We won’t bury the lede: it could be huge, but it’s also probably too soon to tell. The new rule isn’t “official” yet; it could well change shape between now and the effective date and the litigation to enjoin the rule once it becomes effective is nearly guaranteed. However, if any version of the rule goes into effect (and there’s a real chance it will), it’s probably going to have a significant impact across industries and employers of all shapes and sizes. For most, the best strategy for the time being will be to wait, watch, and plan. Let’s unpack all that just a bit further…
What Has FTC Said/Done So Far?
On January 5, 2023, the Federal Trade Commission published a “Notice of Proposed Rulemaking” or “NPRM.” In non-legalese, that means a federal government agency announced that it plans to impose a new regulation. It’s not a “law,” because it wasn’t passed by Congress, but it nonetheless carries the “force and effect of law,” meaning the government can punish non-compliance. Through that NPRM, the FTC announced its intent to broadly prohibit non-competition agreements, which are contracts in which an employee promises not to compete with their employer after they leave. As with all new federal regulations, there is a “notice and comment” period during which anyone can submit feedback supporting or opposing the proposed rule. After that period, the agency can move forward with the rule as originally announced, move forward with a modified version, or retract the rule entirely. As proposed, the FTC’s Non-Compete Rule:
- Prohibits non-competes;
- Prohibits employers from telling or suggesting to workers that they are subject to non-competition restrictions;
- Requires employers to tell employees who are already subject to non-competition agreements that those restrictions are no longer in effect;
- Applies to all employers (regardless of type, workforce size, etc.) and all workers (whether classified as employees, independent contractors, interns, or otherwise); and
- Recognizes a limited exception under which those with a 25 percent ownership or membership interest in a business may be subject to non-compete obligations in connection with the sale of the business.
Other commonly used “restrictive covenants” – such as those limiting customer solicitation, employee solicitation/poaching, or prohibiting disclosure of confidential information – are not expressly prohibited by the proposed Non-Compete Rule. However, the Non-Compete Rule does prohibit those alternative agreements if they are drafted in such a way that they effectively function as a non-compete.
The 60-day comment period for the Non-Compete Rule ends on March 6, 2023. Assuming that FTC does not withdraw the proposed rule, it would then issue a final rule. That final rule would be effective 60 days after publication, and employers would have 180 days after publication to come into compliance with the final rule.
Why is FTC doing this? Is this a surprise?
The answer to all those questions depends on who you ask. FTC says (in very short summary) that it has looked into the way non-compete agreements are used across the country and concluded that employers too often abuse them in ways that prevent workers from being able to earn a living and stifles free market competition. Many employers would counter that it’s equally unfair for an employee to gain access to customers, goodwill, business strategy, training, etc. only to be able to turn around and immediately use their former employer’s investments in competition against them. Historically, each state has sought to balance employees’ and employers’ interests in their own different ways (legislatively or through case law). However, President Biden has long said he planned to explore both FTC’s authority in this arena and specifically instructed the agency to consider banning or limiting non-competes as far back as July of 2021. The FTC hasn’t previously taken much action in this area, and the full scope of its power is a matter of debate.
How big a deal is this, and what happens next?
This is a pretty big deal. There’s no official tally of how many employers use (or how many workers are subject to) non-compete agreements, but they’re common across all types of businesses. Employers and employees alike frequently seek legal counsel to determine whether or not a new job complies with the individual’s non-compete, whether the non-compete is enforceable as written, and how to approach negotiation and litigation strategies to maintain or terminate subsequent employment. Effectively eliminating employers’ ability to utilize non-compete agreements going forward – not to mention undoing existing agreements – would be a seismic shift in the U.S. employment landscape.
This major move by a federal agency not typically active in this regulatory space is similar in many ways to the COVID-19 vaccine mandates promulgated over the last few years by OSHA, OFCCP, and DHS. Like those mandates, the exact shape and scope of the Non-Compete rule may (and likely will) change while still at the agency level, and employers interested in trying to impact the form of the final rule should consider submitting written comments to FTC. That can be done “directly,” with the assistance of counsel, or through trade organizations. Regardless of how the final rule “looks,” it may change further once the seemingly inevitable lawsuits make their way through the courts. Also like the vaccine mandates, those impacted by the litigation process can do little but sit and wait (and watch) while the battle plays out. For many, it will make little sense to proactively eliminate non-competes from existing processes. But for most, it will be worthwhile to examine whether existing non-compete practices are truly necessary and – if so – whether less restrictive alternatives can be prepared in the event the Non-Compete Rule survives. Much can be done to protect a business using non-disclosure and non-solicitation agreements, as well as “non-contractual” strategies like controlling physical and electronic access to sensitive information, robust recruiting and hiring practices (i.e., “hiring slow, firing fast”) and creating compensation, benefit, and cultural packages that incentivize employees to stick around. Prudent employers will use the time during which the regulatory and (likely) litigation processes play out to examine the full range of tools at their disposal to prevent employees from wanting to leave in the first place.
Joe Pettygrove, Aaron Williamson, and their colleagues at KGR regularly advise employers on a wide variety of employment and business issues, including drafting, reviewing, and litigating non-competition agreements and other restrictive covenants.