FTC Proposes New Rule That Would Ban Non-Compete Agreements

On January 5, 2023, the Federal Trade Commission (“FTC”) issued a Notice of Proposed Rulemaking (NPRM), proposing a rule that would largely ban the use of non‑compete agreements between workers and employers.

Key Provisions with Far-Reaching Applicability

The proposed rule would categorize virtually all non‑compete agreements as “unfair methods of competition” prohibited by Section 5 of the FTC Act. It defines a non‑compete agreement to mean “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.” Notably, the proposed rule would apply to all “workers,” paid or not. The term worker would include employees, independent contractors, externs, interns, volunteers, apprentices, or sole proprietor service providers.

In addition, the proposed rule has several significant provisions:

• Bans both explicit and de facto non‑compete clauses. Examples of the latter include broad non‑disclosure agreements that effectively preclude a worker from working in the same field and contractual terms requiring a worker to repay for training if the worker’s employment terminates within a specific time period.
• Includes an exception allowing the use of non‑compete agreements in connection with the sale of a business.
• Preempts all inconsistent state laws and regulations. However, state laws are not deemed inconsistent if they offer greater protections to workers.
• Requires companies to give notice to existing or former employees regarding the unenforceability of existing non‑compete clauses and agreements.

Shifting Enforcement Priorities

The NPRM is the latest and most significant shake up in the federal government’s approach to labor agreements and practices. President Biden initially called on the FTC to use its rulemaking authority to target non‑compete agreements in a July 2021 Executive Order. Several months later in a speech at a White House Roundtable, FTC Chair Lina Khan criticized non‑compete agreements for “block[ing] workers from working for certain other corporations or starting their own businesses” and “reduc[ing] worker wages and benefits and keep[ing] workers trapped.” In November 2022, moreover, the FTC released an updated statement on its Section 5 authority that takes an expansive view of conduct that may constitute “unfair practices” and therefore fall within the FTC’s jurisdiction. 

For example, Section 5 violations may include incipient violations of the antitrust laws (conduct not causing past or present anticompetitive harm but likely to cause harm in the future) and conduct that violates the spirit of the antitrust laws even if not specifically prohibited by the Sherman or Clayton Acts. According to the FTC, non‑compete agreements could fall within both of these examples.

Just a few days into 2023, the FTC has followed through on the Executive Order’s stated intent to crack down on non‑compete clauses. First, on January 4, 2023, the agency issued consent orders in cases enjoining three companies’ usage of non‑competes.¹ Then, it issued the NPRM the following day.

These actions reflect the FTC’s shifting priorities under its new leadership in the Biden administration and may also signal an increased readiness to flex its rulemaking authority. Until recently, the FTC rarely invoked its rulemaking authority, and its past efforts to do so were met with limited success.

Support for the NPRM was not unanimous. FTC Commissioner Christine Wilson issued a blistering dissenting statement, describing the rule as “a radical departure from hundreds of years of legal precedent that employs a fact-specific inquiry into whether a non‑compete clause is unreasonable in duration and scope, given the business justification for the restriction.”² Commissioner Wilson further raised skepticism with the FTC’s authority to engage in rulemaking related to unfair methods of competition and questioned whether the substantial staff resources that will be needed to defend challenges to the rulemaking are the best use of the FTC’s limited resources.

Next Steps

The NPRM is not law, nor does it have the force of law—at least not yet. The FTC has invited public comments on the proposed rule. The agency has specifically requested comments on: whether the rule should: (i) apply to franchisees; (ii) exempt senior executives or apply a rebuttable presumption rather than a ban; and (iii) treat low- and high-wage workers differently. The public will have through March 10, 2023 to submit comments, after which the FTC will review comments and issue a final rule.

We expect substantial pushback, both during and after the rulemaking process. For example, critics are likely to point out the potential procompetitive benefits of non‑compete agreements and the varied impact of these agreements in different industries and among different categories of workers.

In addition, as Commissioner Wilson noted in her dissenting statement, the rule, if adopted, may lead to protracted litigation that could undermine the FTC’s competition rulemaking authority in the future. She noted three likely avenues for legal challenges to the FTC’s rulemaking authority:

• Whether the FTC Act authorizes the Commission to engage in substantive competition rulemaking. And if it does, whether the proposed rule is a proper exercise of that authority.
• The major questions doctrine, recently applied by the Supreme Court in West Virginia v. EPA. Under this doctrine, courts would assess whether the NPRM constitutes a “major question,” and then inquire whether Congress in fact intended to authorize the FTC to address it by regulation.
• The non‑delegation doctrine, based on the principle that Congress cannot delegate its legislative power to the FTC. Indeed, the last Congress considered, but did not pass, the proposed Workforce Mobility Act of 2021 that would have prohibited the use of non‑compete clauses except in the sale of business or partnership context.

The FTC may choose to withdraw or modify the proposed rule in response to public comments and the specter of litigation. Even if the FTC ultimately does not issue a rule banning non‑competes as currently drafted, or if a final rule’s implementation is stayed pending legal challenges, the FTC’s recent complaints indicate a commitment to challenging such agreements under Section 5. We expect that the FTC will continue to do so, rule or not.

Preparing for the Increased Risk of Enforcing Non‑Compete Agreements

With very limited exceptions, no industry is immune from the FTC’s non‑compete enforcement objectives. In addition to the risk of lengthy and costly FTC investigations into alleged unfair methods of competition,³ companies may face the risk of follow‑on litigation brought by private parties or states’ attorneys general, which could lead to monetary damages. This risk is particularly pronounced in states with statutes that mirror Section 5 of the FTC Act and its prohibition on unfair or deceptive practices.

Companies should consider taking immediate steps to reduce the risk of antitrust liability related to non‑competes.

• First, companies should revisit any non‑compete policies and review employment agreements to determine if any contractual clauses might be construed as de facto non‑compete clauses.
• Second, companies should consult experienced antitrust and labor and employment counsel for guidance on how to modify existing policies to avoid potential Section 5 liability.
• Finally, companies should consider submitting public comments, registering their agreement or disagreement with the proposed rule, as well as suggesting modifications. These public comments can also address areas that the FTC has expressly sought comments on, including whether non‑compete clauses are unfair methods of competition and whether employers have alternative methods for protecting trade secrets and investments in employee training. In addition, comments may address potential alternative rules proposed in the NPRM, as the public may not have another opportunity to comment on those alternatives.

O’Melveny & Myers is ready to provide clients with assistance in any of these areas. Please reach out to any of the contacts included here or a member of the Antitrust & Competition or Labor & Employment groups.

¹ The FTC filed complaints against the three companies, and in one case the individual owners, relying on the agency’s stand-alone Section 5 authority to prevent unfair methods of competition. The consent orders resolving the FTC’s concerns bar the companies, and these individuals, from enforcing or attempting to enforce any non‑compete agreements that prevent employees from seeking or accepting work with another employer or operating a competing business after they leave the companies.

² Nor was support for the three cases unanimous. Commissioner Wilson issued two dissenting statements for these complaints and their corresponding consent orders, stating that the complaints were lacking factual support for the FTC’s allegations and did not show any evidence of anticompetitive effects from the challenged conduct.

³ The FTC is generally unable to seek disgorgement or impose monetary fines upon companies found to have violated the FTC Act, except in special cases, such as violations of a final cease‑and‑desist order.