On January 5, 2023, the Federal Trade Commission (FTC) issued a Notice of Proposed Rulemaking essentially banning non-compete clauses and categorizing them as unfair methods of competition. Non-compete clauses serve to protect a business’s trade secrets and other confidential information, which makes the adoption of such a rule a major concern for all US businesses. Our previous article addressed the legal challenges the FTC will likely face in light of the proposed ban on non-compete agreements. The comment period for this proposed rule ends on March 20, and businesses should consider voicing their concerns before the deadline. This article summarizes some of the major ways that the rule could affect businesses, as well as what issues could be raised during the comment period.
Ability to Contract and Negotiate
The proposed rule would take away the right of individuals to bargain for restrictive covenants, such as non-competes, in return for a form of compensation or job security. Both employers and employees benefit from this arrangement, as employers are able to protect confidential information while employees have the opportunity to receive increased salaries and/or severance packages upon their departure from former employers. The proposed rule would strip away this exchange, leaving both employers and employees vulnerable.
Additionally, employers and workers would have to renegotiate their prior agreements, as the proposed rule prohibits not only the creation of non-compete agreements but the maintenance of existing agreements as well. The employer has the burden to provide notice to workers in an individualized communication that the agreement is no longer valid; this burden is also extended to workers who formerly worked for the employer. As such, businesses will want to consider the effect the proposed rule would have on their ability to contract and bargain with workers and may want to voice their concerns in comment to the FTC.
Buying and Selling Businesses
An additional concern is an exception in the rule proposed for sellers and buyers, where only a substantial owner or member of a business could enter into a non-compete agreement. “Substantial owner” is defined as an owner, member, or partner holding at least a 25% ownership interest in a business entity. Consequently, those who hold a 15% or 20% interest would be prohibited from entering into a non-compete agreement with the prospective buyer. As such, the business entity may struggle to sell itself because buyers may not want to purchase an entity where a 20% interest-holding owner could essentially leave the company and open up a competing company the next day. Thus, this proposed rule would likely affect the marketability of businesses.
Alternatives to the Proposed Rule
The FTC seeks to hear from the public regarding potential alternatives to the proposed rule, such as (1) whether the ban should be a rebuttable presumption rather than a categorical ban and (2) whether the rule should apply to all workers or there should be exemptions or different standards for some workers. Under the first alternative, it would be presumptively unlawful for an employer to use non-compete agreements; however, the non-compete would be permissible if the employer met a certain evidentiary standard, which has yet to be articulated. Employers would have to prove that the non-compete is unlikely to harm consumers or be able to identify some competitive benefit that offsets the apparent or anticipated harm.
Under the second alternative, there would be a more lenient standard, such as a rebuttable presumption or an exemption altogether, for workers whose earnings are above a certain threshold, who meet an existing exemption under the Fair Labor Standards Act, etc. More variations of the standard could be based on (1) a worker’s job function or occupation, (2) a worker’s earnings, or (3) a combination of job function/occupation and earnings.
The very nature of how business entities protect their trade secrets and confidential information is at risk, and the proposed rule would change the contractual dynamic of the employer-employee relationship. The public is encouraged to voice their concerns to the FTC during the comment period, which ends March 20. If you have specific questions on how this proposed rule may affect your company or would like assistance in drafting a comment, please contact Joe Lavigne, Tom Hubert, or P.J. Kee.