FTC Takes Aim at Non-Compete Agreements

On Jan. 5, 2023, the Federal Trade Commission (FTC) voted 3-1 to publish a Notice of Proposed Rulemaking for a Non-Compete Rule (Proposed Rule), which provides that virtually all non-compete clauses with employees, independent contractors and other workers are invalid and unenforceable as an unfair method of competition. As a result, if the Proposed Rule takes effect, it will ban employers from entering into and enforcing non-compete clauses with all such workers. This broad prohibition applies to non-compete clauses in all contracts with workers regardless of (1) the employer’s industry; (2) the worker’s position, seniority, salary or duties; (3) the worker’s access to confidential information and trade secrets; and (4) the reasonableness of the non-compete clause’s geographical or temporal scope.

The Proposed Rule is a radical departure from FTC precedent. Indeed, prior to the Proposed Rule, the FTC had never used its rulemaking authority to impose limitations on non-compete clauses. It also represents a potentially massive upheaval to the current legal landscape covering non-compete clauses nationwide. 

While we expect myriad legal challenges to the Proposed Rule, the Proposed Rule and the FTC’s recent enforcement actions demonstrate a broad initiative by the FTC to combat the use of non-compete clauses in pursuit of its goal to ensure fair competition in labor markets.

The Proposed Rule

The FTC has rulemaking authority under Section 6(g) of the Federal Trade Commission Act (FTC Act) “to make rules and regulations for the purpose of carrying out” its mandates. The Proposed Rule is aimed at enforcing Section 5 of the FTC Act, which prohibits “unfair methods of competition in or affecting commerce.” The Proposed Rule marks the first time the FTC has used its Section 6(g) authority to propose rules covering the use of non-compete clauses.

The Proposed Rule provides:

It is an unfair method of competition for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non-compete clause; or represent to a worker that the 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.

A “non-compete clause” is defined under the Proposed Rule as a contractual term between an employer and a worker that prevents, or has the effect of preventing or prohibiting, 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. The Proposed Rule applies to all “workers,” defined broadly as anyone who works, whether paid or unpaid, for an employer. This includes all employees, contractors, interns, apprentices, volunteers or sole proprietors who provide services to a client or customer. There is no distinction between hourly or salary workers, C-suite or lower-level employees, or any other factors.

The Proposed Rule also mandates that all non-compete clauses entered into before the Proposed Rule takes effect (Compliance Date) must be rescinded within 180 days after the publication of a final rule. Further, an employer that rescinds a non-compete clause pursuant to the Proposed Rule must provide written, individualized notice to the worker stating the non-compete clause is no longer in effect and may not be enforced. The notice must be provided to all applicable workers who currently work for the employer, as well as those who formerly worked for the employer, provided that the employer has the worker’s contact information readily available.

The Proposed Rule contains a single, very narrow exception to its outright ban of non-compete clauses in employment and contractor agreements. The prohibition does not apply to a non-compete clause that is entered into by a person who is selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or by a person who is selling all or substantially all of a business entity’s operating assets, but only if that person owns at least 25% of the equity in such business.

The Proposed Rule supersedes any and all state statutes and rules to the extent such statutes and rules are inconsistent with or provide less protection than the Proposed Rule. States can enact their own statutes with greater protections for workers than those outlined in the Proposed Rule.

Notably, the FTC requested comments on potential alternatives to the Proposed Rule, including the possibility of having different rules for “different categories of workers based on a worker’s job function, occupation, earnings, another factor or some combination of factors.” This may suggest a middle road for a final rule.

Recent FTC Enforcement Actions

On Jan. 4, 2023, the FTC announced that it invalidated non-compete clauses in three matters, foreshadowing the aforementioned Proposed Rule. In one complaint, the FTC brought an enforcement action against a security guard company and its key executives for using non-compete clauses on low-wage employees. The FTC also ordered two of the largest U.S. glass container manufacturers to stop imposing non-compete clauses on their workers because they obstruct competition and impede new companies from hiring the talent needed to enter the market.

In the Matter of Prudential Security, et al.

The FTC action against Prudential Security (Prudential) and two of its owners alleged that Prudential’s use of non-compete clauses against their security guards was coercive and constituted an unfair method of competition in violation of Section 5 of the FTC Act. According to the complaint, the security guards (who were paid an hourly wage at or slightly above minimum wage) were required to sign Non-Compete Agreements as a condition of employment. The Non-Compete Agreements required that, for two years following the conclusion of employment, the employee could not “[a]ccept employment with or be employed by” a competing business “within a one hundred (100) mile radius” of the employee’s primary job site. Employees were also restricted from forming their own competing company. Moreover, the Non-Compete Agreements contained a “liquidated damages” clause, which required that the employee pay Prudential $100,000 as a penalty for any conduct in breach of the Non-Compete Agreements. 

The FTC’s order requires Prudential to terminate its non-competes with all of its security guards and to actively notify all employees that these non-compete clauses are now null and void.

In the Matter of O-I Glass, Inc. and In the Matter of Ardagh Group, et al.

The FTC’s actions against two glass manufacturing companies, O-I Glass Inc. and Ardagh Group, alleged that both companies imposed non-compete restrictions on, collectively, more than 1,700 hourly and salaried employees, including those working in key glass production, engineering and quality assurance roles. Notably, the respective complaints are devoid of substantive facts about the companies, the workers’ working conditions and job duties, and the companies’ enforcement of the non-compete clauses.

From the information that is contained in the complaints, O-I Glass’s non-compete clauses typically required that for one year following the conclusion of the worker’s employment, the worker could not, directly or indirectly, “be employed by” or own, manage, operate, join, control, participate in or in any manner be connected with any business that sells products and/or services in the United States that are the same or substantially similar to those in which O-I Glass deals, without its prior written consent.

Similarly, Ardagh’s non-compete clauses typically required that for two years following the conclusion of the worker’s employment, the worker could not directly or indirectly “perform or provide the same or substantially similar services” to those the worker performed for Ardagh to any business in the United States, Canada or Mexico that is “involved with or that supports the sale, design, development, manufacture, or production of glass containers” in competition with Ardagh.

The FTC found that these non-compete clauses violated the FTC Act, reasoning:

Respondent’s use of Non-Compete Agreements as described herein is unfair and has the tendency or likely effect of harming competition, consumers, and workers, including by: (i) impeding the entry and expansion of rivals in the glass container industry, (ii) reducing employee mobility, and (iii) causing lower wages and salaries, reduced benefits, less favorable working conditions, and personal hardship to employees.

Notably, the FTC did not distinguish between different types of workers based on seniority, access to confidential information and trade secrets, or other factors.

Through these enforcement actions, the relief secured by the FTC prohibits these two companies from imposing, attempting to impose, enforcing or threatening to enforce a non-compete with covered workers. The companies must also provide written notice that the non-compete clauses are now null and void.

Legal Analysis

The Proposed Rule and the FTC’s latest enforcement actions undoubtedly represent a concerted effort to upend decades of legal precedent, with the potential to ban non-compete clauses for all workers regardless of the reasonableness of the restriction, the employer’s business or industry, or the worker’s position or compensation level. Indeed, in its current form, the Proposed Rule would overturn well-established state laws and judicial precedent that have long governed the use of non-compete clauses throughout the country.

Unsurprisingly, we expect legal challenges to the Proposed Rule and the FTC’s authority to engage in rulemaking to define an “unfair method of competition” under Section 5 of the FTC Act, let alone to outright ban non-compete clauses. Just one day after the publication of the Proposed Rule, the U.S. Chamber of Commerce released a statement asserting the FTC’s actions are “blatantly unlawful” and “Congress has never delegated the FTC anything close to the authority it would need to promulgate such a competition rule.” And the current configuration of the Supreme Court as well as the anticipated pushback by various stakeholders will make it difficult for the FTC to overcome the expected substantial legal challenges. It thus remains to be seen whether the Proposed Rule (in its current form or otherwise) will take effect or be enjoined by the judiciary.

Timing

The FTC has asked the general public to submit comments on the Proposed Rule within 60 days of its publication. Once this 60-day period closes, the FTC will review the comments and conduct further analysis of the issues presented. 

At an undetermined time after this 60-day period, the FTC will either (i) issue a final rule regulating non-compete clauses (with or without modification to the Proposed Rule) or (ii) decide not to issue any rule. If a final rule is issued, it would go into effect 180 days after publication. Realistically, we do not expect that a final rule will become effective before the last quarter of 2023 and perhaps significantly later. 

Moreover, as noted above, we anticipate serious legal challenges to the Proposed Rule. Aggrieved parties will likely seek — and, given the extraordinary impact of the Proposed Rule, courts may seriously consider — a stay of the rule pending the resolution of such cases.

Conclusions

Our advice: Don’t panic. And don’t change your practices based solely on the Proposed Rule.

The FTC’s issuance of any enforceable rule will take an indeterminate amount of time and will likely be subject to protracted litigation potentially lasting years. Nevertheless, employers should take note of the Proposed Rule and the FTC’s recent enforcement actions. If nothing else, the FTC is demonstrating an unprecedented emphasis on regulating and thwarting non-compete clauses. Even if the Proposed Rule ultimately fails, the FTC can still use its authority to bring enforcement actions against companies using non-compete clauses. In addition, the FTC, under current Chair Lina Khan’s leadership, is signaling that it will be a more active government agency than its predecessors to combat what it perceives to be unfair methods of competition through its rulemaking powers.  

This also may be an opportune time for employers to review their usage of non-compete clauses and other restrictive covenants to ensure they are consistent with recent legal developments in various jurisdictions and are designed to maximize the enforceability of those provisions.

For questions or concerns regarding any of the issues raised in this alert, please contact a member of Kramer Levin’s Employment Law Department.