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Client Alert: FTC Proposes Rule That Would Ban Non-Compete Agreements

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In an aggressive exercise of its authority to prohibit “unfair methods of competition,” on January 5, 2023, the Federal Trade Commission, following up on earlier actions by U.S. President Joseph Biden, announced a proposed regulation (the “Proposed Rule”) which would both prohibit the use of post-employment non-competition covenants with employees and independent contractors and require employers to rescind existing post-employment non-competition covenants.

The Proposed Rule comes on the heels of increasing efforts at the state level to restrict the use of non-competition and non-solicitation covenants, as well as increasing federal attention to restraints on worker mobility.

What Would the Proposed Rule Require?

Ban on Non-competition Clauses

Under the Proposed Rule, entering into, or even attempting to enter into a post-employment non-competition covenant with any “worker” (ostensibly including both employees and independent contractors, as well as volunteers, interns, and anyone else who provides services to the employer—at all levels, including executives) would be deemed an “unfair method of competition” under Section 5 of the FTC Act and would subject the employer to potential civil claims and penalties.

No Grandfathering, and Rescission, of Existing Non-competes

In addition, the Proposed Rule would require employers to “rescind” any existing post-employment non-competition covenants by providing “individualized notice” to all current employees subject to such covenants, and all former employees “provided that the employer has the worker’s contact information readily available.”

Importantly, although the Proposed Rule does not outright prohibit other restrictions such as confidentiality, non-disclosure, or non-solicitation covenants, it does contemplate that such provisions will violate the Proposed Rule if they “ha[ve] the effect of 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 does include a limited exception for post-employment non-competition clauses entered into in connection with the sale of a business or substantially all of a business’s assets.

Open Questions and Implications

The Proposed Rule leaves open a number of important questions, particularly regarding the circumstances in which a restrictive covenant such as a confidentiality, non-disclosure, or non-solicitation covenant will be deemed prohibited. As drafted, the Proposed Rule is unclear as to how restrictive a covenant may be until it “prohibits” the worker from seeking or accepting employment. Without a clearer definition of the scope of the regulation, its effects could be far more sweeping than anticipated.

It is unknown how the Proposed Rule will impact existing agreements where the non-competition provisions are included among a recitation of various rights and obligations between an employee and an employer, such as in the context of executive employment agreements or change in control agreements. In many cases, the perceived value to the employer of non-compete provisions agreed to by the employee are a substantial portion of the consideration provided in exchange for the cash severance protections and other separation-related benefits agreed to by the employer. Employers will need to consider how to approach such agreements should the Proposed Rule be finalized as is.

In the context of corporate transactions, non-compete provisions are often considered in determining whether payments made in connection with the consummation of such transactions are deemed to be excess parachute payments. If the Proposed Rules are finalized in their current form, employers and employees will need to reevaluate any tax positions taken with respect to the golden parachute rules included in Code Section 280G.

The exception relating to the sale of businesses likewise leaves open important questions. As written, the Proposed Rule would permit non-competition covenants with “substantial” owners, members, or partners of the business being sold. But in a world where businesses are often owned through intermediary entities, it is not clear whether such covenants could be applied against the real individuals atop the ownership structure. Where the need for a non-competition covenant is a pressing business matter, this could significantly affect the structure of the underlying transactions.

What to Expect During the Public Comment Period

As soon as the Proposed Rule is published in the Federal Register, which will likely happen as soon as this week, a 60-day period will open during which the public can submit comments. The FTC will then have to take some period of time to consider those comments before either revising the Proposed Rule or issuing it as a final rule. The rule would become effective 180 days after publication of the final version.

It is likely the Proposed Rules will receive significant attention from the private sector. Whenever a final rule is issuedeither in its current form or as revisedlitigation is almost certain to quickly follow. The U.S. Chamber of Commerce, the private business organization, issued a press release within hours of the FTC’s announcement calling the Proposed Rule “blatantly unlawful.”

What Should Employers Do in the Meantime?

Employers should begin to prepare themselves for the possibility that the Proposed Rule, or something quite like it, will eventually come into force. While existing practices need not change yet, the fact that the Proposed Rule would retroactively invalidate existing non-competition covenants is reason enough for employers to consider evaluating their existing agreements to ensure that they will remain adequately protected even if the non-competition covenants are lost. That will also help ensure that, if the Rule does come into force, the employers will not be left scrambling to revise their agreements at the last minute.

In addition, in light of the Proposed Rule’s recission and notification requirements, employers should go through their employment and service contracts to identify which agreements would be affected and which individuals will need to be notified. This could be a substantial undertaking if the records are difficult to find or if the employer has a sufficiently large workforce. As part of this review, employers should note which agreements can be modified or cancelled without unintentionally triggering benefits.

When considering new agreements prior to the Proposed Rules being finalized, employers should carefully consider what restrictive covenants are permitted now compared to what might be permitted post effectiveness of the Proposed Rules. Employers may want to consider including provisions that would invalidate or otherwise reduce severance benefits should the Proposed Rules be finalized in their current form.

In the context of corporate transactions, employers and employees may want to consider whether planning opportunities other than assigning value to a non-compete are available to mitigate any potential “golden parachute” issues under Code Section 280G.

Importantly, while the threat of litigation may stave off the Proposed Rule’s effective date for some time, employers should not take too much comfort from that fact. Once the Proposed Rule becomes final, a court injunction might delay its enforcement, but if the Proposed Rule is later upheld, the FTC and aggrieved workers may still be able to make claims based on violations occurring while the injunction was in force.

Employers should also consider whether to submit comments on the Proposed Rule once it is published in the Federal Register during the 60-day comment period. Once the comment period opens, comments may be submitted at www.regulations.gov.

We Can Help

Barack Ferrazzano’s Compensation & Employment and Antitrust & Commercial Competition Groups have decades of experience in counseling companies and litigating disputes about restrictive covenants and employee competition matters, as well as helping companies smartly navigate compliance issues pertaining to restrictive covenants. Please contact us if you would like to discuss specific questions about your restrictive covenants or review of your agreements and practices or for assistance with participating in the public comment process.

About the Authors

Allison N. Powers, a partner in the Compensation & Employment and Litigation groups, is a versatile employment litigator, trial attorney, and strategic partner with deep experience handling high-profile and “bet-the-company” matters for diverse clients across the country. Allison’s employment litigation practice emphasizes defense of claims of discrimination and harassment in private lawsuits, as well as government agency actions under federal and state anti-discrimination statutes.

Owen H. Smith currently serves as co-chair of the firm’s Antitrust & Commercial Competition Group. He counsels and litigates on behalf of companies in various industries and sectors—banking, automotive, luxury goods, and manufacturing, among others—in a wide range of antitrust and competition matters arising under the federal Sherman, Clayton, and Robinson-Patman Acts, as well as state antitrust and unfair competition laws.

Corwin J. Carr is a senior associate in the firm’s Compensation & Employment Group. Corwin has extensive experience conducting internal investigations and representing companies in labor and employment disputes before administrative agencies and in federal court. Corwin secured a jury and bench verdict in favor of a major US city in a federal court case alleging race and political affiliation discrimination. In addition to trial work, Corwin has represented companies and institutions in arbitration and mediation.

As an associate in the firm's Litigation group, Audrey Springer-Wilson concentrates her practice on a wide range of complex litigation matters. Prior to joining BFKN, Audrey clerked for the Honorable Steven M. Colloton on the U.S. Court of Appeals for the Eighth Circuit. During law school, Audrey gained valuable litigation experience in the Michigan Law School Veterans Legal Clinic, where she litigated on behalf of indigent veterans in Michigan. 

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