Eric Johnston, Traci Clements, and Ian Davis
Millions of employees in America are required to enter into non-compete agreements as a condition of employment. These non-compete agreements prevent employees from leaving to work for a competing business for a certain amount of time and within a certain geographic area.
Enter the Federal Trade Commission (FTC). On January 5, 2023, the FTC unveiled a proposed rule that takes direct aim at the legality of non-compete agreements. Specifically, the proposed rule would make it illegal for an employer to (a) enter into or attempt to enter into a non-compete with a worker; (b) maintain a non-compete with a worker; or (c) represent to a worker, under certain circumstances, that the worker is subject to a non-compete. Thus, not only would employers be prevented from entering into non-competes moving forward, but existing non-competes must be rescinded. The proposed rule would apply to employees, independent contractors, interns, volunteers and other workers.
According to the FTC, because “non-compete clauses prevent workers from leaving jobs and decrease competition for workers, they lower wages for both workers who are subject to them as well as workers who are not. Non-compete clauses also prevent new businesses from forming, stifling entrepreneurship, and prevent novel innovation which would otherwise occur when workers are able to broadly share their ideas.” This pro-employee policy stance is in line with the FTC’s priorities under Commissioner Lena Khan.
The FTC estimates that the proposed rule could increase wages by nearly $300 billion per year nationwide, and even expand career opportunities for roughly 30 million U.S. workers.
Those who endorse non-competes say they make employers more likely to invest in employee development and training, and also encourage employers to share sensitive information that may otherwise be shared with potential competitors when that employee jumps ship. Proponents also argue that employees can bargain for higher pay in exchange for agreeing to non-competes.
Currently, the enforceability of non-competes are governed under state law. For example, in Texas, non-competes must comply with the Covenant Not to Compete Act contained in Chapter 15 of the Texas Business and Commerce Code. In some states, such as California, non-competes are already largely illegal. In its proposed rule, the FTC has made clear that it seeks to supersede any state laws that are inconsistent.
Importantly, the proposed rule would generally not apply to other type of employment restrictions, such as non-disclosure agreements (NDAs). Moreover, the proposed rule creates a carve out for non-competes that are entered into by a person who is selling a business.
As it stands today, the FTC’s proposed rule is just that: a proposal. The FTC is seeking public comment from regulated entities for 60 days. After the public notice and comment period winds down, the FTC will consider making changes in the proposed rule. Eventually, the FTC will very likely publish a final rule, which would take effect 180 days after publication.
Once in effect, employers and employees can expect uncertainty in the status of the regulation, as employers will almost certainly challenge the legality of the FTC’s non-compete rule. Opponents of the rule may allege that the FTC lacks the authority to promulgate such a wide-ranging rule, or that regulation of non-competes is more appropriately left to the states.
For millions of employers and employees in America, it will be important to watch the status of the FTC’s proposed rule. Although a definitive conclusion may be months or years away, the impact of the proposed rule will undoubtably be substantial. Count on McGinnis Lochridge to keep you up to date.