Should business owners be concerned about FTC's proposed ban on non-compete clauses?

By Patrice Arend
Taft Detroit

In January 2023, the Federal Trade Commission (FTC) issued a Notice of Proposed Rule Making (Proposed Rule) to prevent companies from entering non-compete agreements with their workers in many instances in the American workplace.

Under the Proposed Rule, employers would be required to rescind all active non-compete clauses with workers and formally notify each worker of the change in enforceability. While employers are shocked and concerned about the impact such a rule would have on various aspects of their business, they should not panic.

The Proposed Rule defines a non-compete clause to be “any 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 Proposed Rule would cover virtually all workers—with limited exceptions—including employees and independent contractors who work in the United States as well as both paid and unpaid staff.

The FTC maintains that non-compete clauses are a method of “unfair competition” which prevent workers from leaving jobs, often resulting in a decrease in overall wages.

They further argue that non-compete clauses deter entrepreneurial workers from forming new businesses and inhibit workers from bringing innovative ideas to new companies. The federal government estimates that approximately 30 million people work under some form of a non-compete agreement and that the removal of such clauses would increase employee yearly earnings by up to $296 billion.

This Proposed Rule has been several years in the making as President Biden issued an executive order in 2021, directing the FTC to assess the use and impact of non-compete clauses in the workplace.

The President also criticized non-compete clauses in this year’s State of the Union address.

Removing and rescinding non-compete clauses for lower-level employees might be more palatable, but there is extreme concern that top-level, C-suite executives would no longer be bound to these contractual terms.

The Proposed Rule would affect essentially every business in operation that uses non-compete agreements, as the change is more of a positional impact as opposed to an industrial one. Employers still perceive non-compete clauses to have value in the modern American economy, as they protect trade secrets and prevent former employees from taking their expertise to competitors who have made lucrative offers for their services.

If a widespread non-compete ban goes into effect, the question becomes: How will companies safeguard their most sensitive information?  The good news is that the Proposed Rule does not prevent other agreements that restrict outside work during the term of their work for an employer. The Proposed Rule also does not ban other types of restrictive covenants, such as confidentiality or customer non-solicitation agreements, in an employment agreement.

Nevertheless, business owners are still nervous about protecting their trade secrets every time a top-floor executive announces they are leaving. Business owners are concerned with merely having a confidentiality agreement to protect their interests—especially when it comes to determining what specialized knowledge is protected and what falls outside those parameters.  

The good news for businesses concerned about this directive is that the Proposed Rule does not require any business owners to take immediate action.

The FTC announced it extended the initial 60-day comment period on the Proposed Rule until April 19.

The FTC will then review all public comments and debate the final rule—which could take months.  Once a final rule is published, it will go into effect 180 days after publication as currently written.

Even then, the Proposed Rule will be likely subject to numerous legal challenges testing the scope of FTC’s powers, which could take months, if not longer, to resolve. One such argument will almost certainly be a challenge to the FTC’s authority to do this wide-sweeping rulemaking in the first place, either under the Federal Trade Commission Act or the Constitution’s separation of powers.

Moreover, laws regarding contract terms like the one at issue in the Proposed Rule are typically left to the states—a longstanding principle of federalism. Some states ban restrictive covenants altogether, others impose limits based on the type of employee or their compensation level, and others enforce them based on principles of reasonableness and scope among other things.

Finally, the Proposed Rule could trigger a challenge on the major question doctrine—that is, the subject matter of the Proposed Rule would need to be taken by Congress. During these legal challenges, a federal judge may well stay the rule while the case is proceeding. In short, a long road ahead likely exists for the current Proposed Rule before it becomes binding and enforceable.

While the implementation of the Proposed Rule is at minimum many months off, the FTC is obviously focused on this issue and may attempt to use other enforcement mechanisms.  Employers need not panic, but they should be aware of the current laws in effect and plan accordingly.

Michigan recognizes and will enforce reasonable restrictive covenants. Specifically, non-compete agreements must protect an employer’s reasonably competitive business interest and be reasonable in terms of duration, geographic area, and type of employment or line of business.

If the day when a universal ban on non-compete clauses eventually comes, yes, change will be necessary. Suddenly, a robust confidentiality agreement will become what many companies will rely upon to protect their most important trade secrets.

Safety protocols surrounding sensitive information will likely be ramped up in many offices, ensuring that only certain employees have access to sensitive company information.

Until then, advise your clients to relax for now. Business owners need not panic, should watch the development of the Proposed Rule, and be thoughtful about what the business could do to protect the vital secrets that make it unique. Companies also should review with legal counsel any non-compete agreements currently in use and discuss their legality under current laws.

Non-compete clauses are frequently subject to a balancing test of interests, which may not always be readily apparent. Such agreements are more likely to be enforceable if they meet actual business needs.
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Patrice Arend is a partner in the Employment and Labor Relations practice group at Taft Detroit.