Federal Trade Commission Proposes Rule Banning All Non-Competes

February 9, 2023

Major change may be coming to companies who need to protect their trade secrets or good will from departing employees. On January 5, 2023, the Federal Trade Commission (FTC) announced its notice of a proposed rule that would prohibit businesses from using these covenants with their workers.  While some states like California have already banned such provisions, most allow them under certain circumstances.  The proposed federalization of the law in this area could mean substantial change for those businesses who seek to protect their intellectual property from walking out the door.

The covenant not to compete is one of many legal tools businesses may use to protect their intellectual property from the departing employee who may seek to compete unfairly against their former employer.  Other legal protections include the laws banning the theft of trade secrets, laws imposing a duty of loyalty on current employees, and laws imposing a fiduciary duty on some employees holding certain positions with their employers.  These laws governing employee behavior, along with the laws protecting copyrights, trademarks and patents, provide the essential tool kit for companies to protect their intellectual property from unfair competition.

The covenant not to compete differs from the other tools because it is solely a creature of contract.  While the other laws provide their protections as a general matter, a departing employee is presumed free to compete fully against their former employer without restriction.  This is because none of the other laws protect customer goodwill and relationships as an asset.  Unless the employer ensures that its employees execute a contract that expressly prevents the employee from taking the employer’s customer relationships and goodwill, those relationships, and the business stream associated with them, can too easily walk out the door with the departing employee.

Thus, the covenant not to compete has become an important device for companies to protect an asset that is otherwise unprotected under law.  Such covenants come in various forms.  Typically, the provision restricts a departing employee from engaging in competing activity for a period of time.  In most states, these provisions must be reasonable in time and geographic scope, and must be narrowly tailored to protect legitimate business interests, which have generally been defined as the company’s good will, customer relationships, and trade secrets.

The FTC’s proposed rule would, among other things, ban covenants not to compete in the employment context as an unlawful restraint of trade under federal anti-trust law.  Not only would the proposed rule ban use of these covenants, it would require employers to rescind existing non-compete agreements and inform individuals subject to such agreements that the restrictive covenants against competition are no longer in effect.  The proposed rule would cover both employees and independent contractors. They would be banned in all employment agreements and employee severance agreements.  The proposed rule would not prevent a person selling a business, or a franchisor and franchisee, from agreeing to or entering into an agreement with a non-compete.

While this may sound radical, the proposed ban would still allow for other contractual provisions that may be equally effective in protecting against unfair competition.  The proposed rule probably would not ban covenants not to solicit specific customers, or covenants not to solicit company employees.  The proposed rule would also allow confidentiality and non-disclosure agreements, which essentially serve as contractual agreements to comply with trade secret protections.  The FTC Fact Sheet specifically states that employers will continue to have other ways to trade secrets, confidential business information or valuable good will.  Thus, the proposed rule targets the most restrictive form of the covenant not to compete, specifically banning any “contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the workers’ employment with the employer.” The proposed rule labels such terms as “non-compete” provisions.

But companies should not rush to complacency by the apparent limited scope of the proposed ban.  Calling a term a “Non-Solicit” or “Non-Disclosure” provision will not save it if in all practicality it serves as a full on “non-compete” provision.  The proposed rule notes that the function of the provision, and not how it is labeled, will determine if the provision is subject to the ban.  Thus, if a provision that merely prohibits a worker for soliciting clients or employees has the effect of preventing a worker from seeking or accepting employment, it is possible that even those provisions could violate the proposed rule.

So, what does this mean for business who use non-competes?  Well, do not tear up your non-compete agreements just yet.  Many expect a robust legal challenge to the proposed rule on the basis that it goes beyond the FTC’s rule making authority.  While we wait to see what happens with any such challenge, businesses with an interest on the issue can submit comments, pro- or con- by March 10, 2023.  Comments can be submitted here online.

In the meantime, businesses must continue to comply with the limitations on non-compete clauses set by the states in which they do business. California has, for example, long ago banned such provisions but has been very willing to enforce non-disclosure provisions and trade secret laws.  New Hampshire, for example, prohibits the use of non-competes with low wage earners and requires employers to provide a copy of any noncompete agreement to any potential employee prior to the employee’s acceptance of an offer of employment.  In Massachusetts, noncompetition agreements must meet certain minimum, and specific statutory requirements in order to be valid.  Among other things, they must be in writing and signed by employee and employer. They must expressly state that the employee has the right to consult with counsel prior to signing. They must also be specifically supported by fair and reasonable consideration independent from the continuation of employment, and such consideration should amount to at least 50% of the employee’s base salary of the duration of the non-compete or something comparable.

These are just some of the various state requirements that must be followed and there are many others as the movement to regulate covenants not to compete has been developing across the country for years.  Businesses should be mindful of these rules, continue to monitor developments in the law, and seek legal counsel when necessary to understand and comply with limitations applicable to them and their workforce.