FTC Proposes Rule to Ban Noncompete Clauses Between Employers and Workers

The Proposed Rule

Overview of the Proposed Rule

The proposed rule, 16 CFR Part 910, would make the following acts by an employer an “unfair method of competition” under Section 5 of the Federal Trade Commission Act (FTC Act) — and, therefore, unlawful:

1. to enter into or attempt to enter into a noncompete clause with a worker,
2. to maintain a noncompete clause with a worker, or
3. to represent to a worker that the worker is subject to a noncompete clause where the employer does not have a good faith reason to believe the worker is subject to an enforceable noncompete clause.

The proposed rule defines the term “non-compete clause” as a contractual term between an employer and a worker that expressly prevents, or has the effect of preventing, 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. The definition generally does not include other types of restrictive covenants, like nondisclosure agreements or client or customer nonsolicitation agreements. If, however, a term is written so broadly that it has the effect of prohibiting the worker from seeking or accepting employment with a person, or operating a business, after termination, it may be a de facto noncompete clause under the proposed rule.

The application of the rule is broad because under the proposed rule, a “worker” is defined to include any person “who works, whether paid or unpaid, for an employer.” This includes an employee, individual classified as an independent contractor, extern, intern, volunteer, apprentice, or sole proprietor who provides a service to a client or customer. The phrase “works for” is used in the proposed rule’s definition of “worker,” “employer,” and “employment”; it is not defined, however, and is ambiguous as to how it applies to partners, members, and other business owners who are not sole proprietors.

As proposed, the rule would have a retroactive effect because in addition to prohibiting employers from entering into noncompete clauses with workers, the proposed rule would require employers to rescind existing noncompete clauses no later than the rule’s compliance date. Furthermore, an employer rescinding a noncompete clause must provide written, individualized notice to the worker that the worker’s noncompete clause is no longer in effect, within 45 days of rescinding the noncompete clause. Such notice must be provided to both current and former workers whose noncompete periods have not expired, provided that the employer has the former worker’s contact information readily available. The proposed rule includes a safe harbor stating that an employer that provides adequate notice to a worker that the noncompete is no longer in effect and may not be enforced against the worker will have complied with the requirement to rescind the noncompete clause. The proposed rule also includes model notice language for employers to follow.

In addition to releasing the proposed rule, the FTC has released a fact sheet that highlights the background for the proposal to ban noncompete clauses and the agency’s focus on these issues in recent years. In the fact sheet, the FTC states its position that noncompete clauses significantly reduce workers’ wages, stifle new businesses and new ideas, and can exploit workers and hinder economic liberty. It also states that employers have other ways to protect trade secrets and other valuable investments that are less harmful to workers and consumers than noncompetes. The FTC estimates that this proposed rule, if finalized, would affect about one in five American workers — or approximately 30 million people — who are bound by noncompetes.

Relation to State Laws

The proposed rule makes clear that it shall supersede any state statute, regulation, order, or interpretation to the extent that such statute, regulation, order, or interpretation is inconsistent with the rule. However, greater protections at the state level will not be deemed to be inconsistent and, therefore, shall be applied.

Limited Exception in Sale of Business Context

The FTC includes a limited exception to the proposed rule in the sale of business context. Specifically, the proposed rule contains an exception for noncompete clauses that are entered into by a person selling or otherwise disposing of all of the person’s ownership interest in the business entity, or all or substantially all of a business entity’s operating assets, when the person restricted by the noncompete holds at least a 25% ownership interest in (defined as a “substantial owner, substantial member, or substantial partner” under the proposed rule) the business entity at the time the person enters into the noncompete clause. Noncompete clauses covered by this exception would still remain subject to federal antitrust law, as well as all other applicable law, including state law requiring noncompete clauses to be tailored to protect a legitimate business interest and to be limited in duration, geographic area, and the scope of activity prohibited.

The FTC states that this limited exception is intended to acknowledge that noncompete clauses between the seller and buyer of a business are distinct from noncompete clauses that arise solely out of employment, because sale of business noncompetes may help protect the value of the business acquired by the buyer. The FTC explains that this view is consistent with the law of the majority of the states, which treat noncompete clauses between the seller and buyer of a business differently from those arising solely in the employment context. The agency further explains that this exception would apply only in a narrow set of circumstances. Although this exception is available only for a substantial owner, substantial member, or substantial partner, if a nonsubstantial owner is not a worker, then the proposed rule would not apply as an initial matter.

FTC’s Amplified Focus on Promoting Fair Competition

The proposed rule follows on the heels of other recent FTC actions related to unfair competition. Just a day prior to the publication of the proposed rule, on January 4, 2023, the FTC took legal action against three companies and their executives, forcing them to drop noncompete restrictions that they imposed on thousands of workers. In these first-of-its-kind actions by the FTC, the agency took the position that the noncompete restrictions constituted an unfair method of competition under Section 5 of the FTC Act. In November 2022, the FTC also released a policy statement to reinvigorate Section 5 of the FTC Act, which bans unfair methods of competition in or affecting commerce. Over the last few years, the FTC has also challenged noncompete restrictions in connection with mergers reviewed by the agency. These, among other actions, reflect the FTC’s heightened attention to unfair competition and its willingness to crack down on noncompetes as unduly restrictive in multiple contexts.

Considerations for Employers and Next Steps 

Employers should be mindful of continuing developments. The FTC is soliciting comments to the proposed rule, as well as to proposed potential alternatives set forth in the rule, for 60 days from the date of publication in the Federal Register. Also, the proposed rule may face legal challenges, including whether Section 5 of the FTC Act provides rulemaking power to the FTC. If the rule is finalized, employers will be required to comply with the requirements within 180 days after publication of the final rule. Employers should review their current agreements to determine whether they will have to make changes should the rule become law.

Associate Sara Salmonson contributed to this Sidley Update.

For additional information on this topic please view this related Sidley Update.