3 Things Every Business Owner Should Know about the FTC’s Proposed Non-Compete Rule

If you’re like most business owners, you’ve spent a lot of time thinking about how to set your business apart from the competition. You’ve created a unique, recognizable brand. You offer a specialized suite of services. And, most importantly, you maintain a distinctive culture that draws and motivates the right kind of people to join you on your mission.

Perhaps, as a final protection, you’ve even elected to include a non-compete clause in your standard hiring paperwork. Due to a proposed rule by the Federal Trade Commission (FTC), that clause may not be enforceable for long.

Here are 3 things that every business owner should know about the FTC’s proposed non-compete rule: 

• It also affects “de facto” non-compete agreements.
• There are notable exceptions. 
• The rule is not yet finalized. 

Overview of Proposed Rule

Before diving further into each of these points, let’s review what the FTC has proposed. 

On January 5, 2023, the FTC published a new proposed rule. This rule, if upheld, would effectively prohibit the creation of new non-compete clauses. It would also deem existing non-compete clauses as illegal. The FTC estimates that 18% of U.S. workers (roughly 30 million people) are under a non-compete (source). As a result, it posits that these agreements “hurt workers and harm competition.” The FTC believes the new rule will address this concern and increase American workers’ earnings between $250-$296 billion per year. To enable this considerable impact, the proposed rule states that it would supersede state laws. Note: any state law providing enhanced worker protection would still be enforceable.

The proposal defines a non-compete 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.” It defines a worker as “a natural person who works, whether paid or unpaid, for an employer,” and covers a variety of classifications, such as independent contractors, interns, volunteers, and more (source). 

Now that we’ve reviewed the basics, here are 3 more things you should know about the FTC’s proposed rule. 

1. It Also Affects “De Facto” Non-compete Agreements

The impact of the proposed rule would not be limited to language explicitly defined as a non-compete clause. It would also extend to affect language that passes a “functional test for whether or a contractual term is a non-compete clause. The term non-compete clause includes a contractual term that is a de facto non-compete clause because it has the effect of prohibiting 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.”

These de facto non-competes may include non-disclosure agreements that effectively prevent a worker from working in the same area following employment. They could also include contractual agreements stipulating that the worker must repay the employer for training costs not reasonably related to the costs actually incurred in the event of employee termination within a specific period. 

2. There are Notable Exceptions

The proposed rule changes would indeed have far reaching effects. However, there are a few specific situations where non-competes would still be appropriate. These exceptions include non-competes created in relation to the sale of a business or a joint venture, as well as in connection to a substantial owner, member, or partner (holding at least 25% interest in the entity). Additionally, restrictive covenants that do not function as de facto non-competes (see above) would still be enforceable. These include, but are not limited to: non-disclosure agreements, client non-solicitation agreements, no-recruit agreements, and no-business agreements. 

3. The Rule is Not Yet Finalized

While this rule could have significant impact if approved, it’s critical to remember that it has not yet become effective. The proposal is open to comment from the public until March 10, 2023 (60 days after publishing). After the comment period closes,“ the FTC will review the comments and may make changes, in a final rule, based on the comments and on the FTC’s further analysis of this issue.” (source). If the rule becomes law, employers must comply within 180 days of publication. 

Some policymakers have raised questions about whether the proposed rule is within the authority of the FTC to enforce. These questions generally center around the “major questions” doctrine. The doctrine states that democratic process should drive significant or complex policy decisions. If the proposed policy changes are determined to be a major policy issue, it is possible that the rule could face extra hurdles before finalization. 

Final Considerations

Regardless of how exactly the proposed FTC non-compete rules materialize, one thing has become clear. Policy surrounding non-competes is being heavily scrutinized. Business owners would be prudent to engage legal counsel to perform a full review of their hiring policies and to ensure prompt response if new rules are unveiled.