US FTC Announces Major Rulemaking to Bar Non-Compete Clauses Across Economy

The upshot, for busy people:

• On January 5, 2023, the Federal Trade Commission (FTC) announced a sweeping Notice of Proposed Rulemaking (“NPRM” or “Proposed Rule”) that would outlaw non-compete clauses between workers and employers in virtually any company under the FTC’s jurisdiction. According to the FTC, the rule would apply to more than 30 million employees in the US economy, from fast food line workers all the way up to CEOs of public companies who are currently bound by non-compete agreements.

• Comments are due 60 days after the NPRM is filed in the Federal Register, which should happen soon. Notably, due to the rulemaking authority the agency is relying on, this is likely the only comment period available before the agency issues a final rule.

• Because the Proposed Rule would apply only to companies within the FTC’s jurisdiction, the Proposed Rule would not apply to regulated banks, savings and loan institutions, federal credit unions, common carriers, air carriers, and non-profits, among others. 

• Companies and industry groups should consider whether to submit a comment. But even if the agency does not finalize the Proposed Rule, companies using non-compete clauses should be aware that this is another practice on the agency’s radar.

Background

This rulemaking comes against a backdrop of aggressive statements and regulatory action in the antitrust and employment spaces under Chair Lina Khan.

Unfair Competition. The FTC has authority under Section 5 of the FTC Act to prohibit “unfair methods of competition in or affecting commerce.” Among Chair Khan’s first actions upon taking office was to rescind a 2015 policy memo articulating the agency’s view that Section 5’s competition authority should be reviewed under the “rule of reason,” which the FTC majority criticized as inconsistent with Congress’s intent. A new policy statement, released November 2022, explained the FTC’s view that Section 5’s prohibition on “unfair methods of competition” instead would “focus on stopping unfair methods of competition in their incipiency based on their tendency to harm competitive conditions.” The upshot of this new policy was that the FTC appeared poised to allege standalone violations of Section 5, even where other antitrust statutes would not support a charge.

FTC & Labor Law. In recent years, the FTC has honed in on perceived competition issues affecting workers in the labor market. Under the prior administration, the FTC held hearings on non-compete provisions in 2019 and 2020. Since Chair Khan took office, the FTC has held a December 2021 two-day workshop on competition in labor markets (which two of the authors here participated in); begun a rulemaking regarding earnings claims, targeting the gig economy (which we covered in a Legal Update); and then, in July 2022. signed a memorandum of understanding with the National Labor Relations Board to share information regarding “unfair methods of competition” and “unfair labor practices” (which we also covered in a Legal Update). And on January 4, 2023 (the day before releasing the NPRM), the agency announced enforcement actions against three companies for using non-compete clauses, alleging that the practice in each case was an “unfair method of competition.”

What Does the Rule Cover?

The proposed rule itself is relatively concise, doing the work with a few key definitions:

• Non-compete clause. The definition of the key term—“non-compete clause”—is straightforward, defined as “a contractual term between an employer and 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.” But the definition goes further, articulating a “functional test” for whether a contractual term has the “effect of prohibiting a worker from seeking or accepting employment” even though it does not directly prohibit competition. The proposed rule includes two examples: broad non-disclosure agreements and agreements that require workers to repay training costs where the costs are not reasonably related to the training.

• Employer and Worker: These terms are as broad as one could imagine. “Employer” is any “person, partnership, corporation, association, or other legal entity” (a definition imported from Section 20 of the FTC Act). “Worker” is a “natural person who works, whether paid or unpaid, for an employer,” including an “independent contractor, extern, intern, volunteer, apprentice, or sole proprietor who provides a service to a client or customer.”
  • But note: The only exception applies to franchisee-franchisor relationships (i.e., the owner of a fast-food franchise is not the employee of the company creating the franchise).

After that, the Proposed Rule sets out the remaining substantive requirements in two pages (in pre-Federal Register format).

• Prohibits Non-Compete Clauses. The first provision finds that it is an “unfair method of competition” for an employer to enter into, to attempt to enter into, or to maintain a non-compete clause with a worker. The proposed rule also would prohibit any representation that a 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.

• Rescission & Notice for Existing Clauses. For any existing non-compete clauses, the proposed rule requires that employers rescind any non-compete clause by the “compliance date”—defined later as 180 days after publication of the final rule. Employers also must provide individualized written notice to employees (current and former) with a rescinded non-compete clause within 45 days of the rescission. The proposed rule provides model language for that communication, though the proposed rule says that employers can use their own language as long as it communicates the same information.
  • Safe Harbor. The proposed rule makes clear that the employer complies with the rescission requirement when it provides notice to the worker.

• Exception for Sale of a Business. Aside from the franchisee-franchisor context referenced above, the only other exception to the blanket prohibition against non-compete clauses occurs in the context of selling a business or ownership interest. The proposed rule would allow non-compete clauses where the person subject to the non-compete clause owns at least 25 percent of the business in question. (Non-compete clauses in this context would still be subject to other applicable laws, including federal antitrust law.)

• Pre-emption. The proposed rule states that its terms would supersede any inconsistent state law but provides that it would not pre-empt state laws that provide workers with greater protections than would the proposed rule.

• Effective date: 180 days after the final rule is published in the Federal Register.

Alternative Proposals for Comment

In seeking comment from the public, the FTC identified a number of alternative proposals not reflected in the proposed rule.

• Presumption or Categorical Ban. The NPRM explains that the agency may be open to reframing the rule as a rebuttable presumption against non-compete clauses, rather than a categorical prohibition, and requests comment on any specifics for how such a rule might operate (e.g., substantive requirements to rebut the presumption and the procedure necessary to do so).

• Different Categories of Workers. The FTC also seeks comment on whether the rule should apply differently to different types of workers—for example, whether it should apply differently to executives or whether it should have an income threshold.

The FTC also discusses at length whether senior executives should be covered by the rule. According to the agency, non-compete clauses for executives “negatively affect competitive conditions…and may do so in unique ways” but are not “exploitative and coercive at the time of contracting or at the time of the worker’s potential departure.” The agency thus asked for comment on a number of issues related to senior executives, including how to define the term (e.g., should the rule reference earnings or certain defined officers under Securities and Exchange Commission rules?).

The NPRM also references certain contemplated procedural requirements that the agency did not adopt but on which it would like comment: If non-compete clauses are to be permitted, the employers would be required to disclose at the time of the employment offer that the position requires a non-compete clause and to report their uses of non-compete clauses to the FTC.

Rulemaking Authority

In moving forward with this proposed rule, the FTC is exercising purported rulemaking authority that is fairly contested.

Generally viewing itself as a law enforcement agency, the FTC historically has exercised its rulemaking authorities only infrequently. Absent some specific statutory authority, the FTC’s rulemaking powers are normally governed by the cumbersome provisions of Section 18 of the FTC Act—known as “Magnuson Moss Rulemaking” after the 1975 statute that cut back on the FTC’s rulemaking powers after rulemakings in the 1960s and early 1970s. That statute requires the FTC to engage in additional procedural steps beyond simply a proposed rule and a final rule—the agency also must issue an advanced notice of proposed rulemaking and allow interested parties to present and question evidence underlying the rule in something akin to a mini trial. But after the US Supreme Court ruled in 2021 that the agency cannot obtain monetary relief for most first-time violations of Section 5  of the FTC Act, the FTC began a rulemaking initiative on things such as impersonation fraud, earnings claims, and commercial surveillance. The reason for this increased rulemaking is that the agency can collect various forms of money relief for violations of rules written by the FTC (including $50,000 per-violation civil penalties). Notably, all of these rules have involved consumer protection issues—to protect consumers from “unfair or deceptive acts and practices”—which Section 18 expressly covers. That authority does not reference the agency’s competition authority (“unfair methods of competition”).

Here, the FTC is instead referencing a more obscure authority: Section 6(g) of the FTC Act. That provision reads, “The Commission shall also have the power—… from time to time [to] classify corporations and (except as provided in section 57a(a)(2) of this title) to make rules and regulations for the purpose of carrying out the provisions of this subchapter.” Prior to the passage of the Magnusson Moss Act in 1975, one Court of Appeals had upheld the agency’s authority to issue competition-related rules under Section 6(g), and the FTC takes the position (on its website, in the NPRM, and in Chair Khan’s separate statement supporting the rule) that Congress did not disturb rulemaking authorities with respect to competition. That is why, for example, the FTC has gone straight to a proposed rule, and skipped over the advanced notice of proposed rulemaking seen in rulemakings such as the commercial surveillance rulemaking.

Duelling Commissioner Statements Signal Potential Areas for Challenge

The FTC approved the rule by a 3-1 party-line vote, and the Commissioners shared their views in competing separate statements. The statement by Chair Khan and the statement by Commissioner Rebecca Kelly Slaughter defended the necessity and value of the rulemaking and also addressed certain perceived shortcomings noted by Commissioner Christine Wilson in her 14-page dissent. Commissioner Wilson described the rulemaking as a “radical departure from hundreds of years of legal precedent” and identified a number of potential issues that could tie up any final rule in litigation for years. Among other things:

• Assessing the propriety of non-compete clauses is a fact-specific enterprise that is inappropriate for a categorical approach rendering nearly all non-compete clauses unlawful. She notes that this is particularly troubling because 47 states currently allow non-compete clauses, the FTC had no experience in non-compete clauses until the settlements announced the day before the rulemaking launched, and the categorical prohibition ignored all of the evidence on potential benefits of non-compete clauses.

• The 1975 Magnuson Moss Statute displaced the agency’s competition rulemaking authority by giving it only authority to write rules outlawing consumer protection issues (“unfair and deceptive acts and practices”).

• Given the very vague authority Section 6(g) provides, and the huge effect that the Proposed Rule would have on the economy, the proposed rule likely would fail as a “major question” as described in West Virginia v. EPA.

What Does This Mean for My Business?

Comments are due 60 days after the NPRM is published in the Federal Register; companies and industry groups should consider whether to file a comment. Notably, this comment round may be the only opportunity to make a record for possible legal challenges before the agency issues a final rule.

Beyond the rulemaking, the FTC under Chair Khan is obviously keenly interested in using its competition authorities in expansive ways to regulate the labor market. At the very least, companies that use non-compete clauses should be aware that the FTC views those provisions with suspicious eyes, even though they may be perfectly legal under state law.