FTC Takes Legal Action Against Employee Noncompete Agreements; Issues Three Complaints and Proposed Ban

The Federal Trade Commission announced on January 4, 2023, that it has issued complaints against three separate companies for violations of Section 5 of the Federal Trade Commission Act because of noncompete provisions in contracts with their respective employees. These are the first actions since the FTC issued their new Section 5 Policy Statement, which promised more enforcement against “unfair methods of competition.” These are also the first complaints by the FTC challenging employer-employee noncompete agreements outside of the merger context since President Biden issued his July 2021 Executive Order urging the FTC to curtail the use of such agreements. The decision to issue the complaints, and subsequent consent orders, was not unanimous. The three Democratic Commissioners voted in favor; Republican Commissioner Christine Wilson opposed the complaints and issued dissenting statements.

On the heels of that announcement, the FTC proposed a new rule on January 5 that would prohibit employers from imposing noncompete agreements on employees. The basis for the proposed rule, according to the FTC, is that noncompete agreements are an unfair method of competition and therefore violate Section 5 of the FTC Act. As with the complaints the previous day, the vote to publish the proposed new rule broke on party lines, with the three Democratic Commissioners in favor and Commissioner Wilson opposing.

Noncompete Challenges

The complaints focused on noncompete agreements that employees at a variety of levels in the three companies were “forced” to sign, and that prohibited the employees from working for competing companies or performing similar services for two years after employment. In one instance, there was a liquidated damages clause of $100,000 for a breach of the noncompete.

The FTC alleges these post-employment restrictions violated Section 5 as an unfair method of competition. While the complaints certainly send a message to employers, and back up the FTC’s statement that it will more vigorously enforce Section 5, the complaints are thin on alleging actual anticompetitive conduct and the effects from that conduct.

Across all the complaints, only one, against Prudential, alleges more than bare-bones facts. That complaint points to two examples of efforts to enforce the noncompete provisions against employees.¹ The other two complaints, on the other hand, allege no specific facts other than the existence of the noncompete agreements.²

Remarkably, the complaints focus on the harm to the employees, and all but ignores anticompetitive effects in any relevant market of these noncompete agreements. In line with the approach that the FTC laid out in its Section 5 Policy Statement, the complaints do not allege a relevant market or effects in that relevant market, which is traditionally how government and private plaintiffs allege the competitive harm of any particular conduct. The complaints also summarily state that there were less restrictive means of protecting legitimate business interests, such as with confidentiality agreements.

If accepted, the proposed consent orders will be in effect for 20 years and require that all existing noncompete agreements be voided and notice given to affected employees – all 600 plus categories – accordingly. The proposed consent orders also prohibit any new noncompete agreements for new hires.

New Proposed Rule

In addition to the three administrative complaints, the FTC is seeking to wholesale curtail noncompetes through rulemaking for those entities covered by the FTC Act.³ If enacted, the new proposed rule would ban essentially all noncompete agreements between an employer and employee that prohibit employees from seeking work with any other employer after the conclusion of the worker’s employment with the employer.⁴ Noncompete agreements, according to the rule, include de facto provisions that would affect an employee’s ability to find another job, such as a nondisclosure agreement “that is written so broadly that it effectively precludes the worker from working in the same field” and liquidated damages clauses that “require the worker to pay . . . 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.”⁵

The new rule not only prohibits noncompete agreements going forward but also requires employers to rescind existing noncompete agreements within 180 days after the date of publication of the final rule.

There is only one exception explicitly included in the proposed rule: individuals who sell their business where the noncompete agreement is part of the acquisition terms. Importantly, this exception applies only to “substantial” owners or members of the business being sold, not to all employees of the acquired business. The NPRM explains, though, that the new rule, by its definitions, does not apply to agreements between franchisors and franchisees (but it does apply to the employees working at the franchisee’s establishment). Nor would it apply to noncompete or nonsolicit provisions in contracts between a company and a vendor (but it would apply to directly employed independent contractors). However, all of these scenarios are still subject to Federal antitrust law generally.

In the proposed rule, there are no exceptions for senior level employees or employees that have access to intellectual property or trade secret information. As the FTC states in the NPRM, the rule proposed would “categorically ban employers from using noncompete clauses with workers” and “prohibit an employer from using a noncompete clause with any of its workers, without regard to the worker’s earnings or job function.”

The FTC is accepting comments, including specifically on whether there should be a distinction or exception for senior-level or executive-level employees for the next 60 days. The NPRM does suggest an alternative drafting of the rule that would differentiate between workers earning above or below a certain threshold (though the threshold is not defined) or based on job function. The NPRM also suggests an alternative that the final rule adopt a rebuttable presumption of unlawfulness, rather than a categorical ban.

Takeaways

While the FTC and DOJ have been cracking down on employer to employer nonsolicit and noncompete agreements, these complaints and the proposed rule are the latest proof that the FTC will take an aggressive stance on enforcing Section 5 of the FTC Act and on protecting employees. Indeed, in a concurring statement to the complaints, Commissioner Khan states that companies that use “noncompetes to restrain workers and restrict competition” are now “on notice.”⁶ Rahul Rao, the recently appointed Deputy Director of the FTC’s Bureau of Competition, stated that the “FTC will continue to investigate . . . noncompete restrictions and other restrictive contractual terms that harm workers and competition.”⁷

It remains to be seen whether a court would agree with the FTC’s expansive view of Section 5 as applied to employer-employee noncompete agreements. Because the complaints ended with consent agreements, and were not litigated, the FTC’s theory has not been put to the test. As Commissioner Wilson points out in her dissents,⁸ the complaints are extremely light on facts and do not allege a relevant market needed to assess the anticompetitive effects of particular conduct. Unfortunately, merely going through an FTC investigation, even if there is ultimately no litigation, is costly and time consuming and the FTC is showing no signs of slowing down.

In the complaints and in the new proposed rule, the FTC is treating these noncompete provisions as per se illegal. So far, courts have rejected a per se standard for labor-related antitrust violations.⁹ And, as Commissioner Wilson raises, historically, antitrust cases related to noncompete provisions are intensely fact-specific; thus, the new proposed rule would ban noncompete agreements that courts have found enforceable. She warns that the new proposed rule will invite litigation – against the rule itself or when it is applied to future cases – that will take up time and resources from an already stretched FTC and jeopardize the enactment of any noncompete rule.

What Should Employers Do Now?

Companies should be on notice of the FTC’s aggressive posture. While there may be changes to the proposed rule, historically, proposed rules have been enacted in some form. Accordingly, if a final rule is enacted companies will need to evaluate their noncompete agreements and prepare to comply with this regulation – possibly in as little as 180 days from publication. Even if a rule on noncompetes is not enacted, the complaints show that the FTC will still challenge them on a case-by-case basis. Employers should inventory their restrictive covenants with current and former employees to be prepared if the proposed rule takes effect. Employers should also audit their practices as they relate to requiring employees to execute noncompete agreements and review existing noncompete agreements with an eye toward whether they protect a legitimate business interest. For example, companies should consider whether there are “less restrictive means” of protecting their trade secrets and intellectual property.

We will continue to monitor the latest developments. Should you have questions, please contact the authors or your Buchanan attorney.