the proposed rule, as currently written, is scary for numerous reasons, it is important to remember that the proposed rule is just that - a proposed rule. It is in the first stages of the FTC's rulemaking process, with the next step being public comments regarding the proposed rule. ("The FTC will review the comments and may make changes, in a final rule, based on the comments and on the FTC's further analysis of this issue. Comments will be due 60 days after the Federal Register publishes the proposed rule. The public comment period will be open soon."). The FTC is admittedly aware of the challenges the proposed rule presents and welcomes comments, which is why it is all the more troubling that the FTC, nonetheless, decided to publish the proposed rule in the form that it did. Still, any rule promulgated only will go into effect 180 days after made final, and how the rule will actually look when "final" still remains to be seen. Employers and business owners should take advantage of the public comment opportunity and voice clearly the concerns that are evident in the proposed rule as it currently stands, particularly with respect to the broad definitions of what constitutes a non-compete and who is a worker that cannot be bound by such clauses.

While still in the rule-making process, given the proposed rule's sweeping language, employers should be aware of the proposed rule now for planning purposes. Below we discuss the provisions of the proposed rule as they currently are written, what challenges are presented by the terms as written, and what they may mean for employers if not changed in whatever final form the rule takes.

First, the definitions.

"' 910.1 Definitions.

(a) Business entity means a partnership, corporation, association, limited liability company, or other legal entity, or a division or subsidiary thereof.

(b) Non-compete clause.

(1) Non-compete clause means 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.

(2) Functional test for whether a contractual term is a non-compete clause. The term non-compete clause includes a contractual term that is a de facto non-compete clause because it 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. For example, the following types of contractual terms, among others, may be de facto...