Overview
The Federal Trade Commission (FTC) has taken its strongest actions yet to limit private contract terms limiting employees' ability to work for competitors, both issuing a proposed rule barring most noncompete agreements and filing complaints and consent decrees with three companies prohibiting their specific noncompete provisions. Prudent employers should evaluate their own employment contracts to assess the risk of current enforcement actions and plan for future compliance if the proposed rule comes into effect. This alert summarizes the FTC's actions, analyzes their likely impact, and outlines steps employers should take in response.
The FTC's actions against noncompete agreements were twofold. On January 5, 2023, the FTC, by a 3-1 vote, issued proposed rules that, if made final, would ban most noncompete clauses and make unlawful employer efforts to contractually bar their employees from working for competitors. The proposed rulemaking followed an announcement that the FTC—also by a 3-1 vote—would enter into consent decrees with three companies whose noncompete clauses and use thereof allegedly violated Section 5 of the FTC Act. This marks the first time the agency has sued to halt noncompete restrictions.
The FTC is taking direct aim at ending noncompete clauses. And as the enforcement actions show, the agency will not simply wait for its rule to become final before it challenges noncompete clauses it deems violate existing antitrust laws.
The Proposed Rule
Noncompete clauses have been on the Biden Administration’s radar for some time. A frequent talking point of the President, his broad July 9, 2021 Executive Order on Promoting Competition in the American Economy directed the FTC to promulgate regulations regarding noncompete clauses.
In announcing its proposed rule, the FTC described noncompetes as "a widespread and often exploitative practice that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses." Specifically, the rule would make it unlawful for an employer to:
- Enter into or attempt to enter into a noncompete with a worker;
- Maintain a noncompete with a worker; or
- Represent to a worker, under certain circumstances, that the worker is subject to a noncompete.
Using the same legal basis as its concurrent enforcement actions, under the proposed rule such actions would be unlawful as an “unfair method of competition” under Section 5 of the FTC Act. The proposed rule’s application is not restricted to “employees,” but applies to the broader category of "workers." Therefore, the proposed rule bars firms from entering noncompete provisions with independent contractors, volunteers, interns, sole proprietors, and apprentices. There is an exception to the FTC's nearly-complete prohibition. The proposed rule permits a non-compete agreement when there is a sale of substantially all of a business, and the person the non-compete clause restricts is a substantial owner of the business.
Significantly, the FTC also warns that "other types of employment restrictions could be subject to the rule if they are so broad in scope that they function as noncompetes." Thus, the proposed rule also seeks to restrict the application of some non-disclosure agreements, non-solicitation agreements, training payback requirements, and other potential restraints on employee mobility.
The Enforcement Actions
On January 4, the FTC entered into unprecedented consent decrees prohibiting three companies from enforcing noncompete clauses. The FTC noted that "these actions mark the first time that the agency has sued to halt unlawful noncompete restrictions."
According to the FTC, the three companies—Prudential Security, O-I Glass, and Ardagh Group—each engaged in an "unfair method of competition" in violation of Section 5 of the FTC Act by imposing "noncompete restrictions on workers in positions ranging from low-wage security guards to manufacturing workers to engineers that barred them from seeking or accepting work with another employer or operating a competing business after they left the companies."
While the FTC did not specifically note that it sought to attack particularly egregious examples of noncompetes, there are some features of the companies’ restrictions that stand out. For example, in the case of Prudential Security, the company sought to impose on a class of workers earning minimum wage a $100,000 penalty for violating the noncompete clause, and continued to require all security guards to sign noncompetes, even after a Michigan court held Prudential’s clauses unreasonable and unenforceable under state law.
The clauses at issue for O-I Glass and Ardagh Group are more standard fare—restrictions on employees from working in the same industry for one or two years. However, the FTC claimed that both companies are in the "highly concentrated" glass food and beverage container industry, and that "it is difficult for new competitors to enter the market in part because of the need to find and hire people who are skilled and experienced in glass container manufacturing."
What This Means for Companies and Employees
The FTC’s proposed rule represents a sea change in how many courts and enforcers would analyze noncompete clauses. Previously, the legality of noncompetes generally has been assessed under the rule of reason (i.e., whether they are likely to have an anticompetitive effect outweighing any procompetitive justification), by looking at the scope, duration, and any other features of the clause (such as a steep financial penalty on the employee who violates the clause) that could bear on its reasonableness. While a number of states have already barred entirely or significantly limited the enforcement of noncompete agreements, the proposed rule is broader and expressly supersedes any state law to the extent the state law provides less protection. Under the proposed rule, noncompete clauses would be per se illegal (i.e., a court will not examine any justification for the clause), with very few carve outs and exceptions.
The proposed rule roots its legal authority in Section 5 of the FTC Act. The FTC's Section 5 authority is limited to injunctive relief, and the proposed rule does not create a private right of action or subject violators to the treble damages seen for violations of other federal antitrust laws. Nevertheless, private plaintiffs can still bring suit under the Sherman Act and seek monetary penalties. Those private claims, however, are likely to be analyzed under the rule of reason, and not the per-se illegality to be imposed by the FTC's rule.
It is important to remember that the FTC's rule is far from final. Following the public comment period and the anticipated adoption of the rule in final form, companies should expect a flurry of litigation challenging the rule under principles of constitutional and administrative law. Commissioner Christine S. Wilson's dissenting statement called the rule a "radical departure from hundreds of years of legal precedent" and essentially laid the blueprint for future challenges when she identified three ways the rule is "vulnerable to meritorious challenges":
(1) the Commission lacks authority to engage in "unfair methods of competition" rulemaking, (2) the major questions doctrine addressed in West Virginia v. EPA applies, and the Commission lacks clear Congressional authorization to undertake this initiative; and (3) assuming the agency does possess the authority to engage in this rulemaking, it is an impermissible delegation of legislative authority under the non-delegation doctrine, particularly because the Commission has replaced the consumer welfare standard with one of multiple goals.
The notice-and-comment rulemaking process can take many months to complete; all noncompete clauses will not become unlawful overnight, although the FTC has made its position quite clear. But the length of the rulemaking process should not lull employers into a false sense of security. It is no coincidence that the FTC announced its first-of-its-kind enforcement actions targeting noncompete clauses the day before announcing the proposed rule. The message is that while the FTC is issuing a rule to ban this practice, until such a rule becoming final the FTC will continue to pursue noncompetes under existing antitrust law—perhaps but not necessarily focusing on the more egregious examples.
A prudent employer will work to:
- Determine if and how its employment contracts can act to restrict employees from working for competitors.
- Recognize that some "noncompetes" are not clearly labeled as such. Employers should carefully scrutinize contract terms limiting an employee’s use of certain broadly-defined "trade secrets," customer lists, or other acquired knowledge at their next job, and training payback clauses, as these restrictions can serve to limit employee mobility.
- Evaluate whether any existing noncompete clauses are particularly restrictive – and may become targets of enforcement efforts even before the FTC rule is final. While the recent enforcement actions suggest that noncompetes arising in highly concentrated industries or affecting highly-skilled workers are worthy of scrutiny, the FTC's rhetoric suggests that noncompetes affecting low-wage workers and perhaps other groups should also be the focus of close attention.
- Consider participating in the rulemaking process by filing comments during the notice-and-comment process. This can be done through a trade association or with the assistance of an attorney with regulatory experience.
- Develop a plan for compliance should the rule go into effect. Final rules typically become effective either immediately or within a short period. Getting a jump on determining which employment contracts will need to be altered, and what contract provisions might be appropriate to secure a company’s intellectual property and trade secrets, is key.
