On January 5, 2023, the Federal Trade Commission (“FTC”) voted 3-1 to propose a rulethat, if adopted, will dramatically impact companies that use noncompete agreements to protect their business interests. Under the proposed rule, virtually all agreements that prevent a worker from accepting employment with another business post-termination would be prohibited. The only exception would be a noncompete agreement that is entered into by a substantial owner (a person holding at least 25% interest) of a business as part and parcel of the sale of that business (or asset purchase). Answers to some key questions about the proposed rule are set forth below:
Q. What happens to my company's existing noncompete agreements?
A. They would be rescinded and employers would be required to notify both existing and former employees of the rescission.
Q. Does the proposed rule also prohibit nonsolicitation provisions?
A. Maybe.The proposed rule purports to allow employers other legal avenues to protect trade secrets and other sensitive information; however, it incorporates a “functional test” such that a non-solicitation or non-disclosure agreement could be deemed invalid if it is worded so broadly as to have the effect of prohibiting new employment.
Q. Does this apply to noncompete agreements between businesses?
A. No, and the proposed rule explicitly excludes the franchisor/franchisee relationship. Existing federal antitrust law, however, would continue to apply to restrictive covenant agreements in those relationship contexts.
Q. But under the law of my state, my noncompete agreements are enforceable. Does state law prevail?
A. No. The federal rule if enacted (and upheld) would trump and supersede state law. To the extent that state law is more restrictive than the rule, it likely would continue to apply.
Q. Is there any other language in the proposed rule I should know about?
A. The proposed rule specifies that a contractual provision requiring a worker to repay training costs if employment is terminated within a certain period of time could be invalid if the payment is not “reasonably related to the costs the employer incurred for training the worker.” Also, it is notable that the proposed rule would apply to noncompete agreements with not just employees, but independent contractors and anyone else who works for the employer, whether paid or unpaid.
Q. What are the chances that a final rule is enacted mirroring the proposed rule?
A. It is unclear. The proposed rule was issued in response to a key directive of President Biden's competition policy agenda from last year. In a far-reaching July 2021 executive order, the White House directed the entirety of the federal government to prioritize work involving competition policy and enforcement in labor markets. Given the priority that the President has placed on this agenda, the FTC will most certainly issue a rule substantially similar to the proposed rule. However, if we were gamblers, we would expect that the final rule will be tweaked in some form or fashion (i.e., additional exceptions are recognized).
Q. What happens next?
A. The FTC has proposed the rule under the Administrative Procedures Act regime. Over the next couple of months, interested parties will have the opportunity to provide comments (for and against, proposed changes, etc.). It will take some time for the FTC to consider the comments and any final rule would not take effect until six months after the final rule is announced. Even then, court challenges will inevitably take place. It is unlikely that a new rule would be in place until sometime next year at the earliest.
Q. Can the FTC do this?
A. Many believe the answer to this is “no” and that the FTC does not have the authority to issue this rule. The FTC may only enact rules that are within the authority that it has been delegated by Congress and many will argue that the FTC is exceeding its authority. The U.S. Chamber of Commerce issued a statement declaring the proposed rule “blatantly unlawful,” stating that “Congress has never delegated the FTC anything close to the authority it would need to promulgate such a competition a rule” and expressing its confidence that “this unlawful action will not stand.” In a dissent to the proposed rule, FTC Commissioner Christine Wilson labeled the proposed rule a “radical departure from hundreds of years of legal precedent.” She similarly predicted that the proposed rule will not withstand legal challenges such that the FTC “is directing staff to embark on a demanding and futile effort.”
Q. Is there anything our business should be doing in the meantime?
A. At this juncture, we would recommend that companies not panic and allow this some time to play itself out. Like other laws and regulations in their infancy, you never know what the final language will entail. Even if enacted, there is a good chance that the rule would not survive a legal challenge, particularly given the direction taken by the current U.S. Supreme Court.
That said, employers should be mindful of the potential change in the law and be prepared for a scenario in which all of their noncompete agreements are deemed invalid overnight. Companies may want to proactively consider the structure of any future agreements with employees, especially where additional compensation or bonuses are given to the worker in consideration for noncompete agreements. For instance, a company ultimately may not get what it pays for if it bargains to pay an employee a severance based on the employee's agreement not to compete during the severance period. It may be prudent for companies to consider other options such as structuring future employment agreements such that payment of severance is conditioned upon enforceability of the attenuated restrictive covenants.
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