FTC Seeks to Help Workers by Banning Noncompete Restrictions

By Jahan Sagafi and Kerry Zaroogian

Jan. 5, 2023 -- On Thursday, the Federal Trade Commission (FTC) issued a proposed rule that could dramatically improve the ability of workers across the United States to move freely between jobs and negotiate higher pay, by proposing a rule to prohibit employers from entering into non-compete agreements with their workers.

The Rule’s Broad Coverage To Help Workers

The proposed “Non-Compete Clause Rule” will, if it goes into effect, render unenforceable any non-compete clause between a worker and an employer nationwide. The rule will have broad effect. 

First, the rule will protect all workers – not just employees, but also independent contractors, interns, externs, volunteers, apprentices, and sole proprietors. There are some limited exceptions to the proposed rule: non-competes between franchisors and franchisees, as well as those entered into in the context of a sale of a business with an owner of at least 25% of the business's ownership interests, will remain enforceable. 

Second, the rule will apply to contracts regardless of when they were entered into; it will prohibit new contracts from including such restrictions, and it will invalidate existing clauses that seek to restrain competition. So, employers will have to rescind non-compete clauses in effect in existing contracts (with both current and former workers) and issue a written notice of such rescission to all affected workers. 

Third, the FTC's proposed rule covers any clause that functions, in practice, as a non-compete clause, regardless of whether the clause is explicitly labeled a non-compete. This aspect of the rule reflects the common principle in employment law that what matters is the reality of the worker’s situation, not the words and labels used to describe it. While the rule does not expressly prohibit the use of other restrictive covenants – such as non-disclosure agreements, non-solicitation provisions, or non-recruitment agreements – it may extend to such agreements if they functionally prevent a worker from seeking or accepting employment or operating a business after the conclusion of the worker's tenure. The FTC notes that such agreements will continue to be subject to state law and other FTC oversight, including its recent oversight of anti-poaching provisions between companies.

Again, as is standard with much of the efforts of the federal government to working people, the federal rule will set a minimum protection for all workers in the U.S., superseding state law, except for those laws that afford workers even stronger protections.

Similar Recent Governmental Efforts To Protect Workers

While the issue is not a new one – over the past decade, legislators on the state and local levels have passed numerous laws regulating and banning non-compete agreements – this is the second substantial federal step that has been taken to address the issue since the Obama administration issued a clarion call in 2016 for state lawmakers and federal regulators to limit the use of non-competes in the employment context. The first step was three complaints filed by the FTC yesterday accusing three separate employers of violating Section 5 of the Federal Trade Commission Act by requiring low-wage workers to enter into overly broad non-compete provisions.

The Positive Impact On Working People

As a result of the proposed rule, it is estimated that 45% of employees in the private sector will be released from the shackles of existing restrictions, and the rule should have substantial impact on workers' future bargaining rights. The impact will be particularly great on those industries, such as the financial services industry, that use restrictive covenants heavily to limit the movement of their workers between firms. Despite increasing scrutiny under state law, non-compete agreements are still broadly used by employers to limit workers’ freedom to move jobs. Even unenforceable agreements have a chilling effect that can make a restricted employee an unfavorable hire, given the specter of a potential legal action – albeit an unsuccessful one – from a former employer. Candidates who are able to convince a prospective employer to hire them, notwithstanding a non-compete, are forced to concede on other negotiating points and accept lower compensation or less favorable terms of employment. More broadly, non-competes can limit the public’s access to important resources, such as medical professionals, and can prevent new companies from making inroads in industries where established employers have tied up the available talent with restrictive agreements. In the U.S., where employment at-will is the status quo, non-compete agreements are a method for employers to have their cake and eat it, too:  employees are not free to work elsewhere, while employers can terminate the employment relationship whenever they see fit.

The example of California, which has long prohibited non-competes, is instructive. The California economy is a major driver of American economic health, with huge industries thriving, while honoring their workers’ right to move freely between jobs. Thus, a non-compete ban like that proposed by the FTC supports both a thriving economy and a strong, healthy workforce.

What Happens Next

The proposed rule is subject to a 60-day comment period, after which it will become effective 180 days following final publication. As a result, existing non-compete agreements will remain enforceable and intact for at least the next eight months. Outten & Golden will continue to monitor developments as the rule works its way through the notice and comment procedures. Employees should continue to abide by their restrictions in the interim and consult with counsel if they have any questions regarding the enforceability of their non-competes and other contractual obligations. Outten & Golden’s Executives and Professionals Practice Group is a recognized leader in advising clients with respect to their restrictive covenant and other contractual obligations.