The Federal Trade Commission (FTC) released a proposal on Jan. 5 to ban noncompete agreements that restrict mobility among employers. Some employers and attorneys are concerned the rule could hamper retention efforts and make companies’ intellectual property vulnerable.
In the Jan. 5 proposal, the FTC said noncompetes constitute an unfair method of competition and therefore violate Section 5 of the Federal Trade Commission Act. It concluded that noncompetes suppress wages, stifle innovation and make it harder for entrepreneurs to start new businesses. It estimates that ending noncompetes would increase American workers’ earnings by $250 billion to $296 billion per year.
Under the proposal, employers could not ask paid or unpaid employees, independent contractors, interns, volunteers, or apprentices to sign a noncompete agreement. The proposed rule would apply retroactively, so employers would have to give notice to employees and former employees that existing noncompete agreements have been rescinded within 45 days of the rule’s implementation.
“There is at least a reasonable likelihood that the FTC will adopt this rule in some shape or form in 2023,” said Mark Goldstein, an attorney with Reed Smith in New York City. “It would effectively change how many, if not most, U.S. companies operate from the perspective of retaining key talent and safeguarding against employees taking the company’s ‘secret sauce’ and duplicating it right across the street.”
“The FTC’s proposed new rule is of tremendous significance,” said David Woolf, an attorney with Faegre Drinker in Philadelphia. “Although there has been talk about noncompete abuses for years, particularly the last few years, that talk has focused almost exclusively on curbing those abuses—for example, around banning the use of noncompete restrictions for low-wage workers. In its proposed rule, the FTC goes further than 47 states, which to date have been the legislative bodies addressing the proper scope of noncompetition restrictions.”
Emily Dickens, chief of staff and head of public affairs for the Society for Human Resource Management, said the proposed FTC rule is overly broad and could potentially harm businesses that depend on noncompetes to thrive. She cited very small, emerging industries where crucial know-how cannot be safeguarded through nondisclosure agreements alone. Although “there are jobs where it makes no sense to have noncompetes,” Dickens said, “this kind of blanket ban is going to stifle innovation.”
Employers may need to consider whether certain clauses in their employment agreements function as noncompete clauses in practice.
“The ban is drafted broadly not only to prohibit pure noncompetition clauses, but also agreements that are de facto noncompete clauses. It includes the examples of an overly broad [nondisclosure agreement], as well as a provision that requires repayment of training costs where the repayment amounts are not reasonably related to the costs of the employer incurred for training the worker,” said Christopher Banks, an attorney with Crowell & Moring in San Francisco. “The examples of a de facto noncompete do not include nonsolicitation or nonservicing clauses—i.e., clauses that prohibit doing business with certain customers—although arguably would be within the ambit of the rule’s prohibitions. This will be a major source of litigation.”
The commission “sweeps up in its ban legitimate, pro-competitive restrictions, such as restrictions applicable to senior executives and tech workers, as well as other situations where the employee receives a tangible benefit for agreeing to the noncompetition restriction,” Woolf said.
Attorneys also raised concerns that the agency had exceeded its authority.
“Traditionally, this would fall under the purview of the Department of Labor,” said Lauri Kavulich, an attorney with Clark Hill in Princeton, N.J., and Philadelphia. “The fact that the FTC is stepping into employment issues under the antitrust umbrella is out of the ordinary.”
The FTC described noncompetes as “a widespread and often exploitative practice that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses. By stopping this practice, the agency estimates that the new proposed rule could increase wages by nearly $300 billion per year and expand career opportunities for about 30 million Americans.”
California, Colorado, Illinois, Maine, Maryland, New Hampshire, North Dakota, Oklahoma, Oregon, Rhode Island, Virginia and Washington have already banned or restricted the use of noncompete agreements, but the FTC proposal would create a nationwide policy.
“Many states already have rendered unenforceable or outlawed noncompete agreements; however, it is a patchwork of laws national employers have to navigate,” Kavulich said. “Other restrictive covenants, such as nonsolicitation of employees and customers/clients and confidentiality agreements/trade secrets, are still enforceable, and, in light of this, employers need to make sure they are protecting their employees, customers and confidential information if noncompetes are essentially outlawed and an employee can now go to a competitor. This will be the most pressing issue for employers after compliance with this rulemaking by rescission of noncompete agreements.”
The public and employers can submit comments on the proposal within 60 days after the Federal Register publishes the proposed rule. The rule would take effect 180 days after the final version is published. However, “there is likely to be a significant wave of litigation challenging this rule,” said Marlene Williams and Scott McLaughlin, attorneys with Ogletree Deakins in Houston.