Pittsburgh, PA
ACBA Young Lawyers’ Division newsletter Point of Law
(By Alexandra Farone)
On January 5, 2023, the Federal Trade Commission (FTC) proposed a national ban on noncompetition agreements. Noncompetition agreements, or “non-competes,” are contractual terms between employers and workers that prohibit the worker from working for a competing employer or starting a competing business, typically within a certain geographic area for a certain period of time. If a worker violates a non-compete clause, the employer can sue the worker for breach of contract and may be able to obtain a preliminary injunction enjoining the worker to stop the conduct that purportedly violates the non-compete clause. If successful in litigation, the employer may be able to obtain a permanent injunction and/or the payment of monetary damages. If the FTC’s proposed ban becomes final, this is all about to change.
As a basis for the proposed rule, the FTC made a preliminary finding that non-competes constitute an unfair method of competition in violation of Section 5 of the Federal Trade Commission Act (the “Act”). Section 5 of the Act provides that “unfair methods of competition in or affecting commerce” are unlawful, and that the FTC is “empowered and directed” to prevent businesses from using unfair methods of competition.
Under the proposed rule, employers could not ask new employees, independent contractors, or even unpaid volunteers to sign non-competes. All existing non-competes would have to be rescinded, and employers would have to inform current and former workers on an individual basis that their noncompete is no longer in effect within 45 days of the rescission. The proposed rule would also prohibit employers from attempting to enter non-competes, or representing to a worker under certain circumstances that the worker is subject to an enforceable noncompete.
The proposed rule is focused on non-competes, but other restrictive covenants could become subject to the rule if they are so broad that they effectively function as non-competes. For example, the FTC states that a contractual term that requires the worker to pay the employer or a third party for training costs if the worker’s employment terminates within a certain time period, where the payment is not reasonably related to the actual costs incurred for training, may be deemed a prohibited de facto non-compete clause. It is unclear whether non-solicitation agreements (agreements in which a worker agrees not to solicit the employer’s other employees or clients to end their relationship with that employer) would be barred by this proposed rule, as many non-solicitation agreements are drafted broadly to have the near-effect of a non-compete. Many commentators believe that the FTC will revise the proposed rule after the comment period to provide more clarity regarding non-solicitation agreements.
There is also a proposed exception where the ban will not apply to non-compete clauses entered into by someone (1) selling a business entity, (2) disposing all of the person’s ownership interest in the entity, or (3) selling substantially all of a business entity’s operating assets, when the person is a substantial owner, member, or partner in the business entity at the time the person enters into the non-compete. A “substantial” owner, member, or partner is one who holds at least a 25% ownership interest in a business entity. Additionally, entities that are exempted from coverage under the Act – certain banks, savings and loan entities, federal credit unions, common carriers, air carriers, persons subject to the Packers and Stockyards Act of 1921, and entities not organized to carry on business for its own profit or that of its members – may not be subject to the rule.
The FTC voted 3-to-1 to publish the Notice of Proposed Rulemaking (NPRM). The public has 60 days to comment on the proposed rule. In the NPRM, the FTC also describes and seeks comment on several topics related to the proposed rule, including whether non-competes with senior executives should be subject to a different standard than non-competes with other workers, whether low- and high-wage workers should be treated differently, whether franchisees should be covered by the rule, and whether “no-poach” agreements and wage-fixing agreements should be barred. After the comment period closes on March 10, 2023, the rule will either take effect or be struck down.
Compliance would be mandated 180 days after the adoption of the rule. If adopted, it is generally expected that there will be multiple challenges to the FTC’s authority to issue this non-compete ban, which may result in a stay in enforcement of the ban until any litigation is resolved.
This proposed rule has been expected for some time. More than one year ago, on July 9, 2021, President Joe Biden signed Executive Order 14036 encouraging the FTC to limit or ban noncompetition agreements. The FTC estimates that 18% of U.S. workers are currently covered by non-competes. The FTC further predicts that this ban may result in up to $300 billion in additional earned wages, save consumers up to $148 billion on health costs annually, and double the number of companies in the same industry founded by a former worker.
There is a reasonable likelihood that legal challenges to this ban would be successful. In West Virginia v. EPA, No. 20-1530, — U.S. — (June 30, 2022), the Court recently demonstrated skepticism of sweeping rule-making from regulatory agencies, due to potential violation of the separation of powers doctrine. The Court adopted the major questions doctrine, which holds that in extraordinary cases of political and economic significance, where an agency makes “unheralded” use of its authority, the agency must be able to identify a clear statement from Congress authorizing that particular action. Given the broad scope, it is very likely that a national non-compete ban would be considered an extraordinary case of political and economic significance, and would have to clear the major questions doctrine hurdle to survive.
Employers who use non-competes should consider submitting comments to the FTC on the proposed ban and should begin thinking strategically about implementing non-disclosures and confidentiality agreements in lieu of non-compete agreements should the ban become law.
Alexandra Farone is an employment and litigation associate at Babst, Calland, Clements and Zomnir P.C. and can be contacted at afarone@babstcalland.com.
To view the Point of Law Winter 2023 edition, click here.
Reprinted with permission from the Point of Law Winter 2023 edition by the Allegheny County Bar Association.