What Does the Proposed FTC Ban on Noncompete Clauses Mean For Your Business?

On January 5, 2023, in response to the Biden Administration’s July 2021 executive order,¹ the Federal Trade Commission (FTC) proposed a new rule which, if finalized, will prohibit employers from imposing or enforcing noncompete clauses in agreements with workers, including employees and independent contractors, nationwide and in almost all contexts (excluding, specifically, provisions relating to certain sales of businesses). The rule classifies noncompete clauses as an “unfair method of competition” and not only bars most noncompete provisions going forward, it also requires employers to rescind existing noncompetes and provide individualized notice of that rescission to current and former employees.

While the FTC’s stated focus is on the general work force, and specifically on those workers with no or very low bargaining power,² the proposed rule will have broad-reaching impacts on the technology industry, where protection of valuable proprietary information is crucial to commercial success and noncompetes are a longstanding tool. Without them, how can tech-focused companies protect their legitimate business interests?

To understand what the change means to your business, it is crucial to look at where the proposed rule stands now, what the next eight months look like, how the rule may be contested, how far-reaching the rule could be, and what steps can be taken now.

Where are we now and how could the rule be challenged?

The proposed rule is subject to a comment period that runs for 60 days after publication, with the rule going into effect 180 days after publication of the final rule in the Federal Register. The proposed rule will most likely be challenged with regard to its enforcement on jurisdictional and constitutional grounds. Further, it is likely to be challenged based on its broad scope for classes of employees. The rule, as drafted, lacks different standards for varying categories of workers, applying broadly to any paid or unpaid workers, including employees, independent contractors, and sole proprietors who provide services to a client or customer. A challenge on that basis could lead to changes to the rule, including introduction of a safe harbor for certain highly specialized employees and senior executives and providing more leeway for corporations. Note, however, that there is no indication of such a change at this time.

What is covered by the proposed rule? AKA, a noncompete by any other name would still smell as restrictive.

The breadth of the proposed rule is not just with regard to the type of employee; it extends to a wide array of types of agreements and contractual restrictions. The rule defines a noncompete 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.” Accordingly, the proposed ban would capture, in addition to traditional noncompete agreements, any “de facto noncompete clause”³ that has the same functional effect as a noncompete. In the definitions section of the proposed rule, the FTC provides two non-exclusive examples of such de facto noncompete clauses: (1) NDAs so broadly drafted that they effectively preclude the employee from working in the same field following a termination of employment and (2) contractual terms requiring a worker to repay the employer for training costs if the worker’s employment terminates within a specified time period where the required payment is not reasonably related to the costs the employer incurred for training the worker.⁴

What else could be caught up as a “de facto noncompete clause”? A deeper dive into decisions relating to far-reaching NDAs (and similar agreements) in jurisdictions with a history of disfavoring or banning noncompetes provides additional, potential guidance.

• California courts have found that, when using an excessively broad definition of confidential information, an NDA should be deemed equivalent to a voidable noncompete. One court found that, by including in the definition of confidential information all information that is “usable in” or that “relates to” the industry of the employer, the company in effect barred the employee in perpetuity from doing any work in the relevant field.⁵
• Proprietary information and inventions agreements (PIIAs), which typically include covenants restricting the use and transfer of sensitive and proprietary information, have undergone a similar type of functional scrutiny in California, and have been found unlawful in certain instances, particularly when they extend post-employment.⁶
• Broad provisions around acquired knowledge have fared similarly. The First Circuit stated that an employer's interest “does not extend to prohibiting the employee from using general knowledge acquired by the employee,” and the circumstance alone that such knowledge and skill were developed during employment does not constitute adequate support for a restrictive covenant.⁷

What should your business do for now?

The FTC’s new rule, the express inclusion of NDAs, and the implied (eventual?) inclusion of PIIAs, poses an immediate question for IT and life sciences companies who have long-used broad NDAs and PIIAs in an effort to protect corporate intellectual property—how does your company pivot its IP protection practices to align with the changing regulatory landscape?

Looking at the FTC’s rule, commentary, and relevant caselaw, the beginnings of a well-thought-out strategy can take shape during this interim comment and challenge period. In lieu of issuing direct noncompete agreements and provisions, or overbroad NDAs and PIIAs, consider the following for your company:

• Have in place comprehensive and enforceable protections, such as internal policies and accurately drafted assignment agreements ensuring corporate ownership of developed IP;
• Deploy NDAs and PIIAs that contain only such restrictive covenants necessary to protect legitimate and specific business interests (and avoid IP assignment provisions that extend past the term of employment);
• Avoid unnecessarily broad clauses in agreements with employees that aim to capture more than what could be arguably described as their specific material interest; and
• Avoid relying on the belief that courts, if called to interpret and enforce those clauses, will reform any overbroad covenant to render it reasonable. As recent decisions have shown,⁸ companies that engage in such far-reaching protection could end up with nothing (rather than a scaled down version of the original covenant), should a court take the position that revising an overbroad covenant might be contrary to public policy.

For additional information on the proposed rule, please see our recent Advisory, available here. 

© Arnold & Porter Kaye Scholer LLP 2023 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.