On January 5, 2023, the Federal Trade Commission (FTC) proposed its long-awaited new rule  banning non-compete agreements. This was an anticipated event after a July 9, 2021, executive order from President Biden that directed the FTC “to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”   

Significant Takeaways
1. In public comments about the FTC’s intent to propose a rule concerning “non-compete” provisions, it was unclear whether the FTC intended to implicate all restrictive covenants such as non-solicit/accept/service provisions relating to clients, non-poach provisions relating to employees, or simply true “non-compete” provisions. This proposed rule targets both non-competes and de facto non-competes, and looks to treat broad non-poach and non-solicit/accept/service provisions as de facto non-competes.

2. According to the proposed rule, “it is an unfair method of competition for an employer to”:

• Enter into or attempt to enter into a non-compete clause with a worker.
• Maintain a non-compete clause with a worker.
• Represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause. 

3. The proposed rule covers a “Worker” including employees, independent contractors, and sole proprietors who provide a service to a client or customers.  The proposed rule does not cover other business entities, nor restrictive covenants found in B2B agreements.
    
   4. There is a limited carve-out to the proposed rule for an individual selling all of their interest in a business or substantially all of a company’s assets if the individual is a substantial owner, substantial member, and substantial partner holding at least a 25 percent ownership interest in a business entity.
   
   5. The proposed rule also forbids “de facto” non-compete provisions. The proposed rule provides examples of a de facto non-compete:

• 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 Supplementary Information the FTC provides on de facto non-compete provisions also notes that other provisions, when broad can be de facto non-competes including:
 

• Liquidated damages provisions requiring the payment of a calculated amount due to the violation of a non-compete;
• Client or customer non-solicitation or “no-business” provisions (including, by logical extension, tied to client based restrictions); and
• Non-recruit (non-poach of employee) provisions.

See the FTC website for more information here.
 
The proposed rule does not mention nor explain whether or not notice provisions, garden leave provisions or employment agreements for terms would be considered “de facto” non-competes. The proposed rule also omits any mention on whether or not forfeiture for competition provisions will be permitted (such as under New York’s employee choice rule). 

6. The proposed rule is both retroactive and proactive, banning new non-compete provisions, maintaining existing non-compete provisions, or claiming to a worker that they are subject to an enforceable non-compete clause when it is really not enforceable.
 
7. The proposed rule explicitly requires the rescission of non-compete clauses with workers by providing a notice to the worker in an “individualized communication” that “the worker’s non-compete clause is no longer in effect and may not be enforced against the worker.”
 
8. The proposed rule would supersede state law unless such law provides greater protection than this proposed rule (i.e., California law concerning client-based restrictions).
 
9. Compliance requirements would go into effect 180 days after the date of publication of the final rule. The proposed rule has yet to be published. Given the major financial impact (see here concerning the “Major Questions Doctrine”), questionable FTC authority to make a retroactive rule voiding restrictive covenants in asset purchase and merger agreements, and the likelihood of a volume of public comments, there is a significant likelihood that the Final Rule will not be in effect in the 2023 calendar year.  

Concerns with the Proposed Rule
The proposed rule has significant deficiencies that are sure to be noted during the public comment period such as: 
 

• The retroactive nature of the proposed rule will impact many sale transactions that have occurred in the last 5 or more years – either where the buyer of a business priced into the transaction non-competition from former owners or in which a business hired a former owner for a role and at a salary level which would have been lower had there been a risk that the individual would leave and immediately compete. The proposed rule thereby accidentally favors former business owners over those that purchased their business. 

• The use of a 25% threshold for owners that can have non-competes applied to them is entirely arbitrary.  A 25% owner of a $1 million business ($250,000 ownership interest) can have a non-compete applied to them, but not the 24% owner of a $1 billion business.  This is an absurd result.  The same would apply to a de facto owner of 100% of a business where the owner’s direct interest was less than 25%, but a greater portion was owned by a trust or family member. To apply the voiding of non-compete retroactively to buyers and sellers that had no prior notice that a percentage of ownership interest would materially impact the enforcement of their non-competes is inequitable.

• Future Sellers of a business in which ownership is held in less than 25% portions may have to discount their sale prices to account for the potential that usual and ordinary non-competes will be deemed to be unenforceable at a later date.

• There is no income threshold involved in the non-compete ban. The FTC seeks to help extremely high income workers  earning $1 million a year or more at the same time and in the same way as individuals making minimum wage. Numerous states have legislated prohibitions on the use of non-competes earning less than a set income threshold including the highly compensated threshold under the FLSA. It would be an oversight to have the stated purpose of helping low- and middle-income workers but also attempt to retroactively void all non-competes including those for C suite and high income workers.

 
Looking Ahead
Based on this proposed rule, what’s next?
 
1. Watch this space but don’t overreact.  Based on a number of factors, this proposed rule is unlikely to be in force in 2023. First, the proposed rule needs to be published in the Federal Register.  Next, a 60-day comment period will occur, after which changes may [should!] be made to the proposed rule.  Then, 180 days after publication of the final rule it would be in force.  Prior to this occurring, there is a high likelihood that, if the proposed rule remains significantly similar to its present form, one or more parties would seek to enjoin it and it would be the subject of litigation for a significant period of time.

2. Diligently observe other state legislators who pass similar laws in the space including if the then Final Rule is enjoined. Given the many state laws enacted concerning restrictive covenants  since 2016, it is anticipated that States will continue to legislate rules concern the use of restrictive covenants anticipated to be  in a prospective and more thoughtful manner.

3. Consider the restrictive covenants you are using on a going forward basis in your sale and employment agreements and make sure they comply with existing state law. Whether or not this proposed rule is finalized and creates legal obligation or is enjoined, state legislatures and attorneys general are bound to be more active in pursuing the “ claim[s]… to a worker that they are subject to an enforceable non-compete clause when it is really not enforceable”  and courts are more likely to look at overbroad covenants in a dim light.      
 
 
Attorney Advertising. The information contained in this Legal Alert provides a general summary of the topics covered and is not intended to be and should not be relied upon as legal advice. You should consult with your legal counsel for advice and before making legal, business or other decisions.