The Federal Trade Commission’s (FTC) new proposed rule that would prohibit many employers nationwide—including trade and professional associations but not including charities and other nonprofits—from entering into any non-compete agreements with all workers (including independent contractors and not excluding senior executives) has gotten the attention of the association community. What the final rule will look like and whether it will be challenged in court and survive such challenges is unclear. Meanwhile, at the state level, approximately fifteen states and Washington, DC, have enacted laws that impose some form of limitation on the use of employee non-compete agreements. In DC, a new law took effect last October that significantly restricts employers’ use of non-compete agreements, but in a much-scaled-back version compared to the original law. On the other side of the country, California has for many years had the nation’s most sweeping statutory ban against employee non-compete agreements. Overlaid on top of all of this is every state’s and DC’s “common law,” which has always permitted but imposed limitations and conditions on employers’ use of non-compete agreements, with the limitations and conditions varying from state to state.
Common Law on Non-Compete Agreements
Common law in the United States treats non-compete agreements as generally enforceable, but subject to certain limitations and requirements. Non-compete agreements are generally defined as contractual agreements between employers and employees that restrict employees from competing with their former employers for a certain period of time and within a certain geographic area after the termination of employment.
As noted above, the enforceability of non-compete agreements varies by state, as they are governed by state law. Some states, such as California, have common law restrictions that limit the enforceability of non-compete agreements, while other states’ common law, such as Texas’, generally enforce them more liberally. And some states have statutory restrictions on non-compete agreements, which further limit their enforceability. The DC and California statutes are discussed below.
Under most states’ common law, for a non-compete agreement to be enforceable, it must generally meet the following requirements:
Consideration: Non-compete agreements must be supported by valid consideration, which means that the employee must receive something of value in exchange for agreeing to the restrictions. For example, the offer of initial employment, a promotion, or additional compensation may serve as valid consideration.
Reasonableness: Non-compete agreements must be reasonable in terms of their scope and duration. This means that the restrictions must be no broader than necessary to protect the legitimate business interests of the employer, such as protecting trade secrets, confidential information, and/or customer relationships. The duration (length of time) and scope (geographic, functionally, and otherwise) of the non-compete agreement also must be reasonable, and overly broad or overly long restrictions may be deemed unenforceable.
Public Policy: Non-compete agreements must not violate public policy. For example, non-compete agreements that unreasonably restrict an employee’s ability to seek new employment or that are against the public interest may be deemed unenforceable.
Notice: Non-compete agreements must be clear and conspicuous, and employees must be given reasonable notice of the restrictions before or at the time of entering into the agreement.
Overview of the FTC Proposed Rule
The FTC—which has jurisdiction over trade and professional associations (but not over non-association nonprofit organizations)—has proposed a Non-Compete Clause Rule that would prohibit employers nationwide from entering into non-compete agreements with all workers (including independent contractors and not excluding senior executives), on the basis that non-compete agreements constitute an unfair method of competition under Section 5 of the FTC Act. The FTC believes that non-compete agreements stifle competition, resulting in reduced wages and suppressed labor mobility.
The proposed rule would ban non-compete clauses categorically and is more restrictive than virtually all state non-compete laws, including Washington, DC’s (which exempts employees earning over $150,000 annually and which does not apply to independent contractors). Most states do not currently have a categorical ban on non-competes, and they typically differentiate amongst workers (such as by job function, earnings, etc.). The proposed rule would expressly preempt state law that is inconsistent with it.
The proposed rule defines “employer” as a person or entity that hires or contracts with a “worker” to work for the employer. “Worker” is defined as a natural person who works, whether paid or unpaid, for an employer. The term “worker” includes “an employee, [ ] independent contractor, extern, intern, volunteer, apprentice, or sole proprietor who provides a service to a client or customer.”
The proposed rule would apply to post-employment non-competition restrictions and would require employers to rescind existing non-compete agreements and provide notice to workers that they are no longer in effect.
The FTC defines a non-compete agreement 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.” As such, in most cases, if a non-compete provision exists merely in an association employee handbook, it likely would not rise to the level of a contract, but any (enforceable, i.e., with consideration) non-compete agreements entered into between employers and their workers prior to, during, and following employment would be covered by the proposed rule, including both employment agreements and severance/separation agreements.
The FTC clarified that whether a contractual provision will be considered a “non-compete” clause will depend not on what it is called, but how it functions. The FTC’s definition of a non-compete clause would generally not include other types of restrictive employment covenants—such as nondisclosure agreements and non-solicitation agreements—because these covenants generally (if they are appropriately tailored) do not prevent a worker from seeking or accepting employment after leaving the prior job. However, such covenants would be considered non-compete clauses where they are so unusually broad in scope that they function as such. The proposed rule makes clear that “a contractual term [ ] is a de facto non-compete clause [when] 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.” For example, a nondisclosure agreement between an employer and a worker that is written so broadly that it effectively precludes the worker from working in the same field after the conclusion of the worker’s employment with the employer could be considered a de facto non-compete clause.
The proposed rule exempts non-compete agreements that are entered into by a person who is selling a business or an ownership interest in a business, when the person restricted is a substantial owner or member of the business being sold.
The proposed rule was published in the Federal Register, and the FTC received scores of public comments on it before the comment period closed on March 20, 2023. Notably, FTC Commissioner Christine Wilson published a dissenting opinion that provides a roadmap for employers seeking to oppose the proposed rule.
Compliance with the final rule will be required as of 180 days after publication in the Federal Register. In addition, as of the compliance date, employers must rescind any existing non-compete clauses and provide notice to their workers that their non-compete clauses are no longer in effect.
Legal challenges to the final rule are to be expected, with the U.S. Chamber of Commerce and some Republicans in Congress already contending that the FTC does not have the authority to issue the rule.
While not related to the FTC’s proposed rule, at least two bills have been introduced in Congress to impose federal statutory limitations on employers’ use of non-compete agreements.