From Non-Compete To Non-Existent: Proposed FTC Rule Would Render Almost All Non-Competition Agreements Void and Unenforceable

Non-compete agreementFor decades, businesses in Michigan and across the country have relied upon non-competition agreements to protect their interests from departing employees who may want to set up their own shops or go to work for rival companies. For just as long, courts and legislatures have struggled with these provisions, attempting to balance a business’s legitimate business interests with fundamental principles of fair competition and an individual’s right to earn a living in their chosen profession or occupation. Over the years, this struggle has evolved into increasing disfavor of non-competes, especially for lower-level employees. This has led to a patchwork of court decisions and state laws about the acceptable scope and enforceability of non-competes, leaving employers and employees uncertain whether their agreements will stand up to judicial scrutiny.

But if the U.S. Federal Trade Commission (FTC) has its way, there will no longer be any question as to whether a non-competition agreement is valid and enforceable. That is because under a new proposed rule it released on January 5, 2023, there will no longer be any valid and enforceable non-competition agreements.

The proposed rule, which would supersede any inconsistent state laws on the subject, deems non-competition agreements to be an “unfair method of competition” and thus unlawful under Section 5 of the Federal Trade Commission Act. If finalized and published in its current form, the proposed rule would render almost all existing non-competes void – whether with c-suite executives, minimum wage workers, or independent contractors. This would leave companies with little recourse when a former employee uses the knowledge, insights, and resources they gained during their tenure against their former employer.

Specifically, the FTC’s proposed rule would make it unlawful for an employer to enter into, attempt to enter into, or maintain a non-competition agreement with a worker or represent that the worker is subject to a non-competition agreement.

Employer Rescission and Notification Obligations Under the Proposed Rule

All existing non-competes would be void and unenforceable as of 180 days after the rule’s publication in its final form. It also imposes obligations on employers to affirmatively rescind any current non-competes and notify any affected employees that they are no longer bound by those provisions.

Specifically, employers would need to:

  • Provide each worker with an individualized communication on paper or in a digital format notifying them of the rescission.
  • Provide the notice within 45 days of rescinding the non-competition clause.
  • Provide the notice to current workers as well as former workers if the employer has the worker’s latest contact information readily available.

While employers are free to develop their own language notifying the worker that their non-compete is no longer binding or enforceable, the rule does include the following model language for the notice:

A new rule enforced by the Federal Trade Commission makes it unlawful for us to maintain a non-compete clause in your employment contract. As of [DATE 180 DAYS AFTER DATE OF PUBLICATION OF THE FINAL RULE], the non-compete clause in your contract is no longer in effect. This means that once you stop working for [EMPLOYER NAME]:

  • You may seek or accept a job with any company or any person—even if they compete with [EMPLOYER NAME].
  • You may run your own business—even if it competes with [EMPLOYER NAME].
  • You may compete with [EMPLOYER NAME] at any time following your employment with [EMPLOYER NAME].

The FTC’s new rule does not affect any other terms of your employment contract. For more information about the rule, visit [link to final rule landing page].

Non-Competes Related to the Purchase and Sale of a Business Still Valid

The rule contains one notable exception to the blanket prohibition on non-competes involving agreements entered into as part of the purchase or sale of a business. Specifically, the rule provides that it shall not apply to:

a non-compete clause that is entered into by a person who is selling a business entity or otherwise disposing of all of the person’s ownership interest in the business entity, or by a person who is selling all or substantially all of a business entity’s operating assets, when the person restricted by the non-compete clause is a substantial owner of, or substantial member or substantial partner in, the business entity at the time the person enters into the non-compete clause.

Rule Allows for Non-Solicitation and Non-Disclosure Agreements – If They Aren’t Non-Competes in Disguise

People often use the term “non-compete” interchangeably for three related but distinct limitations on future business and employment activities. But non-competition provisions are very different from non-solicitation and non-disclosure clauses, and the rule would treat them as such.

The proposed rule defines a “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.” The rule clarifies that the definition of a non-compete clause “would generally not include other types of restrictive employment covenants—such as non-disclosure agreements (“NDAs”) and client or customer non-solicitation agreements—because these covenants generally do not prevent a worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer.”

However, the rule provides that a provision that purports to be something other than a non-compete could be deemed one and thus prohibited “where they are so unusually broad in scope that they function as such.” Accordingly, “whether a contractual provision is a non-compete clause would depend not on what the provision is called, but how the provision functions.”

There is no reason to panic at this point given the anticipated time period between the 60-day public comment period (ending on March 10, 2023), the unknown time period thereafter for any proposed rule to become final, the uncertain outcome of the language in any final rule, and the 180-day grace period after that for employers to become compliant with any final rule. Accordingly, there is no reason to immediately stop using such restrictive covenant agreements in your business, provided such agreements are otherwise reasonable and enforceable under applicable state law.

However, given the position the FTC has taken on this issue and the increasing scrutiny covering such agreements around the country, it may be prudent to evaluate their utility and what steps may be needed if some variation of the proposed rule takes effect in the future. It is unclear what the rule will look like in its final form and when it will become effective. What is clear is that the end appears to be near for non-competes, and business owners should be prepared for that likelihood.

If you have questions or concerns about the proposed FTC rule or your company’s current non-competes, please contact Jordan Held or Mariah Natzke at Kreis Enderle today.

Welsh Wire Podcast

You can listen to Jordan and Mariah discuss the proposed rule change on the Welsh Wire Podcast hosted by Welsh & Associates.

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