What are Non-Compete Provisions?
Non-compete provisions are contractual terms that prohibit an employee from working for a competitor of the current company. The purpose is to protect a company’s proprietary information – like customer lists or trade secrets – from being used by a competitor.
What Did the Federal Trade Commission Propose?
On January 5, 2023, the Federal Trade Commission (FTC) announced a “Notice of Proposed Rulemaking” proposing a rule banning the use of “non-compete” agreements in employment contracts or relationships. The proposed rule would make national the practice of several states in banning such clauses and would be applied retroactively, requiring employers to notify employees and ex-employees the clauses can no longer be enforced. The proposal is consistent with a number of recent FTC actions to focus on anticompetitive practices impacting workers and not just consumers.
Courts have frequently created special carveouts and exceptions to enforcing such provisions, but the proposed rule would impose a ban. Such a ban is needed because it would likely eliminate the widespread practice of employers threatening to enforce non-compete provisions even when they know for a fact that the provisions are unenforceable. Employers appear to make widespread use of illegal non-compete provisions. The FTC study found that employers are just as likely to include non-compete provisions in employment contracts in states which forbid them like California, North Dakota and Oklahoma, as they are in states where non-competes are completely legal.
Why is the FTC Proposing Banning Non-Compete Provisions?
It makes sense for the FTC to take this action, which is similar to an action the Securities and Exchange Commission (SEC) took years ago. In 2017, the SEC adopted a rule prohibiting companies from interfering with anyone’s ability to obtain a financial reward for being a whistleblower. The SEC sanctioned several companies for requiring in severance agreements that employees give up their ability to obtain a whistleblower award – a provision that violated the SEC rules and was unenforceable.
Calling non-compete provisions “agreements” is usually a misnomer. Non-compete provisions are typically imposed by employers as a condition of employment and are not subject to any negotiation. According to a study cited by the dissenting FTC commissioner, at least one-third of employees are not informed of the existence of a non-compete until after they begin employment.
The FTC notice and supporting statements identify four main reasons for the proposal.
- Non-compete clauses exploit workers and reduce workers’ wages, by preventing workers from switching jobs or even threatening to switch jobs which might spur their current employers to pay fairer wages.
- Non-compete clauses stifle competition, by interfering with the creation of new businesses and adoption of new ideas. This is not just because workers are unable to start their own competing businesses, but also because it prevents the cross-fertilization of good ideas that can take place when workers take jobs with competitors.
- Non-compete clauses hinder economic liberty, by coercing employees into staying in jobs they would rather leave.
- Employers have other ways to protect their interests in proprietary information. Importantly, nothing in the proposed rule prevents employers from negotiating confidentiality or non-solicitation agreements with prospective employees, or seeking to protect trade secrets. Most of the potential harm cited by opponents of the rule conflate non-competes with these other more targeted protections. In fact, the proposed rule contemplates exceptions in the sale of a business or for certain kinds of senior executives.
Who Should and Should Not Be Subject to Non-Compete Provisions?
Until recently, only senior executives were typically subject to non-compete agreements. Those clauses only recently became ubiquitous – covering fast food workers and other low-wages workers. The ubiquity of non-compete clauses seems to be part of the motivation for the FTC to act at this time. Estimates are that 30 million workers in US are subject to non-competes. Reports suggest that at least one-third of workers covered by non-compete clauses earn less than $13 per hour. For example, in a case the FTC announced along with its Notice of Prospective Rule Making, it described a Michigan-based security company that includes non-compete clauses for all its employees, including security guards being paid minimum wage. The company has actively enforced these non-compete provisions, which include a $100,000 liquidated damages clause.
In a recent case brought by the FTC against a multi-level marketer (MLM), the MLM’s policies and procedures barred the half million current and former members from working in any capacity in the health or beauty products industry anywhere in the U.S. – or working for any other MLM regardless of what it sold — for at least two years, even though most members never earned a penny working for the MLM. Even unpaid workers are often subject to non-competes, including entry-level unpaid interns, and in at least one instance, volunteers for a youth soccer league.
Why is the FTC Issuing This Proposal Now?
A little background on the FTC may be helpful to explain the timing of this proposal. The FTC has two missions, which are sometimes but not always complementary:
- protecting consumers and
- protecting competition.
Historically, and particularly in recent years, the FTC has focused the bulk of its enforcement efforts on the first of those missions – protecting consumers. The FTC has done this by filing cases for violations of the FTC Act – usually in federal court, but also in administrative proceedings.
To fulfill its mission of protecting competition, the FTC has the power to issue “trade regulation rules,” like this proposed ban on non-compete provisions. These rules are virtually indistinguishable from statutes enacted by Congress or state legislatures, and the FTC has created and enforces more than fifty trade regulations and guidelines – which include the rule that created the national Do-Not-Call-Registry as well as obscure rules like the Test Procedures and Labelling Standards for Recycled Oil Rule or the recently rescinded Picture Tube Rule.
But whether for political reasons or simply institutional reluctance, the FTC rarely proposes “trade regulation rules.” There is no statutory prohibition on such rulemaking, and based on the statements made by Commissioners both supporting and opposing this non-compete proposal, we should expect more competition-based proposed rules in the next few years.
The FTC may be turning to rule-making because of recent Supreme Court rulings limiting the FTC’s ability to obtain money judgments in consumer cases under the FTC Act. Two years ago, the Supreme Court reversed nearly forty years of precedent and held in AMG Capital Management, LLC v. Federal Trade Commission, 141 S. Ct. 1341 (2021), that the FTC is precluded from obtaining redress (sometimes referred to as disgorgement or restitution, but essentially just money judgments) in cases it brings under the FTC Act. This ruling does not, however, affect the FTC’s ability to recover money for victims in cases it brings to enforce one of its trade regulations or consumer protection regulations. There are certain limitations, but the FTC has begun to bring consumer protection matters to recover losses for consumers under its regulations rather than the FTC Act.
What Can You Do?
This is the time to make your voice heard by submitting a comment to the FTC. The FTC will review all comments before it decides on a final rule. If you are seeking to retain an attorney to prepare your comment on this proposed rule, contact David O’Toole at David@SECDefenseAttorney.com or (847) 906-3460.
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