A discussion of the Federal Trade Commission’s recently proposed regulation on non-compete agreements, which, if enacted, would ban all worker non-compete agreements (for all employees and individual independent contractors) in all industries and positions, with only limited exceptions.

The Federal Trade Commission (FTC) recently proposed regulation on non-compete agreements, if enacted, would ban all worker non-compete agreements (for all employees and individual independent contractors) in all industries and positions, with only limited exceptions for agreements involving the sale of a business or agreements between a franchisor and franchisee, sweeping away centuries of common law and overriding statutes in 47 states which permit enforcement of non-competition agreements under certain circumstances.

The Proposed Rule

On Jan. 5, 2023, the Federal Trade Commission issued a Notice of Proposed Rulemaking (notice) in which it proposed an across-the board ban on post-employment non-compete agreements for all employees and individual independent contractors, in all industries and positions (including highly skilled workers and senior executives).  The only exceptions are for: a) non-compete agreements given by a business owner in the context of the sale of the business; and b) non-compete agreements between a franchisor and a franchisee.  If and when the regulation becomes effective, all non-compete agreements are immediately rescinded and unenforceable.  Employers must promptly notify all persons subject to such agreements (including current and former workers) within 45 days after the compliance date that the non-compete agreements have been automatically rescinded. The notice invites public comment by no later than March 20, 2023.

The proposed rule, if enacted, would sweep away the entire body of common law caselaw which has generally allowed enforcement of non-compete agreements based on a case-by-case examination of whether the non-compete is reasonable in scope, duration and geographic reach; whether the employee had specialized skill or training, access to confidential information or trade secrets, or relationships with customers; and whether it would cause undue hardship to the employee. It would also preempt the statutes in more than 30 states which explicitly allow enforcement of non-compete agreements under certain circumstances.

The proposed ban, as written, applies broadly to all “workers” which is defined as a “natural person.” Notice, at 212.  As a result, non-compete agreements between a business and an independent contractor that signs the agreement as an entity, would arguably not be subject to the ban.

Justifications

The FTC justifies this across-the-board ban by making a preliminary finding that all worker non-compete agreements (regardless of level or position) constitute an “unfair method of competition,” because all such agreements “negatively affect competition conditions in markets for products and services” including consumer prices, ability of competitors to access talent, a negative impact on new business formation, and decrease in “innovation.”  Notice, at 78-80.   Section 5 of the FTC Act prohibits “unfair methods of competition.” 15 U.S.C. § 45(a)(1).

This focus on worker unfairness flows from President Biden’s July 9, 2021 Executive Order which encouraged the FTC to exercise its rulemaking authority to curtail the “unfair use” of non-compete clauses that may unfairly limit worker mobility, and the FTC’s November 2022 Policy Statement announcing a new, broader standard for determining what constitutes “unfair competition.”

While acknowledging there is empirical evidence that non-compete clauses have some beneficial effects, including increased worker training and capital investment, the FTC discounts these benefits, in part because it says that employers have alternatives to non-compete clauses to protect their investments.  First, employers can sue employers for theft of trade secrets under both federal and state law.  Notice, at 93-98.  Second, employers can require employees to sign a confidentiality agreement which prohibits the employee from disclosing information which has been treated as confidential and has value to the former employer. Notice, at 98-99.

The notice points to three states, including California, Oklahoma, and  North Dakota which have had categorical bans on non-compete agreements for many years, noting that some industries in those states have flourished despite the absence of enforceable non-competition agreements.  Notice, at 100-101.

State-Level Policy Determinations

Forty-seven states, including New York, currently allow enforcement of non-compete agreements in certain circumstances.  At least 30 states have statutes addressing the issue, while New York and other states address it through legal precedent in court decisions.

New York has not adopted a statute governing non-competes for all employees, although such legislation has been proposed.  New York statutes do contain a limited ban for broadcast industry employees, N.Y. Lab. Law § 202-k, and New York’s ethical rules prohibit them for attorneys, NY ST RPC Rule 5.6, while FINRA rules restrict their use for registered securities representatives. R.  2140 and 11870.

New York common law currently allows enforcement of a non-compete to the extent it (1) is necessary to protect the employer’s legitimate interests, (2) does not impose an undue hardship on the employee, (3) does not harm the public, and (4) is reasonable in duration and geographic scope.  An employer’s legitimate interest may include protecting an employer’s trade secrets and confidential information and preventing employees from taking unique or extraordinary specialized skills they gained on the job to a competitor. See, e.g., BDO Seidman v Hirshberg, 93 NY2d 382, 388 (1999); Reed, Roberts Assocs., Inc. v. Strauman, 386 N.Y.S.2d 677, 679 (1976); Ticor Title Ins. Co. v. Cohen, 173 F.3d 63, 70 (2d Cir. 1999).

In the meantime, even in the absence of a statute, the New York Attorney General has investigated and entered into consent agreements with several business who were regularly using non-compete agreements for low-paying unskilled workers, where it was clear that such agreements were unenforceable and inconsistent with New York’s existing common law.  See the list of such actions in Non-Compete Agreements in New York State, Frequently Asked Questions, at the New York State Attorney General website.

The Attorney General has exercised this authority, acting on employee complaints, under New York Executive Law §63(12), which gives the Attorney General authority to take action against businesses who engage in repeated “fraudulent” or “illegal” activities, with “fraudulent” being defined broadly to include “unconscionable contractual provisions.”

In New York, legislation has been introduced every year the past few years that would limit the use of non-competes. A current proposed law, Assembly Bill 1278, would ban all non-compete agreements, and provide a private right of action for employees to void such agreements, with liquidated damages of $10,000 and attorney fees.

Earlier bills, such as A07193 and A10511 in the 2019-2020 session, would have prohibited the use of non-competes for any employee below the salary threshold set by Labor Law §190(7) (then $900 per week), prohibited non-compete agreements broader than needed to protect the employer’s trade secrets or confidential information or that cause undue hardship, required non-competes to be reasonable in scope or duration, required the employer to provide the non-compete agreement before a job offer is extended, made non-competes unenforceable if an employee is discharged without cause, and created a private right of action with liquidated damages and attorney fees.

Other states, including Colorado, Illinois, Massachusetts, Oregon, and Virginia, have recently enacted similar statutes which ban non-competes for low-wage workers, and contain other  innovative requirements, such as notice, disclosure, duration, and garden leave provisions. See Employee Non-competes – A State-by-State Survey, Beck Reed Riden LLP (providing a summary of state laws).

Next Steps

The FTC’s analysis represents a shift away from a focus on consumer welfare and business justifications.  Its discussion of non-competes gives little weight to arguments that non-competes encourage businesses to invest in training workers, that start-up companies may need non-compete agreements to prevent larger companies from cherry-picking talent, that non-competes may encourage innovation by allowing businesses to obtain a return on their investments similar to patent protection, or that increased wages arguably negatively affect consumer welfare by increasing prices. Notice, at 170.

Recognizing the serious effects of its proposal, the FTC repeatedly emphasizes that its proposal for a categorical ban is only based on its “preliminary assessment,” and cautions that the Commission could very well decide to adopt alternatives to a categorical ban, such as limiting the ban to low-wage workers, a disclosure rule requiring employers to give workers a separate written notice, or a rule requiring employers to report their use of non-competes to the Commission. Notice, at 136-156. The FTC repeatedly encourages the public to submit their comments on the proposed ban as well as any possible alternatives.

Businesses and workers with an interest in this issue should submit comments by the March 20, 2023 deadline, using the FTC’s online Comment Form.

Conclusion

The recent increased level of legislative activity at the state level demonstrates that state legislatures are capable of hashing out the intricacies of a rule which will protect both workers and businesses. And the FTC’s own extensive discussion of possible alternatives in its Notice of Rulemaking, and its own expressed uncertainty in the notice itself about what the best rule might be, demonstrates that the FTC’s rule-making process, which only allows public input for a 60-day comment period, is probably not the best forum to decide upon a nationwide law that will have such significant effects on workers and businesses.