FTC proposes sweeping ban on non-compete clauses for workers

The U.S. Federal Trade Commission (FTC) has proposed a new rule that would largely ban employers from requiring employees to not compete with them following cessation of employment. If adopted, the FTC’s rule would supersede a patchwork of state laws that, in most jurisdictions, permit non-competition agreements so long as they are reasonable in length of time and geographic scope.

What you need to know

• The FTC proposes to materially change the terms of employment for an estimated 30 million American workers by imposing a sweeping ban on non-compete clauses.
• The ban would allow a limited exception for non-compete clauses intended to protect a business’s goodwill when sold to a new owner.
• The FTC is soliciting comments from the public through March 10 and the proposal may face court challenges.

Why the FTC seeks to ban non-compete clauses

The proposed rule is the latest salvo by the Biden administration in its efforts to protect competition, with particular attention on labor markets, and follows through on the president’s July 2021 executive order that encouraged the FTC to reduce the use of non-compete clauses that limit workers’ mobility and the FTC’s November 2022 policy statement on the scope and meaning of unfair methods of competition under Section 5 of the FTC Act. In a statement accompanying publication of the proposed rule, FTC Chair Lina Khan said, “Non-competes block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand”.

Scope of the non-compete ban

The FTC has determined that it is an “unfair method of competition” for an employer to enter into, attempt to enter into, or maintain a “non-compete clause” with a “worker”. A “non-compete clause” is defined to mean 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.

Accordingly, the proposed rule would not prohibit employers from imposing non-compete restrictions on a worker during the duration of her employment. A “worker” is broadly defined to include any person “who works, whether paid or unpaid, for an employer”, including employees, independent contractors, volunteers, and even sole proprietors providing service to clients or customers. The proposed rule does not distinguish between rank-and-file employees and highly compensated workers (who are exempt from, so subject to less stringent, restrictions on non-competition agreements under some state laws).

The rule, if materially implemented as drafted, will not only preclude employers from imposing non-compete restrictions going forward; it would also require them to rescind existing non-compete restrictions within 180 days after adoption of the final rule (as well as actively inform former workers subject to such restrictions that they are no longer effective). 

In its commentary to the proposed rule, the FTC acknowledges that most other restrictive employment covenants, including non-disclosure agreements and non-solicitation clauses, would not be affected by the non-compete ban unless such provisions are drafted so broadly as to act as a de facto non-competition restriction. On its face, the rule also would not apply to non-compete clauses entered into between a shareholder and a corporation or a partner and a partnership, because such clause would not be between an “employer” and a “worker”. That said, the applicability of the rule to circumstances where an individual is both a shareholder and an employee, for example, will be subject to further clarification in the final rule or precedent based on enforcement.

Exception to the rule

The proposed rule includes a limited exception for non-compete clauses between the seller and buyer of a business, available only when the party restricted by the non-compete clause is an owner, member or partner holding at least a 25% ownership interest in a business entity.

The FTC has proposed a 25% ownership interest threshold because it does not believe the exception should be available where the ownership interest in question is so small that the restriction on competitive activity would not be necessary to protect the goodwill of the business acquired by the buyer. For example, the FTC says, the exception should not be available where a worker with a small amount of company shares sells them back to the company as part of a stock redemption agreement when the worker’s employment ends. The FTC believes a 25% threshold strikes the appropriate balance between a threshold that may be too high (and would exclude many scenarios in which a non-compete clause may be necessary to protect the value of the business acquired by the buyer) and a threshold that may be too low (and would allow the exception to apply more broadly than is needed to protect such an interest).

The proposed rule would also clarify that non-compete clauses covered by this exception would remain subject to federal antitrust and other applicable state law.

The road to implementation

The FTC is soliciting comments from the public through March 10, 2023, and has identified several issues for specific consideration, including whether (a) franchisees should be covered by the rule, (b) senior executives should be exempted or subject to a rebuttable presumption, and (c) the rule should be applied differently to low-wage and high-wage workers.

The proposed rule may be challenged in court, which could delay its implementation. The U.S. Chamber of Commerce, for example, has said that the rulemaking is “blatantly unlawful”, and FTC Commissioner Christine Wilson, in dissent, stated that the FTC’s authority to promulgate the rule “certainly will be challenged”.