A New Playing Field With Competitive Concerns

On Jan. 5, 2023, the Federal Trade Commission proposed a new rule that would prohibit employers nationwide from entering new non-compete agreements or maintaining existing agreements with employees and independent contractors. 

Substantively, the proposed rule is quite expansive, covering both strictly defined non-compete clauses—that is, a clause 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”—as well as overly broad non-disclosure agreements, customer or employee non-solicitation agreements, or agreements that have the effect of prohibiting workers from seeking or accepting new employment. For example, employers would be prohibited from requiring workers to reimburse employers for certain costs that are not reasonably related to actual costs incurred.

The proposed rule would also largely federalize the existing patchwork of state law, superseding any state statute, regulation, order, or interpretation that is inconsistent with the provisions of the final rule, except to the extent that they provide workers with greater protections or are subject to a very narrow exception. According to the FTC, this exercise of federal power is allowed for in Section 5 of the FTC Act, and indeed, the government launched three such Section 5 enforcement actions the day before the new rule was proposed.

While non-compete agreements are uncharted territory for the FTC, the Biden administration has demonstrated a willingness to depart from longstanding government policy on matters pertaining to labor and employment law. For example, in 2020, the Department of Justice broke with decades of practice and pursued criminal prosecutions—rather than civil litigation—in Sherman Act cases involving alleged naked wage-fixing and no-poach agreements between competitors. The first two forays into criminalizing these alleged Sherman Act violations ended in disaster, as juries in Texas and Colorado found the defendants not guilty. Such losses might counsel some degree of regulatory restraint; however, the department continues to move forward with pending charges brought against other companies, and more indictments are likely to follow.

The policy initiative stems from the administration’s stated goal of becoming “the most pro-union, pro-worker administration of our lifetime.” Since his inauguration, President Biden has pursued a “whole-of-government” approach, targeting portions of labor and employment law previously seen as state law issues. One of the big targets for this effort are employers who allegedly restrict workers’ mobility or otherwise suppress the competition for workers. In July 2021, Executive Order 14036 explicitly directed the FTC “to curtail the unfair use of non-compete clauses,” so to a certain degree, the FTC’s proposed rule should not be a surprise, its severity notwithstanding.

Many are skeptical that the proposed rule, as written, will remain intact after the public comment period or, if adopted, will survive the court challenges that would surely follow from conservative state attorneys general and/or business groups. After all, historically, the FTC has not regulated non-compete agreements between employers and employees, and there are sound arguments that the FTC’s interpretation of Section 5 is overbroad. Notable among them is Commissioner Christine Wilson’s dissenting opinion from the proposed rule, which likely provides the initial road-map for a legal challenge (Wilson recently resigned from the FTC, noting FTC overreach in this and other areas as the reason).

However, the interest of the federal government also comes at a time when many state legislatures and courts are becoming more hostile to restrictive covenants and is likely indicative of that trend continuing, regardless of the fate of this proposed rule. For example, Colorado passed a bill last year that significantly limits the enforceability of non-compete agreements executed after August 10, 2022. Moreover, a bi-partisan group of U.S. senators has reintroduced a bill to ban the use of non-compete agreements nationwide through legislative action. 

If there is sufficient bipartisan legislative momentum to pass the bill, the chances of a nationwide non-compete ban going into effect are far greater. Many companies may seek to avoid the hassle and risk of litigation altogether by phasing out the use of non-compete agreements or rescinding existing non-compete clauses.