FTC Issues Proposed Regulation Prohibiting Non-Compete Clauses
On January 5, 2023, the Federal Trade Commission (FTC) issued proposed regulations that would ban non-compete clauses. As we recall, in July of 2021, President Biden issued an Executive Order instructing the FTC to issue rules as they relate to restrictive covenants. Now, over a year later, the FTC delivered. Below is an overview of the proposed rules. Please note that these regs are open for a 60 day comment period.
FTC’s Definition of Non-Compete
The FTC provides an interesting defintion of non-compete. The proposed regs provide the following definition:
[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.
“With a Person…”
As you see, the definition applies to contractual terms that prevent a worker from “seeking or accepting employment with a person.” That is certainly an interesting choice of words. While it seems abundantly clear that the FTC is seeking to ban terms that restrict an individual from seeking subsequent employment, it is puzzling that Commissioner Khan selected the phrase “with a person.” We certainly anticipate comments on this phrase.
“Worker…”
According to the FTC, a “worker” is a natural person who works , “whether paid or unpaid, for an employer.” In other words, these regulations protect all individuals- not just citizens. The definition provides examples of the individuals it protects: employee, independent contractors, extern, intern, apprentice, sole proprietors.
The definition also includes contractual terms that are de facto non-competes. In other words, these rules would ban contractual terms that have the same effect as non-competes. The Commission identifies two examples of such clauses:
Non Disclosure Agreements. Some NDA’s as written have stifling effects on an employee’s ability to move.
Training Cost Terms. Some employers include terms that require employees to remit payment for training/coursework if they leave employment within a specified time period. FOR EXAMPLE: Trucking company agrees to pay for an individual’s CDL course. Company includes a term that if the employee leaves within 90 days of the course completion, they owe the Company the cost of the course.
What About Severance Agreements?
Again, we anticipate many comments on these proposed rules. One such question being does this apply to severeance agreements? If an individual is terminated, it is questionable as to whether they would be a “worker” under these new rules. Per the rules, a non-compete clause is between an “employer and a worker.” If these rules come into fruition, it would make sense for employers to negotiate severance after terminating the employee. This way, any restrictions included in the severance agreement would not be between “employer” and “worker.” Rather it would be between and “employer” and “former employee.”
Unfair Methods of Competition
The proposed rules make it an unfair method of competition to: (1) enter into, (2) attempt to enter into a non-compete clause with a worker. It also makes it unfair to (3) represent to a worker that they are subject to a non-compete clause.
Rescission Requirement
The proposed rules require employers to rescind all non-competes by the Compliance Date (180 days after the effective date). The FTC proposes that employers be required to rescind all non-competes in an “individualized communication” to all current and former employees who are/were subject to the terms. Employers would need to provide this notice within 45 days of the rescission.
While these are merely proposed rules, this sends a signal to employers to revisit their contract tracking systems. Employers will be expected to identify former employees subject to a non-compete.
Exception
The proposed rules make an exception to this ban on non-competes as it relates to corporate transactions.
Under these proposed regs a non-compete is enforceable and valid when placed on an individual who is (1) selling a business entity, (2) otherwise disposing of all the person’s ownership interest in a businses entity, or (3) selling all or substantially all of a business entity’s operatin assets. However, this only applies to individiuals who are substantial owners, substantial members or substantial partners in the business entity at the time they enter into the non-compete. The proposed regulations define “substantial” as 25% ownership interest in the entity.
Now these proposed regulations does not mean that any employee with 25% ownership interest in an entity can be subject to a non-compete. It just means that if they are entering into a corporate transaction, and at the time of the transaction they have a 25% ownership interest in an entity, they can be subject to the restriction.
We anticipate many comments on this exception. Placing such a seemingly arbitraty number on the ownership stake will affect deals.
What Should Employer Do? What Can Employers Do?
Prudent employers will stay up-to-date on the FTC’s moves. These rules are open for a 60 day comment period. Needless to say we anticipate many comments on these proposed regs. We will keep you posted on these udpates.