The Federal Trade Commission’s Proposed Rule to Ban Most Non-Compete Clauses

In recent years, more and more states have begun to disfavor non-compete agreements and strictly construe them against employers.  Continuing with this recent trend, on July 9, 2021, President Biden issued an Executive Order directing the Federal Trade Commission (“FTC”) to exercise its “statutory rulemaking authority under the Federal Trade Commission Act to curtail the unfair use of non-compete clauses[.]”[1] 

On January 5, 2023, in response to President Biden’s directive, the FTC issued a proposed rule which purports to ban most employers from entering into non-compete clauses with their employees or independent contractors.  In doing so, the FTC is relying upon Section 5 of the FTC Act (i.e., 15 U.S.C. § 45), which declares unfair methods of competition to be unlawful and authorizes the FTC to prevent persons, partnerships, or corporations . . . from using unfair methods of competition in or affecting commerce.  The FTC welcomed comments from the public on its proposed rule until March 20, 2023, which the FTC later extended to April 19, 2023.

The FTC’s vote on the proposed rule is expected to take place in April 2024.  If the rule becomes adopted, there will inevitably be litigation challenging the rule, which could take months, and even years, to resolve.

Importantly, the FTC’s proposed rule is not intended to impact other restrictive covenants such as non-solicitation and confidentiality agreements preventing former employees from soliciting their employer’s customers to cease doing business with them and disclosing company proprietary and confidential information.  Non-solicitation and confidentiality agreements remain important tools for businesses seeking to protect their customer relationships, employee base, other third party relationships, and confidential information.  However, this new rule may impact such non-solicitation and confidentiality provisions if the restriction is drafted so broadly that it effectively functions like a non-compete restraint. 

The FTC estimates that approximately 30 million Americans are currently subject to non-compete clauses, and that eliminating non-competes will increase wages, innovation, competition, and new business formation.  On the other hand, opponents of the rule contend that non-compete clauses are needed to protect a company’s confidential, proprietary, and trade secret information, and that companies will not invest in training of employees without the protection of non-compete clauses.

We will continue to monitor this proposed rule as it is reviewed for implementation by the FTC.  The information below is additional guidance on the proposed rule, including what the proposed rule purports to accomplish, which types of employers are covered under the proposed rule, and consequences for violations of the proposed rule, among other considerations.

What is a non-compete clause?

A non-compete clause is a contractual term between an employer and a worker that prohibits the worker from working for a competing company, or starting a competing company, within a certain geographic area and period of time after the worker’s employment ends.  They are upheld in Arizona so long as they are reasonable in geographic and temporal scope and are no greater than necessary to protect the employer’s legitimate business interests.  Rules regarding non-compete agreements are set forth on a state-by-state basis.

What does the proposed rule seek to prohibit?

The proposed rule prohibits employers from: (1) entering into a non-compete clause with a worker; (2) attempting to enter into a non-compete clause with a worker; (3) maintaining a non-compete clause with a worker; and (4) representing to a worker that the worker is subject to a non-compete clause.

The proposed rule would require employers to rescind (meaning, invalidate) existing non-compete clauses no later than the rule’s “compliance date,” which would be 180 days after the final rule is published in the Federal Register, and notify the worker that the non-compete clause is no longer in effect. 

Does the proposed rule apply to all employers in the United States?

No.  Certain entities are exempt from coverage under the Federal Trade Commission Act (“FTC Act”), and therefore are exempt from the proposed rule, including:

• Banks
• Savings and loan institutions
• Federal credit unions
• Common carriers
• Air carriers and foreign air carriers
• Persons and businesses subject to the Packers and Stockyards Act of 1921, subject to certain exceptions.
• Entities that are not organized to carry on business for their own profit or that of their members. (This particular exemption begs the question of whether and to what extent the proposed rule would apply to 501(c)(3) nonprofit organizations, including 501(c)(3) nonprofit healthcare organizations.)

The proposed rule would apply to all covered employers, regardless of size or number of employees.  With that said, the proposed rule would only apply to businesses involved in interstate commerce.  This interstate commerce standard, however, has been interpreted broadly by courts.  The broad application of the interstate commerce rule places many businesses in a “grey area,” and it is advisable for those businesses to consult with their attorneys to determine the applicability of the proposed rule to their business.  For businesses not engaged in interstate commerce, be sure to monitor state law developments restricting non-compete clauses.

Does the proposed rule cover all non-compete clauses?

The proposed rule exempts non-compete clauses entered into between the seller and buyer of a business, so long as the party restricted by such a non-compete clause and selling the business is an owner, member, or partner of the business holding at least a 25% ownership interest in the business being sold.

Does the proposed rule impact confidentiality or non-disclosure clauses and non-solicitation clauses?

As referenced above, the proposed rule does not impact confidentiality, non-disclosure, or non-solicitation clauses (such as non-solicitation clauses prohibiting solicitation of customers or employees of the company) unless they are so broad in scope that they effectively function as a non-compete clause.  Thus, the use of these other restrictive covenants remains intact consistent with applicable state and local law.

Does the proposed rule apply to only employees, and not independent contractors?

No.  The proposed rule prohibits employers from entering into non-compete clauses not only with employees, but also with independent contractors.

Is it anticipated that the proposed rule will pass?

It is anticipated that the proposed rule will pass in some shape or form.  Importantly, the FTC welcomed comments on several alternatives to the proposed rule, including whether non-compete clauses between employers and senior executives should be subject to a different standard, whether the non-compete clause ban should only extend to lower-wage employees, and whether a non-compete clause should be subject to a “rebuttable presumption” of unlawfulness in lieu of a complete ban.  Furthermore, the FTC recently took legal action against companies to stop them from enforcing non-compete restrictions, signaling the FTC’s intention to abrogate non-compete clauses altogether.

Without non-compete clauses, what can a company do to protect its proprietary information?

Employers still have many options to protect their confidential information, employee base, customers and clients, and other third party relationships.  As referenced above employers may still enter into confidentiality, non-disclosure, and employee and/or customer non-solicitation clauses with workers, so long as they are not overly broad so as to function as a non-compete clause.  The laws with respect to these agreements are generally governed on a state-by-state basis.  Employers are encouraged to consult with local attorneys for discussion regarding these viable options.

Employers may also sue workers in court for misappropriation of a company’s trade secrets under state trade secrets laws and for misappropriation of a company’s confidential information pursuant to common law doctrines. 

Would the proposed rule impact state law?

The proposed rule expressly preempts (i.e., supersedes and voids) any state law to the extent it is inconsistent with the proposed rule.

Do any states ban non-compete clauses today?

Non-compete clauses are currently generally unavailable in California, North Dakota, Oklahoma, Minnesota, Washington D.C., and soon New York, with limited exceptions.  Various other states ban non-compete agreements unless the worker earns above a certain threshold.

Are non-compete clauses enforceable in Arizona?

As noted above, today, non-compete clauses are enforceable in Arizona so long as they are reasonable in geographic scope and time, and so long as they are no greater than necessary to protect a company’s legitimate business interests.

If you have additional questions regarding your non-compete clause or if you would like assistance in preparing one, please call or email Shar Bahmani at Bahmani@SacksTierney.com  or Katya Lancero at Lancero@SacksTierney.com.

[1] The FTC’s mission is to protect the public from deceptive or unfair business practices and unfair methods of competition.