FTC Proposes Rules Which Would Limit Noncompetes

In response to President Biden’s July 2021 Executive Order on Promoting Competition in the American Economy, on January 5, 2023, the Federal Trade Commission (FTC) promulgated a proposed rule which generally bans all non-competition clauses with workers (including employees and independent contractors) as unfair methods of competition, subject to a limited sale of business exception. The proposed rule would have a broad application, generally prohibiting employers from entering into any new noncompetes and requiring the recission of all existing noncompetes. This Advisory summarizes the key takeaways from the proposed rule.

General Rule as Proposed

The proposed rule would generally prohibit employers from (i) entering into or attempting to enter into a noncompete clause, (ii) maintaining any pre-existing noncompete clause, or (iii) representing to a worker that the worker is subject to a noncompete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable noncompete clause.

The term “noncompete clause” refers to any contractual term between an employer and a worker that prevents the worker from seeking or accepting employment or operating a business post-termination. Although the proposed rule refers only to noncompete clauses (and not to non-solicitation or other restrictive covenant clauses), in practice, the proposed rule would apply more broadly due to the rule’s “functional test” that treats some restrictions as “de-facto” noncompete clauses. One example of a “de-facto” noncompete is a non-disclosure agreement written so broadly that it effectively precludes the worker from working in the same field post-employment.

The proposed rule would preempt state law, but only to the extent that state law is less restrictive than the proposed rules.

Sale-Based Noncompete Exception

The only exception allowed by the proposed rule is for certain sale-based noncompete clauses. This narrow exception would permit the enforceability of noncompetes entered into by a person selling a business entity or otherwise disposing of all or substantially all of a business entity’s operating assets, but only if the person subject to the noncompete clause is a substantial (defined as 25 percent or more) owner, member, or partner in the business at the time the person enters into the noncompete clause. We note that the 25 percent substantial ownership threshold is significantly higher than is typically applied under many state laws and would effectively prohibit obtaining noncompete agreements from management teams of most private equity and venture portfolio companies.

Rescission Requirement for Existing Agreements

In addition to prohibiting employers from entering into new noncompete clauses, the proposed rule also requires employers to rescind all noncompliant existing noncompete clauses. An employer would have 180 days following the publication of the final rule to rescind such noncompete clauses and 45 days following the rescission of the noncompete to provide notice to the affected workers through an individualized communication. The proposed rules provide model language that may be used in the worker notices.

Request for Comment

The proposed rule is broad and sweeping as drafted, and the FTC has requested comments. One specific issue which the FTC requested comment on is whether to implement different rules for certain categories of employees, such as high-wage or highly-skilled workers or senior executives. Comments on the proposed rule must be received within 60 days following publication in the Federal Register. If the final rule is similarly as broad as the proposed rule, legal challenges are likely, which may delay the rule taking effect and therefore we do not anticipate employers need to make changes to their existing restrictive covenant arrangements at this time but should monitor the development of this rule.

© Arnold & Porter Kaye Scholer LLP 2023 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.