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March 24, 2023

What Employers Need to Know About the FTC's Proposed Rule Banning Non-Competes

What Employers Need to Know About the FTC's Proposed Rule Banning Non-Competes

Non-compete clauses have been used by employers for decades to guard against a number of employee behaviors including leaving the company for competitors, sharing trade secrets, or later starting a competing business. The Federal Trade Commission’s (FTC) latest rule could ban these clauses outright.

The FTC’s Proposed Rule

The FTC recently proposed a new rule that would bar employers from using non-compete agreements entirely. In the FTC’s announcement accompanying the proposed rule, the agency refers to non-competes that restrict an employee’s ability to switch jobs as an exploitative practice “that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses.” The FTC estimates that this new rule could increase wages and expand career opportunities for as many as 30 million Americans.

Definition of a “Non-Compete” Clause

The proposed rule would define a non-compete clause as 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.”

Under the new rule, non-disclosure and non-solicitation provisions are still permitted. However, they will be subject to a functionality test and can be invalidated if the FTC determines they are “de facto” non-compete provisions.

Retroactivity

This proposed rule would apply to all existing non-compete clauses, not just new ones going forward. The proposal specifically states that the rule would prohibit employers from “maintaining” such agreements with their workers. Employers would be required to rescind any existing clauses and notify workers of the rescission.

Exceptions to the Rule

This proposed rule does allow for a limited exception in the case of a non-competes clause between the buyer and seller of a business. The exception is only available when the person subject to the non-compete clauses is an owner or partner holding at least 25% ownership of the company.

Penalties for Violations

If the rule goes into effect, the FTC may issue a complaint if it believes the rule has been violated. The Commission can seek a range of remedies including injunctive relief, damages, restitution, and civil penalties. The Commission can even issue orders requiring companies to rescind violating contracts or reform existing contracts. 

Why Did the FTC Take This Action?

The FTC proposed this rule pursuant to an executive order signed by President Biden in July of 2021. The Executive Order, “Promoting Competition in the American Economy,” specifically directed the FTC to curtail the use of non-compete clauses or other agreements that may limit worker mobility.

Prior to seeking comment on the rule, the FTC made a preliminary finding that non-compete clauses constitute an unfair method of competition in violation of the Federal Trade Commission Act. According to research from the FTC, an estimated 18% of workers are covered by non-competes and this rule would increase workers’ earnings by nearly $300 billion.

When Will the Rule Take Effect?

The current public comment period closes on April 19, 2023. The FTC will then review comments and decide to move forward with the rule as drafted or amend the rule  based on feedback. This process could take weeks, months, or even years.  

What Should Employers Do?

There is no way to predict what the final rule will look like and how the FTC will fare if the rule is subject to legal challenge. However, employers can take preliminary action to avoid a scramble If the rule takes effect this year. 

Employers should first revisit their existing non-competes agreements to ensure they are not overly broad. This proposed rule is the latest in a string of FTC action around non-competes and unfair competition. Even if this rule does not survive legal challenge, it is likely that this Commission will continue to enforce against employer agreements it deems unlawful. Employers should also explore other instruments to protect their interests such as a non-solicitation clause or confidentiality provision.

Experienced New York Labor and Employment Attorneys

The Employment & Labor Law department at PN Lawyers represents both individuals and businesses. It is our mission to ensure fair treatment for both employees and employers. We will continue to monitor this proposed rule as it advances through the FTC process and potential legal challenges. If you need help re-examining or structuring your non-competes clauses or other restrictive covenants, get in touch with one of our New York labor and employment attorneys by calling 212-213-8511.

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