Coming Soon: A Nationwide Ban on Noncompete Agreements?

On January 8, the Federal Trade Commission published a proposal to ban the use of noncompete agreements for most workers nationwide. The proposed rule, entitled the Non-Compete Clause Rule, would prohibit all employers — regardless of size — from imposing covenants not to compete on employees and independent contractors, with no carve-out available that would permit the use of noncompetes with executives or other highly-compensated workers. The rule is not yet in effect, and, if enacted, it will not prohibit the continued use of properly drafted non-disclosure and non-solicitation clauses under federal law.

Traditionally, noncompete clauses have been the province of state law. In Arizona, courts acknowledge that noncompete clauses may be “restraints on trade,” but hold that if a clause is narrowly tailored to protect an employer’s legitimate business interests, the clause will be upheld. While the standard is sometimes difficult to apply, it is well-established, and many noncompete clauses are upheld under the standard. If the FTC’s proposed rule becomes final and survives legal challenges, these state laws would no longer apply, and businesses would be required to comply with federal law.

In support of its proposed noncompete ban, the FTC asserted that such restrictions “hurt workers and harm competition,” by (1) significantly reducing workers’ wages, (2) stifling new businesses and new ideas, and (3) exploiting workers who lack economic bargaining power. The FTC also estimates that its new regulations could “increase American workers’ earnings between $250 billion and $296 billion” per year. The FTC rule did not discuss how the rule would impact executives at a high level, such as CEOs, who commonly have employment agreements containing noncompete agreements. Under this rule, the CEO of a company like Pepsico would have no noncompete to limit future employment by another soda company, even direct competitor Coca-Cola.

Not only do the proposed regulations prohibit employers from imposing noncompetes on newly retained talent, but they would also require employers to rescind covenants not to compete in employees’ and contractors’ existing agreements if those covenants are rendered unlawful under the new rule. Such rescission would have to occur within 180 days of the official publication of the final version of the FTC’s new rule in the Federal Register. The proposed rule also requires employers to separately notify employees that noncompete clauses are no longer in effect.

Importantly, the proposed regulations would not ban employers from using all forms of restrictive covenants with their workforces, assuming such covenants are otherwise permitted under applicable state and local law. For example, employers will still be permitted — at least at the federal level — to use non-disclosure clauses so long as they are not written so broadly as to “effectively preclude the worker from working in the same field after the conclusion of the worker’s employment with the employer.” Similarly, customer non-solicitation clauses will remain available under federal law unless they have “the effect of prohibiting 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.” However, some states already limit or ban the use of these types of restrictive covenants in the employment setting.

The new proposed rule does contain a limited exception permitting the continued use of covenants not to compete in connection with the sale of a business or an ownership interest in a business. However, this exception is narrow, requiring that the person restricted by the noncompete clause to hold an ownership, partnership or membership interest of at least 25% at the time he or she agreed to the noncompete covenant.

Compliance — both in terms of a prospective ban on future use of restrictive covenants not to compete and the retrospective rescission of existing noncompete agreements — will be required within 180 days after the date of publication of the Final Rule.

The rule will undoubtedly be subject to myriad legal challenges, and many businesses are asking whether the rule will survive legal scrutiny. In its comments when publishing the proposed rule, the FTC set forth its rationale regarding the proposed rule, noting that the Federal Trade Commission Act declares “unfair methods of competition” to be unlawful, and asserting that noncompete clauses are such an unfair method of competition.

Only time will tell whether the Non-Compete Rule will become final. In the interim, employers now have the opportunity to provide comments to the rule, and should confer with employment counsel regarding enforceability of their current non-competition and other restrictive covenant agreements with employees.

Deadline Now to Speak Up

The proposed rule was published in the Federal Register on January 8, and, interested stakeholders have 60 days to submit comments on it. As of January 19, nearly 4,000 comments had already been received. The FTC will then “review the comments and may make changes, in a final rule, based on the comments and on the FTC’s further analysis.” Very often, when proposals such as this one are published, the agency will make changes to the final rule. Such changes could include modifications to allow noncompete agreements to stay in place for high-level executives, or for employees with at least a certain amount of compensation. 

Spencer Fane partner Helen Holden helps businesses understand how successfully navigating the alphabet soup of federal and state employment laws can positively impact company culture.