The Federal Trade Commission (FTC) recently released a proposed rule which, if adopted, will broadly ban the use of non-compete agreements with workers throughout the U.S.
The proposed rule focuses on “non-compete clauses” and would prohibit their use with workers. If adopted in its current form, the proposed rule would become effective sixty days after becoming final and employers would have 180 days after that to cease using noncompete clauses and notify their workers that existing noncompete clauses are rescinded.
The proposed rule is breathtakingly broad. It will apply to agreements with “workers,” which include any individual who works for an employer, whether as an employee, independent contractor, or volunteer. It will permit restrictions on competitive activities during employment, which has long been recognized as legitimate and legal. However, the proposed rule will prohibit any “non-compete clause” that prevents a worker from seeking or accepting employment elsewhere, or operating a business, after their employment ends.
The FTC explains that this is a “functional” approach to defining what a “non-compete clause” is. But because of this approach, some contracts that are not commonly thought of as non-compete agreements may fall within the proposed ban. The FTC suggests that nondisclosure agreements, if they are too broad, may fall within the ban. Similarly, agreements that require workers to repay training costs if their employment ceases before completing a specific period of employment would fall within the ban, if the payment is not reasonably related to the training costs the employer incurred for the training.
The FTC recognizes that its proposed rule is so broad that it may ban non-compete agreements that commonly accompany the purchase and sale of a business. This would create difficulties for such transactions, so the proposed rule has an exception for using non-compete clauses in those transactions, but only with individuals who are “substantial owners.” And the threshold for being a “substantial owner” is high: 25% ownership. Under this threshold, the sale of a business owned by five equal partners (20% each) could not be backed up with a non-compete clause with any of them. This aspect of the proposed rule raises issues not only for the sale of business organizations, but also the use of non-compete clauses in buy-sell agreements among owners of a closely held business.
If your business uses non-compete clauses with workers, pursues growth by acquiring other businesses, or you are a party to one, the current proposed rule will impact all of those activities. If you wish to submit comments and desire guidance, please contact us. And watch for further FTC action on this proposal to ban non-compete clauses which they have already paused.