FTC Proposes Rule Banning Use of Noncompete Agreements in Employment

The rule can be found here.

The FTC issued the Notice of Proposed Rulemaking (NPRM) on a 3-1 Commission vote. Commissioner Christine Wilson, the dissenting vote, issued a statement describing the proposed rule as “a radical departure from hundreds of years of legal precedent,” despite “a lack of clear evidence” to support such a dramatic change.

Comments on the proposed rule must be filed within 60 days after the proposed rule is published in the Federal Register. In particular, the FTC seeks comment on the following topics:

• Whether a different standard should apply to noncompetes that cover senior executives or other highly paid workers;
• Whether the rule should cover noncompetes between franchisors and franchisees; and
• Whether there are tools other than noncompetes that employers can use to protect valuable investments that are sufficient for that purpose.

The Proposed Rule

The proposed rule would apply broadly, not just to all employees, but also to independent contractors and any individual who works for an employer, whether paid or unpaid (e.g., externs, interns, volunteers, apprentices, or sole proprietors). It also would apply not just to noncompetes that expressly prohibit a worker from seeking or accepting certain employment after the conclusion of the worker’s employment with the employer, but also to any contractual provision that functions as a de facto noncompete. The proposed rule includes the following types of contractual terms that the FTC asserts may function as a de facto noncompete in certain circumstances:

• Non-disclosure agreements written so broadly that they effectively preclude the worker from working in the same field after the conclusion of the worker’s employment with the employer; and
• Contractual terms that would require the worker to pay the employer or a third-party entity for training costs if the worker’s employment terminates within a specified time period, where the required payment is not reasonably related to the costs the employer incurred for training the worker.

The FTC’s proposed rule would also require employers to rescind any existing noncompetes within six months of the Rule’s publication and provide notice to employees “in an individualized communication” that such restrictions are no longer in effect and may not be enforced against the worker.

The proposed rule would not, however, apply to concurrent-employment restraints — i.e., restrictions on what the worker may do during the worker’s employment with the employer. It also would not apply to noncompetes in the context of sales of businesses or between franchisors and franchisees (although the franchisees’ employees would be covered by the rule).

The Unprecedented Scope of the Proposed Rule

Though a number of states and local jurisdictions in recent years have passed laws restricting the use of noncompetes, almost all have limited the restrictions to lower-wage workers or provided some exception for executives and similar positions, and almost all expressly state that they do not apply retroactively to noncompetes already in existence. The FTC’s proposed rule goes much further. Indeed, most state and local jurisdictions expressly recognize, either by statute or by judicial opinion, the appropriateness of narrowly tailored noncompetes to protect legitimate business interests.

Next Steps

The FTC has established a 60-day comment period for affected parties to submit public comments in response to the rule. The FTC will review the comments and may make changes in a final rule based on those comments. Any final rule will take effect 180 days after its publication, although we expect that litigation challenging the rule is likely. Commissioner Wilson’s dissenting statement argues that the NPRM is vulnerable to legal challenge because the FTC lacks the authority and clear Congressional authorization to engage in “unfair methods of competition” rulemaking, and even if it had such authority or authorization, the rulemaking is an impermissible delegation of legislative authority.

ArentFox Schiff LLP will continue monitoring developments in this area.