Potential Ban on Non-compete Agreements: How In-House Counsel Can Prepare for Possible Impact

By Elias Kahn | Senior Product Manager, Lexis Practical Guidance

The Federal Trade Commission (FTC) issued a notice of proposed rulemaking last month that, if adopted, would ban virtually all non-compete agreements nationwide between employers and employees. The potential non-compete ban would be one of the broadest expansions of agency authority in the FTC’s history, as reported by Law360. Note also that on February 1, 2023, a bipartisan group of U.S. Senators also proposed legislation that would ban most non-compete agreements, as reported by Law360.

The FTC press release announcing the proposed rule claims that the new proposed rule could increase wages by nearly $300 billion per year and expand career opportunities for roughly 30 million American workers.

While there are major questions about whether a federal non-compete ban is enforceable — this issue has traditionally been a matter of state law (see Non-competes and Trade Secret Protection State Practice Notes Chart and Non-competes and Trade Secret Protection State Expert Forms Chart) — labor and employment law experts are advising in-house counsel to monitor this regulatory development very closely.

“Cloaked in sweeping language about consumer protection, the proposed rule is likely to attract significant attention from the state attorneys general across the country,” writes Ryan Strasser and Carson Cox, in an Expert Analysis column published by Law360. “Given the long-standing hostility and aversion to non competes already existent in many states, state attorneys general may be poised to use the FTC’s bold action as a springboard to serve as additional enforcers of the proposed rule through the deployment of even more powerful tools available to them.” Strasser and Cox explain that a ban on non-competes could lead to more state unfair and deceptive practices (UDAP) actions. They also write it could lead to more Defend Trade Secrets Act (DTSA) litigation. See Defend Trade Secrets Act (DTSA) and Other Legal Claims and Recourse to Protect Employers' Confidential Information and Trade Secrets and Defend Trade Secrets Act (DTSA) Fundamentals.

Alternative Arrangements to Non-Compete Agreements

Sasser and Cox also recommend that employers consider alternative arrangements to non-compete agreements such as garden leave provisions. Under a garden leave arrangement, employees must provide a specific amount of notice before resigning. During the notice period, employers often instruct employees to not come to work, but the employers keep the employees on their payrolls during this time. Garden leave helps employers prevent employees from taking and retaining employers’ confidential information and using this confidential information while working for competitor employers. For more information on garden leave, see Garden Leave Provisions: Negotiation, Drafting, and Legal Issues.

Given the ubiquity of non-compete agreements, especially regarding how commonplace they are in executive employment agreements, it is essential for in-house counsel to stay on top of the potential non-compete ban and start preparing now for the possible implications.

Critical Components of Proposed FTC Rule for In-House Counsel

Lexis Practical Guidance recently published an article, authored by employment law experts David J. Walton and Lauren Frisch of Fisher & Phillips LLP, which identifies the critical components of the proposed FTC rule that all in-house counsel should understand to begin preparing for possible impact: (1) It would prevent employers from entering into non-compete clauses with workers; (2) It would require employers to take active steps to rescind existing non-compete clauses; and (3) It would impose explicit notice requirements applying to both current and former employees.

The authors contend that the rule, if finalized in its current form, would drastically change the way that employers could use non-compete restrictions in four key ways:

• Broad Coverage, Narrow Exceptions

By its specific terms, the rule would apply to virtually every worker and employer in the country, even to independent contractors and unpaid workers. Even the "exceptions" to the rule are not truly exceptions under which non-compete clauses may be used in the employment context. Instead, these exceptions confirm that the use of non-competes outside of the employment context, such as those involving franchisees and those incident to the sale of a business are still permitted.

• Non-disclosure Agreements Under Fire

The use of a functional test to define a non-compete clause as a de facto restriction could also greatly expand the coverage of the proposed rule. As an example, the FTC specifically flagged non-disclosure agreements as potentially being de facto non-compete clauses under the proposed rule. This should raise a major red flag for employers. See Non-disclosure Agreements: Key Negotiation, Drafting, and Legal Issues (Pro-Employer).

• Customer and Employee Non-solicitation Agreements Questioned

Another question employers should consider is whether the definition of a non-compete clause will cover employee and customer non-solicitation agreements. See Customer and Employee Non-solicitation Agreements: Key Negotiation, Drafting, and Legal Issues. Under the functional test, a de facto non-compete exists whenever a clause has the functional effect of prohibiting 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." For example, could a non-solicitation clause that prevents the worker from "accepting" business from a former customer be deemed a "de facto" non-compete clause? 

• Rescission Requirements Headache

The proposed rule's rescission and notice requirements are also unprecedented in that they explicitly require all employees take affirmative steps to rescind and give notice of the rescission of all covenants entered into prior the creation of this rule to all current and former workers. Employers will need to take their rescission and notice responsibilities seriously to avoid running afoul of the FTC’s rule if it goes into effect.

In-house counsel need to track this proposed rule closely and be prepared to revisit all of the company’s restrictive covenant clauses contained in employment agreements — for both current and former employees — within the next year. Lexis Practical Guidance offers a number of resources to assist with this review, including the Restrictive Covenants Resource Kit and Non-compete Agreements: Key Negotiation, Drafting, and Legal Issues, a practice note.

Click here to get a free trial of Lexis Practical Guidance.

All of these news, analysis and practical guidance resources regarding the proposed FTC ban on non-compete agreements are accessible from Lexis+ General Counsel Suite. Lexis GC Suite is an all-in-one information resource designed for the modern GC that provides in-house counsel with a vast collection of legal resources, breaking business and legal news, and practical guidance content.

Click here for a free 7-day trial of GC Suite.

Elias J. Kahn is a Senior Product Manager for Practical Guidance and Analytical at LexisNexis for Labor & Employment, Tax, and Employee Benefits and Executive Compensation.  Prior to joining LexisNexis, Kahn was an associate at Littler Mendelson, P.C. Previously, he was an associate at Debevoise & Plimpton LLP.

Kahn earned his J.D., *** laude, at the University of Pennsylvania Law School. At Penn, Kahn was a senior editor of the Law Review and a member of the Moot Court Board. After law school, Kahn clerked for the Honorable Judge Shirley Wohl Kram, United States District Judge for the Southern District of New York.