The Federal Trade Commission announced on January 5, 2023, a Notice of Proposed Rulemaking (NPRM) that would categorically ban employers from entering into or maintaining non-compete clauses with workers.¹ The proposed rule would ban virtually all non-compete provisions in agreements with workers, both retroactively and going forward, by defining them as an “unfair method of competition” under Section 5 of the FTC Act.  According to the Commission’s own estimate, the proposed rule would affect nearly 1 in 5 employment agreements in America, many of which were privately negotiated for significant consideration, a sweeping effect on the economy by any measure.² Though the proposed rule applies to all sectors of the economy, the FTC also signaled that the health care sector may be a particular target.³

The NPRM announcement follows the FTC’s November policy statement on “unfair methods of competition” under Section 5 (discussed here) in which a majority of the Commission previewed its intent to dramatically expand the FTC’s authority to ban business practices that the agency dislikes, without regard to evidence of anticompetitive effects or harm to consumers.

The FTC will soon publish the proposed rule in the Federal Register, and stakeholders will have sixty days to submit comments.  This is likely to be the only chance for interested parties to comment on the proposed rule and build a record of its anticipated effects, including potential unintended consequences that the FTC has not yet considered.

After the comment period closes,⁴ the FTC will vote whether to promulgate the final rule.  Business groups are likely to challenge the rule in court at that point, but if the final rule is not enjoined, businesses will have a 180-day grace period to comply with it.

The Proposed Rule

The proposed rule declares that 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 with a worker a non-compete clause; or 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.” 

The rule would effectively ban all existing and future non-compete clauses, subject only to a narrow exception for non-compete clauses between the seller and buyer of a business that would only be available where the restricted party is a “substantial” owner of the business with at least a 25% ownership interest.  

The proposed rule broadly defines the term “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.  While the proposed rule claims to exclude most other restrictive employment covenants, such as non-disclosure agreements and non-solicitation agreements, the NPRM notes that such covenants could be deemed a non-compete clause under the proposed rule where they are “so unusually broad in scope that they function” as a de facto non-compete clause.

Notably, the term “worker” extends to any natural person who works, whether paid or unpaid, for an employer, and includes independent contractors, interns, externs, and others regardless of how such workers are classified under state or federal labor laws.

With respect to existing non-compete clauses, employers would be required to rescind all such provisions within 180 days of publication of the final rule and provide individualized notice of the recission to current and former employees.  The proposed rule provides a safe harbor from enforcement to employers who comply with these requirements and includes model language of a proposed notice.

The proposed rule would preempt all state and local rules that are not “consistent” with the provisions, but would allow state laws or regulations that provide greater protections for workers.

Significant Legal Obstacles for the FTC Should It Promulgate a Final Rule

The FTC’s attempt to ban non-compete clauses under Section 5 of the FTC Act represents a significant expansion of the agency’s authority.  First, the FTC had never previously found non-compete clauses to be an unfair method of competition before three recent settlement agreements announced literally one day before the NPRM.⁵ Further, as Commissioner Wilson, the sole Republican member of the Commission, noted in dissent, a blanket ban flies in the face of academic research and more than a century of legal precedent, which has consistently recognized that non-compete provisions can advance legitimate business purposes and protect incentives to engage in procompetitive conduct (e.g., investing in human capital, building goodwill with customers, and developing expertise or technology breakthroughs that have relatively weak protection under IP law).   

Additionally, as Commissioner Wilson argues in her dissent and as some of us have previously observed,⁶ the FTC likely lacks the authority to promulgate substantive competition rules under Section 6(g) of the FTC Act (the section of the FTC Act upon which the NPRM relies).  Further, even if the FTC has such authority, the proposed rule may well violate the Supreme Court’s “major questions doctrine” because Congress has not clearly authorized the FTC to promulgate rules that would have such profound effects on the economy, such as a total ban on non-compete clauses.  Finally, even if Congress did intend to delegate such authority to the FTC, the proposed rule may exceed the limits of the Supreme Court’s non-delegation doctrine.  Congress may only delegate its legislative powers when it articulates an “intelligible principle” that the agency must follow. Commissioner Wilson doubts that one exists for declaring that broad swaths of conduct are “unfair methods of competition,” given the highly fact-specific nature of that question.

Interested Parties Should Consider Submitting Comments to the FTC

As mentioned above, this NPRM is likely to be the only opportunity for the public to submit comments to the FTC before it publishes a final rule—which it no doubt will push to do as quickly as possible after the comment period closes, and which could happen as early as mid-2023.  Although any final rule will almost certainly face challenges in court, the viability of a final rule will depend, in part, on how the FTC responds to comments submitted by stakeholders.

The FTC has requested comment on a broad variety of issues raised in the NPRM, some of which include:

• Alternative formulations of the rule which could apply different standards to different classes of workers, such as one standard for workers who are exempt from the minimum wage and overtime requirements under the Fair Labor Standards Act, such as executives or professionals, and another standard for those who are not exempt.

• Whether to exclude senior business executives (or other classes of highly skilled workers) from the ban on the theory that they are less likely to be exploited in contract negotiations.A complete ban on non-compete clauses could have important tax consequences that are not considered in the NPRM. For instance, such a rule could seemingly significantly increase excise taxes payable by certain executives pursuant to Section 4999 of the Code (the “golden parachute” tax rules) in connection with changes of control by eliminating the ability to reduce parachute payments for the value of the executive’s compliance with a non-compete.

• Whether certain other restrictive covenants, including broad NDAs, client or customer non-solicitation agreements, no-business agreements, no-recruit agreements, liquidated damages provisions, training-repayment agreements, no-poach agreements, or wage-fixing agreements ought to be defined as impermissible.

• The FTC’s exemption for non-compete clauses in the sale of a business by an owner with at least a 25% ownership interest. The windfall experienced by certain employees, including senior executives, who agreed to comply with non-competes for significant consideration, particularly in connection with prior sales of businesses, is not considered in the NPRM.

• The FTC’s economic rationale for the rule, including the FTC’s conclusions that reducing the enforceability of non-compete clauses raises wages and that the FTC lacks conclusive evidence that non-compete clauses incentivize job creation and the value associated with any given worker, among other things.

• The FTC’s claims that the economy-wide harms from wage suppression (estimated at $250 to $296 billion per year) outweigh the benefits to workers from training, capital investments, and other legitimate business reasons for using non-competes.

If you are interested in submitting a comment to the FTC, Baker Botts attorneys can help.  Please contact Jody Boudreault, Robin Melman, or any member of the Antitrust group.

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