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FTC Proposes an End to Employee Non-Compete Agreements

In a dramatic departure from long-standing practice, the Federal Trade Commission hopes to put an end to the use of non-compete agreements by employers. A Proposed Rule published yesterday by the FTC would prohibit employers from entering into non-compete agreements or representing to workers that they are covered by non-compete agreements. Additionally, employers would be required to nullify existing non-competes and notify workers within 45 days of nullification that the restrictions will not be enforced.  The Proposed Rule – which would apply to both employees and independent contractors, whether paid or unpaid – is based on a preliminary finding by the FTC that non-compete agreements constitute an unfair method of competition and violate Section 5 of the Federal Trade Commission Act. Historically, the enforceability of such agreements was predicated on state law.

The Proposed Rule specifically states that 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 such a clause or represent to a worker that the worker is subject to such a clause if the employer has no good faith basis for such representation. The Proposed Rule does not nullify non-solicitation, non-disclosure and other confidentiality agreements, unless they are so broad that they effectively function as non-competes. In the Notice of Proposed Rulemaking, the FTC notes that the term “non-solicitation agreement,” for purposes of the Proposed Rule, is intended to refer to contractual provisions prohibiting workers from soliciting clients or customers of the employer, not agreements not to solicit employees. Non-solicitation agreements with respect to employees may therefore still be viewed as problematic and potentially subject to challenge.

The Notice of Proposed Rulemaking contemplates the possibility of applying different standards for senior executives or other highly compensated workers and the possibility of including restrictions on such agreements between franchisors and franchisees.  The Proposed Rule provides for an exception in the context of the sale of a business, but only if the restricted party is an owner, member or partner holding at least a 25% interest in the business entity.  It leaves open the possibility for enforcement action under federal antitrust laws with respect to such covenants, however.

Physician non-competes would likely be included unless subject to an exception.  In the Notice of Proposed Rulemaking, the FTC lists examples of non-compete clauses and includes a case involving a contractual term between a medical services firm and an ophthalmologist which provided that, for two years after employment termination, the physician was not allowed to engage in the practice of medicine in two Idaho counties unless the physician paid the firm a practice fee.  [Intermountain Eye & Laser Ctrs. P.L.L.C. v. Miller, 127 P.3d 121 (Idaho 2005)]

Detailing the estimated benefits of the Proposed Rule, the FTC includes a section on physicians, as one of four broad classes of workers meriting specific attention as a sector for which researchers have generated empirical estimates of the effects of non-compete clause enforceability.  One cited study indicated that for a physician with 10 years of experience in the state which enforces non-compete clauses most readily, a prohibition on non-compete clauses and removing such physician’s non-compete clause would lead to a 12.7% increase in earnings.  For a physician with just one year of experience, the study indicated that the increase in earnings would be 37.4%. 

The proposed Rule represents action on President Biden’s Executive Order issued on July 9, 2021, which encouraged the FTC to use its rulemaking power to curtail the use of non-compete agreements, which may unfairly limit worker mobility. The Proposed Rule also aligns with the FTC’s recent statement that it intends to reinvigorate Section 5 of the FTC Act.  It follows just one day after the FTC announced consent agreements resolving allegations that the application of non-compete provisions to hundreds of skilled glass workers and security guards constitute unfair competition under Section 5 of the FTC Act.

The FTC argues that non-compete clauses reduce competition in labor markets, suppressing employee earnings and benefits and reducing innovation and competition in product and service markets by decreasing the flow of information and knowledge among firms. If the Proposed Rule were enacted as written, many employers would no longer be able to rely on non-competes to deter workforce attrition.  In an already tight labor mark, competition between employers to attract and retain talent would rise and result in increased costs to businesses.  It may also make it easier for competitors to enter a market because they will be able to attract talent more easily, but they will face the same challenges with respect to retention of such talent.  The Proposed Rule represents a major departure from legal precedent that has often allowed such agreements, as long as not unreasonable in duration and scope, if there are appropriate business justifications. Only three states currently prohibit such restrictions entirely. In the M&A context, it would likely reduce transaction values if buyers are unable to ensure that key employees will remain after an acquisition.  There may also be reduced incentives for employers to invest in personnel development.

The public has been given 60 days (after the date of publication of the Notice of Proposed Rulemaking in the Federal Register) to provide comments to the Proposed Rule.  Challenges to the FTC’s authority to issue the Rule seem inevitable.  The FTC has stated that Sections 6(g) and 18 of the FTC Act enable it to make rules to carry out the FTC Act’s provisions and that the FTC has the explicit authority to prescribe rules with respect to unfair methods of competition in or affecting commerce. In July 2021, the FTC streamlined its Section 18 process rules in a way that allows it to reduce delays, stripping away steps such as the need for a written staff report.  As noted in the Dissenting Statement of Commissioner Christine S. Wilson, however, the Notice of Proposed Rulemaking is vulnerable to challenges that the FTC lacks authority to engage in substantive rulemaking with respect to competition.  In addition, citing West Virginia vs. EPA, if the Proposed Rule presents a major question (which would include the power to resolve a matter of great political significance, regulate a significant portion of the American economy or intrude in an area that is the particular domain of state law), the FTC would be required to identify clear Congressional authorization to impose a regulation banning non-compete clauses.  The final rule will almost certainly be subject to significant legal hurdles.

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Beth Vessel
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