Proposed Federal Rule Limiting Non-Compete Agreements Remains In Limbo

Legal precedents and challenges in restrictive contracts

Highlights:

• FTC’s rule to restrict a broad spectrum of non-compete agreements will impact diverse categories of workers and alter employer practices.

• One section of the public expects the rule to boost job mobility and wages, while the other is concerned about its potential impact on investments and competition.

• Legal disputes are emerging on a national scale as the FTC takes legal action against employers who utilize non-compete agreements.

It has been more than eight months since the Federal Trade Commission (FTC) released its proposed non-compete clause rule, which would significantly curtail employers’ ability to impose and enforce restrictions on employees seeking or accepting employment from competitors. And following receipt of thousands of comments during an extended public comment period, many recent news reports suggest that the proposed rule is unlikely to be submitted for a final vote by the FTC before April 2024. 

As the fate of the proposed rule remains in limbo, here is what to know about its scope, recent efforts by other federal and state agencies to curtail the use and enforcement of non-compete agreements, and steps employers can take to prepare for potential future limitations on non-compete agreements.

 

Scope of the Proposed FTC Rule

Citing the FTC’s authority under Sections 5 and 6 of the FTC Act to “prevent persons, partnerships or corporations … from using unfair methods of competition in or affecting commerce,” and to “make rules and regulations for the purpose of carrying out the provisions of the Act,” the proposed non-compete clause rule would:
 

• Preclude employers from entering into or maintaining any “non-compete clause” with any worker.
• Preclude employers from requiring workers to pay back training costs upon termination unless the payment is reasonably related to the cost the employer incurred for training the worker.
• Require employers to rescind existing non-compete clauses with workers.
• Require employers to notify current and former employees subject to non-compete clauses of their release from those restrictions. 

The proposed rule defines a non-compete clause as “any contractual terms between an employer and worker that prevents the worker from seeking or accepting employment with another person or employer after the conclusion of the workers’ employment with the employer.” 

This would apply to any contractual provision that functions as a restriction on future employment, regardless of what the provision is called. Employer is defined broadly to include anyone who hires or contracts with a worker. Worker is similarly broadly defined to include any natural person who works for an employer, whether paid or unpaid. This includes employees, independent contractors, externs, interns, volunteers, apprentices and sole proprietors, regardless of title or earning level, with no exceptions for highly paid, executive or salaried employees.

The proposed rule would supersede all less restrictive state laws, though states would remain free to impose and enforce greater restrictions on the use of non-compete agreements. The proposed rule would not, however, restrict an employer’s ability to impose other restrictive covenants, such as non-disclosure or non-solicitation agreements, provided they are not “so unusually broad in scope that they functionally preclude future employment in the affected industry.” 

The proposed rule also allows for limited imposition of non-compete clauses in conjunction with the sale of a business, but only if the worker has a 25% or greater interest in the acquired company. Additionally, the proposed rule would not impact employers or workers in industries exempted from compliance with the FTC Act, which include the banking industry, common carriers, air carriers and many non-profit organizations.

Public Comments Regarding the Proposed Rule

The FTC received more than 27,000 comments during the extended public comment period that ended on April 19. Supporters of the rule include a group of 12 U.S. senators and 52 members of the U.S. House of Representatives, the Antitrust Division of the Department of Justice, and the Attorneys General from the District of Columbia and 17 states. Those supporting legislators and agencies cited anticipated wage increases of $250 billion to $300 billion each year associated with the removal of job restrictions affecting nearly 30 million Americans, with significant portions of those increased wages benefiting low and middle-wage workers. 

The American College of Cardiology also submitted a supporting comment citing the importance of not restricting employment opportunities for healthcare workers, though the group did express support for limited geographical restrictions where employers make significant investments in developing and training newly hired physicians.

Among those submitting comments in opposition to the proposed rule were the U.S. Chamber of Commerce, the International Franchise Association and the American Hospital Association. The U.S. Chamber of Commerce claimed the proposed rule “fails to recognize that non-compete agreements can serve vital procompetitive business and individual interests, such as protecting investments in research and development, promoting workforce training and reducing free riding (relying on prior employers to train your workforce) that cannot be adequately protected through mechanisms such as trade secret suits and non-disclosure agreements.”  

The American Hospital Association’s submittal focused on the proposed rule’s lack of any exceptions for executive or highly paid employees and suggested that the invalidation of non-compete agreements would exacerbate an already existing scarcity of healthcare workers, especially in underserved areas like rural communities. The International Franchise Association claimed, “Non-compete clauses protect the integrity of franchising and individual franchisees from unfair competition from existing and former franchisees.” It added that “a ban (on non-compete clauses) would be extremely damaging to the franchise business model, encourage breaches of contract, and hurt small business owners that depend on the viability of the franchise system to protect their equity in their franchised business.”  

Though not part of the formal comment process, resigning FTC Commissioner Christine Wilson, who had opposed the adoption of the proposed rule, cited it in an op-ed for the Wall Street Journal as an example of the FTC’s “willful disregard of congressionally imposed limits on agency jurisdiction … defiance of legal precedent and … abuse of power” under the leadership of FTC Chairperson Lina Khan. Wilson further claimed that “this proposed rule defies the Supreme Court’s decision in West Virginia v. EPA (2022), which held that an agency can’t claim ‘to discover in a long-extant statute an unheralded power representing a transformative expansion in its regulatory authority.’”

Other Efforts to Challenge Non-Compete Agreements

The proposed rule is not the only ongoing effort to challenge non-compete agreements. In the past year, the FTC has filed multiple suits against individual employers seeking to prohibit enforcement of non-compete agreements involving workers across a variety of positions, arguing that the imposition of non-compete restrictions is an unfair method of competition precluded under Section 5 of the FTC Act. 

In a similar vein, the general counsel for the National Labor Relations Board issued an enforcement memorandum in May, in which she alleged that most post-employment non-competition agreements affecting non-management and non-supervisory workers constituted a violation of their rights under Section 7 of the National Labor Relations Act to take collective action to improve working conditions. 

And continuing a trend over the past several years that saw restrictions or bans on non-compete agreements adopted by several states, including Colorado, Illinois, Maryland, Nevada, Oregon and Virginia, Minnesota recently joined California, Oklahoma and North Dakota in adopting a nearly complete ban on post-employment non-compete agreements. The New York legislature recently adopted a similar ban, which is awaiting Gov. Kathy Hochul’s signature.

What’s Next?

The FTC will sort through the thousands of comments over the next several months, following which it may revise the proposed rule or withdraw it – though complete withdrawal is unlikely. Among the alternatives proposed by commenters, which the FTC has previously indicated it might consider are a mix of categorical bans and rebuttable presumptions of unlawfulness dependent upon worker categories, responsibilities and earnings, or providing exceptions to the ban on non-compete clauses for executive and/or highly compensated employees.

Before final publication, the Office of Information and Regulatory Affairs (a subdivision of the Office of Management and Budget) is required to provide a final analysis of the estimated impact the rule will have on the U.S. economy. Should the FTC elect to adopt the current or a modified version of the proposed rule next year, it cannot go into effect until at least 60 days after publication in the Federal Register.  During that period, Congress can pass a resolution of disapproval which, if signed by the president or overridden by Congress following the president’s veto, would void the rule. 

If an adopted Rule survives Congressional review, it would still be subject to challenge in the courts. In addition to the challenges referenced in Former Commissioner Wilson’s op-ed piece, court challenges are likely to focus on: 
 

1. whether the FTC has the inherent power to impose a nationwide ban on noncompete agreements; 
2. whether the rule violates the “major question doctrine,” which precludes federal agencies from regulating issues of vast economic or political significance in the absence of clear congressional authority; and 
3. whether the rule’s retroactive components constitute an improper taking under the Fifth Amendment, which precludes the taking of private property for public use without just compensation.

While the ultimate fate of the proposed rule remains unknown, employers can take steps to protect their interests and reduce the potential impact of non-compete restrictions that may ultimately be imposed by the FTC or others. 

These include: 
 

1. utilization of carefully tailored non-solicitation, confidentiality and non-disclosure provisions to prevent poaching of customers or disclosure of proprietary information by former employees; 
2. undertaking measures to clearly identify and safeguard trade secrets; and 
3. identifying potentially recoverable employee training and development expenses and providing for their recovery in existing employee contracts.

Ronald M. Schirtzer is a Partner at Weinberg, Wheeler, Hudgins, Gunn & Dial. He has diverse experience in complex commercial litigation matters, having represented clients and tried cases across a broad range of practice areas.