FTC Proposes Rule to Ban Non-Compete Clauses

In this space, I normally discuss current appellate cases that affect the security industry. I am changing the format this time around because of recent action taken by the U.S. Federal Trade Commission (FTC) in regard to non-compete clauses. 

The FTC issued a Notice of Proposed Rulemaking on Jan. 5 that would prohibit employers from entering into or enforcing non-compete clauses with workers. The proposed rule would broadly cover all workers, regardless of whether the worker is an employee or independent contractor, or whether the worker is paid or unpaid. The FTC’s rule does not preempt state laws that provide greater protections to workers. 

The proposed rule applies to all agreements an employer has with a worker, including employment contracts and separation agreements. With respect to existing worker agreements, the rule would require employers to rescind all non-compete clauses within 180 days after the final rule is published, and provide a notice to current and former workers that the clause is rescinded.  

A non-compete clause is defined by the proposed rule to mean “a contractual term between an employer and a worker that prevents 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.” 

Additionally, the rule would create a functional test to determine whether other terms in an agreement with a worker are de facto non-compete clauses. The functional test evaluates whether the contractual clause has the effect of prohibiting the worker from seeking or accepting employment at the end of an employment relationship. Even though this functional test could apply to any contractual provision, the FTC identifies two examples of a de facto non-compete clause: 

“A non-disclosure agreement between an employer and a worker that is written so broadly that it effectively precludes the worker from working in the same field after the conclusion of the worker’s employment with the employer.” 

“A contractual term between an employer and a worker that requires the worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specified time period, where the required payment is not reasonably related to the costs the employer incurred for training the worker.” 

The FTC rule does not prohibit employers from including non-disclosure terms in an agreement to protect sensitive information, but these terms would need to be carefully drafted to help ensure they are not interpreted as preventing a worker from seeking or accepting employment. 

There is also a safe harbor for employers with respect to existing non-compete clauses. If an employer provides a rescission notice, the proposed rule states that employer will be in compliance with the rescission requirement. 

It should be pointed out that the FTC rule applies to employees or independent contractors, but does not apply to acquisitions where a company is sold and the buyer requires the principle sellers to sign a non-compete clause. The issue may arise in an acquisition if the buyer requires an employee of the selling company other than the principle sellers to sign a non-compete clause, in which case the probability is that the FTC rule would apply. 

Another issue that could arise is where the principle shareholders of a corporation in an M&A transaction are also employees of the selling company. Can the buyer require the principle shareholders who are employees to sign a non-compete? Stay tuned! 

The above is not a final rule. The FTC will review public comments and may make changes in the final rule, based on the comments and on the further analysis of the issue. The comment period is open through Mar 10. The final rule will go into effect 180 days after formal publication. We assume there will be many legal challenges.