The FTC announced a proposed regulation ("Non-Compete Rule") that, if implemented, would ban most employer/ employee non-compete clauses nationwide, superseding state laws that are less restrictive than the FTC rule. Under the proposed rule, an employer would violate § 5 of the FTC Act, which prohibits "unfair methods of competition," if it:
- enters or attempts to enter a prohibited non-compete clause with an employee,
- maintains an existing prohibited non-compete clause, or
- represents that an employee is subject to a non-compete without a good-faith belief that the non-compete is lawful.
As drafted, the Non-Compete Rule would apply to almost all employers and workers. The broad definition of "worker" covers both employees and independent contractors, and other workers whether or not classified as employees, including externs, interns, volunteers, apprentices, or sole proprietors who provide a service to a client or customer. Once adopted, the draft Non-Compete Rule would require employers, within 180 days of the final rule's publication, to inform each employee subject to a prohibited non-compete that the employer has rescinded the non-compete.
The FTC claims that non-compete clauses prevent workers from pursuing better jobs, higher pay, or improved working conditions. It further claims that approximately 20% of workers—30 million—have a non-compete clause with their employer. Despite mixed economic evidence on the effect of non-compete clauses on compensation, the FTC also claims that the Non-Compete Rule would increase workers' wages by $250 billion to $296 billion per year.
Historically, courts and U.S. antitrust enforcers would have evaluated non-compete clauses under the rule of reason, which evaluates a restriction's net effect on competition, balancing the harms and benefits. That analysis considers marketplace facts, the benefits or justification for the non-compete, and its reasonableness with respect to its scope (employee coverage and content of the restriction), geography, and duration. The FTC's Notice of Proposed Rulemaking ("NPRM") rejects that analysis, instead building on the FTC's recent Policy Statement (See this November 2022 White Paper), promising expansive use of § 5 of the FTC Act to challenge conduct that, in the FTC's view, is an unfair method of competition.
WEREN'T THERE FTC COMPLAINTS AND SETTLEMENTS THE DAY BEFORE THE FTC RULE WAS ANNOUNCED? WHAT WERE THEY, AND ARE THEY RELATED TO THE RULEMAKING?
The FTC released the proposed rule a day after it filed and settled allegations that three companies and two individuals violated § 5 of the FTC Act by imposing and enforcing anticompetitive employer/employee non-competes.1 One FTC complaint alleged that Prudential Security used individual lawsuits to enforce non-competes, which required low-wage security guards to pay a $100,000 penalty if violated. The FTC also alleged that Prudential continued to require employees to sign non-competes even after a state court determined the restrictions were unreasonable and unenforceable under Michigan law.
The FTC's other complaints alleged that O-I, Inc.'s non-competes prohibited working for a U.S. competitor for one year following employment, while Ardagh's non-competes prohibited working for a North American competitor for two years. O-I and Ardagh are competitors in the manufacture and sale of glass containers used for food and beverage packaging in the United States.2 The parties' employer/employee non-competes covered a range of job titles, including glass production, engineering, and management positions.
The companies and individual owners settled with the FTC, which ordered the parties to stop using non-compete agreements, end enforcement of existing non-competes, and notify affected employees that the non-competes no longer restrict their employment options.
In stinging dissents, FTC Commissioner Christine S. Wilson argued that the FTC's complaints offered no evidence of anticompetitive effects in any relevant market and only "conclusory" assertions that legitimate objectives could have been achieved through less restrictive means. She noted the complaints failed to address "the business justification and procompetitive benefit of employer-provided training." She also observed that the parties may have elected quick settlements with the FTC to avoid lengthy and expensive investigations, and possibly litigation.
Commissioner Wilson further observed that the glasscompany settlements, which listed job titles for which the companies would be prohibited from using non-competes, excluded senior executives and research and development employees. Beyond that implicit acknowledgement that there are benefits to non-competes—protecting a company's competitively sensitive secrets and strategies—the settlements provide little practical guidance to businesses about when an employer/employee non-compete agreement might violate the federal antitrust laws (if indeed they do). Notably, the FTC's settlements are not legally binding precedent, and it remains an open question how such challenges would fare in court. However, the three consents are the clearest indication of the policy the FTC will implement unless and until it adopts the Non-Compete Rule in final form.
DOES THIS MEAN ALL EMPLOYEE NON-COMPETES ARE UNLAWFUL ONCE THE RULE IS IMPLEMENTED?
Under the Non-Compete Rule, most employer/employee non-compete clauses would be unlawful. However, the NonCompete Rule would have four exceptions:
- Employers that are exempt from the FTC Act, as the FTC has no power to regulate those employers. Certain banks, savings and loan institutions, federal credit unions, air carriers, livestock-related businesses, and nonprofits will be exempt from the Non-Compete Rule.
- State or local governments and government-affiliated private entities, to the extent they are considered "state actors" under the law.
- Non-compete clauses between a buyer and a seller of a business, where the person selling the business is a "substantial" owner, member, or partner in the business being sold. The Non-Compete Rule defines "substantial" to mean a person holding at least a 25% ownership interest in the target business. Such clauses must still pass muster under federal and state antitrust laws.
- Non-compete agreements between franchisors and franchisees that restrict franchisees, although the NonCompete Rule will still cover any employer/employee noncompetes between franchisors or franchisees and their respective employees.
Unlike many state laws, which include exceptions for highly compensated, executive, and managerial employees, the FTC's proposed ban contains no exemptions for high-level employees or those with unique, specialized skills or knowledge. The NPRM requests comments about whether the final rule should have an exemption for senior executives or apply a rebuttable unlawfulness presumption to non-compete clauses between employers and senior executives (as compared to the ban for other workers). A senior executive exemption would be consistent with the FTC's recent O-I and Ardagh non-compete cases, noted above, in which the FTC did not include senior executives (or R&D employees) in a list of job titles for which O-I and Ardagh were prohibited from having non-competes. Although the FTC was not explicit, we assume it is thinking about treating senior executives differently because they are most likely to have competitively sensitive information that could harm the company. Unlike for other workers, the FTC states that noncompetes for senior executives are "unlikely to be exploitive or coercive."
However, the FTC claims that there are "compelling reasons" to ban senior executive non-competes because such clauses negatively affect business formation, innovation, and competitors hiring highly skilled workers. To that end, the FTC even argues that a ban on non-compete clauses for highly skilled workers and senior executives may benefit consumers even more than prohibiting non-compete clauses for other workers. Therefore, even if the FTC adopts an exemption for senior executives, it is likely to be narrow.
DOES THE NON-COMPETE RULE AFFECT CUSTOMER NON-SOLICIT CLAUSES OR OTHER RESTRICTIVE COVENANTS?
As drafted, "the definition of non-compete clause would generally not include other types of restrictive employment covenants—such as non-disclosure agreements ("NDAs") and client or customer non-solicitation agreements... ." The FTC, however, also noted in the NPRM that it may consider such covenants to be prohibited non-compete clauses where "they are so unusually broad in scope that they function as such." That analysis will turn, in part, on the competitive dynamics in a given industry. For example, if a customer non-solicitation agreement applies to sales employees that sell into a downstream market with very few customers, the FTC may argue that a customer non-solicit is a de facto non-compete. Similarly, the FTC could view a very broad non-recruit agreement applied to an inhouse recruiter (e.g., a limitation prohibiting the employee from being able to effectively recruit talent in his or her particular industry) as potentially also running afoul of the FTC's rules.
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