The Federal Trade Commission has proposed a rule that would prohibit most non-compete clauses in employment contracts, calling it “a widespread and often exploitative practice that suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses.” The agency estimates that the rule may increase wages by nearly $300 billion per year and expand career opportunities for approximately 30 million workers.

Commission Chair, Lina M. Khan says non-compete clauses “block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand. By ending this long-standing practice, the FTC’s proposed rule would promote greater dynamism, innovation, and healthy competition.” Elizabeth Wilkins, Director of the Office of Policy Planning, said the proposed rule would “ensure that employers can’t exploit their outsized bargaining power to limit workers’ opportunities and stifle competition.”

Non-compete agreements are widely used across all industries and at all levels of organizations, from line workers to C-suite executives. Currently, the legality of such clauses is a matter of state law, with some states more tolerant of the practice than others. Generally, state laws require enforceable non-compete clauses to be reasonable in scope and rationally related to the employer’s interest to be protected.

In Oklahoma, for example,  a person who makes an agreement with an employer, whether in writing or verbally, not to compete with the employer after the employment relationship has been terminated, shall be permitted to engage in the same business as that conducted by the former employer or in a similar business as that conducted by the former employer as long as the former employee does not directly solicit the sale of goods, services or a combination of goods and services from the established customers of the former employer. The law states that any provision in a contract between an employer and an employee in conflict with the provisions of this section shall be void and unenforceable.

Some so-called “blue pencil” states permit courts to reinterpret unreasonable non-compete clauses and enforce them in a modified form that is reasonable.

In other states, such as California, non-compete clauses are almost always unenforceable. Khan notes that companies in California, despite the state’s ban on non-competes, have managed to innovate quite successfully. (Take for example, Apple, Disney, and Google.)

Khan’s got a message for those firms which will now face the scary prospect of losing those clauses if the FTC rule becomes official. “At the end of the day, companies have to invest in workers if they want to be successful,” she says. “You retain talent by actually competing, offering them better wages, better benefits, better training and investment opportunities. That’s how you keep retention high rather than locking workers in place.”

The proposed FTC rule would add a new subchapter to Title 16 of the Code of Federal Regulations, titled “Rules Concerning Unfair Methods of Competition.” The regulation defines “non-compete clause” 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.” Moreover, any contractual term with “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” is considered a non-compete clause. The latter captures, for example, non-disclosure agreements so broad as to effectively prohibit the worker from taking employment in the same field or reimbursement obligations for training in which the amount of payment exceeds the reasonable costs to the employer providing the training.

The proposed regulation would also do away with existing non-compete clauses and require employers to serve notice on affected workers that their non-compete clauses are no longer in effect and may no longer be enforced by the employer. In addition, the proposed rule would also apply to independent contractors and anyone who works for an employer, whether they are paid or unpaid.

The only exception provided for in this proposed regulation, are non-compete clauses that restrict the seller of an interest of 25% or greater in a business or its operating assets.

The proposed rule would preempt state law through an explicit provision that the regulation supersedes any conflicting state law, regulation, or interpretation to the extent inconsistent with rule.  In the FTC’s view, federal preemption will benefit an increasingly mobile work force and businesses who would need only comply with a uniform federal law governing employment non-compete clauses, rather than the vast and conflicting state laws that firms must currently navigate.

What are your thoughts on the proposed rule?