On January 5, 2023, the U.S. Federal Trade Commission (“FTC”) proposed a new rule banning employers from imposing noncompete provisions on their workers. The rule would supersede all state laws, except to the extent that a state’s law gives workers greater rights.
Whether one chooses to see it as a pretext or as a context, the FTC maintains that non-competes are a form of unfair competition and that banning them is within its purview.
It’s highly likely that there will be legal challenges to the FTC’s authority to adopt such a rule.
As framed in the proposed rule, “employer” and “worker” are not limited to the true employer-employee relationship, and include subcontractor and independent contractor relationships as well.
Interestingly, the proposed federal rule goes beyond what certain states, for example, California, have enacted in terms of covenant not to compete prohibitions. For example:
1. It requires an “employer” that has entered into a noncompete with a worker to give notice to the worker that his or her noncompete is no longer in effect and is unenforceable.
2. The notice must be given both to current and former workers subject to such covenants.
3. It defines prohibited noncompetes much more broadly commonly seen. It would include other contractual terms that amount to de facto noncompete clauses because 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”.
4. The proposed rule incorporates an exception for noncompetes in connection with the sale of a business, but only as to a “substantial” owner, defined as someone with at least a 25% ownership interest in the business.
At this point, the rule is simply proposed rule, and the FTC is seeking public comments which will be due within 60 days after the proposed role is published in the Federal Register.
In addition to drawing legal challenges related to the FTC’s authority, one can imagine the various unintended (or perhaps they are intended?) consequences of the rule.
Certainly, covenants not to compete have always been a creature of state law and federalizing the issue raises constitutional concerns.
Additionally, although some states have prohibited covenants not to compete in regard to workers, making it illegal to bind selling business owners who hold less than a 25% interest (think, for example, of a medical group with 25 shareholders, each owning 4%) to a covenant not to compete in connection with the sale of the business, could gut a significant portion of the value that a purchaser might be willing to pay for the business. Whether or not this proposed rule becomes final, the push to restrict noncompetes and to broaden their definition underscores the need for “employers” to seriously consider other alternatives to protect against the theft of trade secrets and the disclosure of confidential information in the context that they are not merely proxies for what might become impermissible covenants not to compete.