FTC’s new rule banning non-competes: Comment period extended until April 19

On Jan. 5, 2023, the Federal Trade Commission issued a Notice of Proposed Rulemaking essentially banning non-compete clauses and categorizing them as unfair methods of competition. Such clauses serve to protect a business’s trade secrets, confidential information and customer relationships, which makes the adoption of such a rule concerning for employers. The comment period for this proposed rule has now been extended to April 19, so businesses still have time to voice their concerns directly to the FTC. This article summarizes some of the ways that the proposed rule, if enacted, could affect businesses.

Ability to contract and negotiate

The proposed rule would take away the ability of employees and employers to bargain for restrictive covenants. Currently, only California, North Dakota, Oklahoma and Washington, DC, ban such agreements, although nine other states prohibit them for individuals who do not meet a certain wage threshold. Both employers and employees currently benefit from such bargaining, as employers are able to insulate themselves from the actions of former employees for whom they have, in turn, provided consideration in the form of continued employment, access to confidential and proprietary information, goodwill and specialized training. The proposed rule would strip away this right from both sides.

Under the current language of the proposed rule, the ban on non-compete agreements applies retroactively, meaning that employers will have to discard prior agreements and provide individualized notice to current, as well as former, employees that the agreement is no longer valid. Employers will then have to navigate how to account for the consideration previously provided or promised.

Related: Business groups say FTC’s noncompete ban is too broad

Employers will inevitably have to address payments that may have already been promised but not yet provided. This could also be a concern for employees who may be due stock options or cash payments at the time of termination or former employees who have yet to receive promised awards or payments.

Most forms of consideration given to employees, including specialized training and access to confidential information and customers, cannot be undone. This leaves employers at a clear disadvantage. These employers will find themselves vulnerable to competition from former employees. They may also see increased poaching of key employees in an already competitive hiring environment.

There may be some unexpected consequences to employees as well. While they may find themselves free to switch jobs and obtain higher wages, employers may become reluctant to hire or train new workers, share confidential and trade secret information or provide access to key customers.

Buying and selling businesses

One exception to the proposed rule is for buyers and sellers of a business, where only a “substantial” owner of a business will be able to enter into a non-compete agreement. “Substantial owner” is defined as an owner, member or partner holding at least a 25% ownership interest in the business entity. Consequently, those who hold less interest, presumably a greater number of key employees, would be prohibited from entering into a non-compete agreement with a prospective buyer.

This would have a cooling effect on such transactions, because prospective buyers may be less willing to purchase a target entity where key personnel could essentially leave and open up a competing business the next day. And a kicker is that individuals who loved the idea of being a small percentage owner of a company in return for agreeing to certain restrictions may never get that opportunity without the protections currently in place in most states around the country.

Alternatives to the proposed rule

The FTC is currently seeking comments from the public regarding potential alternatives to the proposed rule, such as (1) whether the ban should be a rebuttable presumption, rather than a categorical ban; and (2) whether the rule should apply to all workers or there should be exemptions or different standards for some workers.

Under the first alternative, non-compete agreements would be presumptively unlawful. However, such agreements would be permissible if the employer were to meet a certain evidentiary standard. Employers in that case may have to show that the non-compete agreement would not harm consumers or may have to identify some competitive benefit that offsets the apparent or anticipated harm. This sounds like a reasonableness standard all over. Under the second alternative, there would be a more lenient standard or an exemption for those employees whose earnings are above a certain threshold or who meet an existing exemption under the Fair Labor Standards Act. Additional variations could depend on a mix of a worker’s job functions, pay grade, and field of occupation.

In short, the proposed rule would strip away the rights of both sides to bargain freely, change the contractual dynamic between employees and employers and make employers less able to block the actions of their current and former employees.

Nick Spiliotis is a partner in the Labor & Employment Practice Group at Jones Walker LLP in Houston. Tom Hubert is a New Orleans-based partner in the Labor & Employment Practice Group and a lead trial attorney for the trade secret, unfair competition, and non-compete team at Jones Walker LLP.