On January 5, 2023, the US Federal Trade Commission unveiled a proposed regulation that would effectively prohibit the enforcement of noncompetition agreements, with the exception of noncompetes in the context of franchise agreements and sale-of-business agreement. This regulation is not yet final and will likely be subject to court challenges. Nevertheless, this regulation has the potential to significantly disrupt settled expectations by many employers regarding their ability to prevent key employees from leaving employment and immediately competing against their former employer.

Background

In the employment context, a noncompetition covenant is essentially an agreement by a worker not to engage in competition with the employer for a period of time after the worker’s employment ends. Historically, the enforcement of noncompetition agreements has been a subject of state law, and there has been wide variation in how states view such agreements. In a few states, such as California and Oklahoma, noncompetes are entirely (or nearly-entirely) prohibited in the employment context. In other states, such as Florida and Georgia, noncompete covenants are more readily enforceable as long as they contain some reasonable limits on their scope and time. Most states fall somewhere in the middle, with courts applying varying levels of scrutiny but generally allowing enforcement of narrow, “reasonable” covenants. 

Because noncompetition covenants are essentially restraints on trade, they have long sat in an uneasy co-existence with antitrust law, although noncompetes have generally been viewed as not constituting an antitrust violation as long as the covenant is narrow and reasonably supported by pro-competitive justifications, such as protection of trade secrets or customer goodwill. In recent years, the US Department of Justice has pursued antitrust claims against companies that entered into “no poach” agreements, under which the companies agree not to hire away each other’s employees, but the DOJ and the Federal Trade Commission (both of which have a hand in antitrust enforcement) had not directly attempted to bring antitrust law into the realm of noncompete agreements between employers and employees. Under the Biden administration, however, the FTC has taken a more aggressive position on a number of antitrust topics, and the new proposed noncompete regulation reflects an effort to use antitrust law to impose a sweeping prohibition on noncompete agreements in most contexts.

The Proposed Regulation

The FTC has proposed adding a new section to its regulations that would essentially prohibit a broad swath of noncompete provisions in the US. Specifically, the FTC regulation would declare it to be an “unfair method of competition for an employer to enter into or attempt to enter into a non-compete clause with a worker; maintain with a worker a non-compete clause; or represent to a worker that the worker is subject to a non-compete clause where the employer has no good faith basis to believe that the worker is subject to an enforceable non-compete clause.” (Section 910.2(a) of the proposed regulations.) Moreover, any employer that has previously entered into a noncompete agreement with a worker must, within 180 days after the regulation is finalized, affirmatively notify each such worker that the noncompete is rescinded and no longer enforceable.

The proposed regulation defines a “noncompete agreement” broadly, as “a 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 worker’s employment with the employer.” The regulations then go further and establish a “functional test” for what can constitute a “de facto noncompete agreement” even if not expressly framed as a noncompete; the examples given in the regulations are (a) a nondisclosure agreement written so broadly as to effectively prevent the employee from engaging in competition, and (b) an agreement to repay training costs, if the required payment is not reasonably related to the actual costs incurred by the company for training the worker.

Under the FTC’s definitions, the definition of “worker” is also quite broad, encompassing not only employees but also independent contractors, volunteers and interns. There is an express exception for noncompetes entered into in the context of the sale of a business by a substantial owner (at least 25%) of the business being sold. And it appears that noncompetition covenants in the context of franchise agreements will also be outside the scope of the new regulations.

Procedural Path and Likely Challenges

The proposed regulation is open for public comment for a period of 60 days. After that time, the FTC will consider the comments and may make changes before publishing a final regulation.

Assuming the final regulation is similar to the proposed regulation, there is widespread speculation that a strong court challenge could be mounted against the regulation, on the theory that the FTC has exceeded its regulatory authority in enacting such a sweeping regulation without express and clear Congressional authorization to do so.

What Should Employers Do Now?

Until the regulation is finalized, there is no immediate action that employers must take. Nevertheless, it will be important to keep an eye on developments in this area, as employers may soon have an affirmative duty to notify employees of the rescission of existing agreements, and to alter existing habits of requiring employees to enter into noncompete agreements.

The Employment & Labor team of Dentons stands ready to assist you with questions about these and other developments.