No More Employee Noncompetes?
Antitrust and Competition Law Alert® | January 13, 2023
Authors: Bernard (Barry) A. Nigro Jr., Nathaniel L. Asker, Richard A. Powers, Peter L. Simmons, Harrisson Kummer, Megan Ingram; Special thanks to Madison Chajson and Lexi Michaud, Antitrust and Competition Law Clerks, for their valuable assistance in the research and drafting of this client alert.
On January 5, 2023, the Federal Trade Commission issued a notice of proposed rulemaking seeking to categorically ban noncompete agreements between employers and a broad class of “workers.”[1] But “worker” is defined in sweeping terms and includes all employees (as proposed, even senior employees and executives), independent contractors, externs, interns, volunteers, apprentices, and sole proprietors who provide services to a client or customer. While the FTC’s rule does not explicitly prohibit NDAs, non-solicitation agreements, or forfeiture for competition clauses, the proposal includes a functional test to determine whether such covenants effectively operate as noncompete clauses. The proposed rule is also retroactive, requiring the rescission of any such restrictive covenants currently in existence, and thus upsetting carefully negotiated prior bargains.
Until now, limitations on employee noncompete agreements have generally been left to states and judged under a reasonableness standard,[2] making the FTC’s categorical ban a major departure from prior practice. While it is expected that any final rule will be challenged in federal court, this proposal marks the latest in ongoing efforts by the Biden administration to increase antitrust enforcement generally and in labor markets in particular.
Proposed Rule Highlights
The FTC’s proposed “Non-Compete Clause Rule” provides that an employer entering or attempting to enter into a noncompete agreement with a worker is engaged in an unfair method of competition in violation of Section 5 of the FTC Act, and would ban noncompete agreements between employers and employees. Additionally, NDAs and non-solicitation agreements that are unusually broad in scope or burdensome on the employee’s ability to work in a given field will be considered impermissible noncompete agreements.
The proposed rule includes a single, limited exception for noncompete clauses between the seller and buyer of a business, where the employee restricted by the noncompete is an owner, member, or partner holding at least a 25% ownership interest in a business entity and sells the entirety of the ownership interest in a transaction. In other words, founders who have sold down their interest in prior transactions but retain 10% or 15% of the business could not give a noncompete, and it is questionable whether even majority owners rolling over a portion of their investment in connection with a transaction (even if they are exchanging their interest for shares in Newco) would qualify under the proposed rule.
The proposed rule would require compliance no sooner than after the expiration of the current 60-day public comment period concluding on March 10, 2023[3], plus the mandatory 180-day notice period after publication of the final version of the rule. Employers would have to rescind existing noncompete agreements, and notify employees of the change within 45 days of the rescission. Employers will also be prohibited from entering into new noncompete agreements, and the FTC could seek civil penalties or an injunction against any company within its jurisdiction that violates the rule.[4]
Noncompete Clause Enforcement Actions
The FTC’s proposed rule comes just one day after it announced settlements with three companies resolving allegations that their use of employee noncompete agreements with both minimum wage and highly skilled employees was coercive and violated Section 5 of the FTC Act.[5] These settlements represent the FTC’s first enforcement actions brought under its new policy to pursue conduct through Section 5 that violates “the spirit of the antitrust laws,”[6] following the FTC statements in November 2022 that the agency intended to aggressively pursue business conduct under Section 5.[7]
FTC Noncompete Rule Is Consistent with DOJ Civil and Criminal Enforcement Efforts
The FTC’s proposed rule also mirrors the DOJ’s recent emphasis on competition enforcement in labor markets. In 2022, the DOJ advanced its enforcement in the labor space by trying its first criminal wage-fixing[8] and no-poach cases;[9] successfully suing to block a merger based on alleged harm to worker compensation;[10] and petitioning courts to adopt its stance that no-poach agreements separate from any joint venture or other transaction are per se illegal.[11] Going forward, we expect that both the FTC and DOJ under the Biden administration will continue to seek opportunities to bring civil and criminal actions to protect competition in labor markets.
Protecting Legitimate Business Interests Despite Noncompete Rule
The FTC’s proposed rule presents serious concerns for companies seeking to protect their proprietary information and prevent free riding on their investments. As currently proposed, other than the limited exception in connection with the sale of a business, no employee noncompete, regardless of duration, geography, or business scope, would be permitted. The proposed rule extends to C-suite executives with access to trade secrets, business plans/strategies, and customer or investor relationships, and to employees who have received significant training. The FTC acknowledged potential concerns regarding the impact of the proposed rule on trade secrets and invites comments on the subject, as well as whether different standards should apply for senior executives or based on the employee’s job function, compensation, or other factors.
If the rule goes forward, there are several steps that companies may want to consider. Employers could reassess their existing policies and procedures that protect proprietary information. Companies may also want to consider adopting: NDAs or confidentiality agreements with employees, vendors, partners, and interview candidates; carefully crafted customer non-solicitation agreements, which could protect key customer relationships without imposing restrictions on former employees; or compensation policies designed to incentivize valuable, high-level employees to stay. Compensation policies can include simple retention bonuses or deferred compensation, such as the conditional award of stock options in the form of RSUs.
Employers seeking alternatives to noncompete agreements should be advised that the FTC has released guidance that the test used to determine whether an NDA is functionally a noncompete agreement will be applied to other alternative agreements. Companies should be mindful of the FTC’s new position regarding noncompete and other contractual restrictions that may prevent employees from working for rivals and consider alternatives that serve to protect their trade secrets and investments.
[1] See, FTC, 16 CFR Part 910: Non-Compete Clause Rule Notice of Proposed Rule Making, (Jan. 5, 2023).
[2] See, e.g., Code of the District of Columbia, § 32–581.02(a)(1) (“No employer may require or request that a covered employee sign an agreement or comply with a workplace policy that includes a non-compete provision.”). Other states that have broadly rendered noncompete agreements unlawful or unenforceable include California, Colorado, Montana, Oklahoma, and Oregon.
[3] Interested parties may provide comments on the proposed rule by visiting https://www.regulations.gov/docket/FTC-2023-0007/document.
[4] The proposed rule applies only to entities under the FTC’s jurisdiction, and does not apply to regulated industries outside of the FTC’s authority, such as banking institutions or common carriers.
[5] See, Statement of Chair Lina Khan In the Matters of Prudential Security, O-I Glass Inc., and Ardagh Group S.A., at 3 (Jan. 4, 2023).
[6] FTC, Policy Statement Regarding the Scope of Unfair Methods of Competition Under Section 5 of the Federal Trade Commission Act, Commission File No. P221202, at 1, 12 (Nov. 10, 2022).
[7] For more on the FTC’s new Section 5 policy, see our client alert on the subject: FTC Increasing Pressure on “Unfair” Methods of Competition Through New Enforcement Policy, (Dec. 20, 2022).
[8] See, United States v. Jindal, 2022 U.S. Dist. LEXIS 61784 (E.D. Tex Apr. 1, 2022) (where DOJ brought a criminal wage-fixing charge from an FTC investigation into an alleged illegal agreement between a healthcare staffing company and its competitors to lower rates paid to physical therapists).
[9] See, United States v. DaVita, Inc., 592 F. Supp. 3d 970 (D. Colo. 2022). See, also, United States v. Patel, 2022 U.S. Dist. LEXIS 217330 (D. Conn. Dec. 2, 2022) (DOJ’s most recent attempt to enforce an alleged unlawful no-poach agreement criminally).
[10] See, Mem. Op., United States v. Penguin Random House, LLC, Civil Action No. 21-2886-FYP (D.D.C. Oct. 31, 2022) (where DOJ successfully sued to block Penguin Random House’s acquisition of Simon & Schuster, alleging that the combination would lower compensation for authors of anticipated top-selling books).
[11] See, e.g., Statement of Interest of the United States, Curtis Markson v. CRST International, Inc., No. 5:17-cv-01261 (C.D. Cal. July 15, 2022) (where DOJ argued that the transportation and logistics companies’ agreement not to hire each other’s workers should be considered per se illegal, regardless of any potential procompetitive justification).
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